Does interdependency affect firm and industry profitability? an empirical test

Strategy researchers have argued that heterogeneity in firms' practices and profitability within and across industries may derive from industry‐level differences in the extent of interdependencies among firms' activities. Theoretical models have clarified how and why differences in the extent of the interdependencies faced by firms across industries may affect the distributions of firm profits, but the specific predictions from these models have not been empirically tested. In this paper, we present what we believe is the first large scale empirical analysis linking differences in the extent of interdependencies across industries to differences in the distribution of firm profits within and across those industries. We use survey data to measure interdependencies systematically across a wide number of industries, thus addressing the primary obstacle to incorporating interdependencies in larger scale empirical work, and find evidence consistent with the theoretical predictions: average profitability is highest in industries with moderate levels of interdependency; the dispersion of profits among firms is higher in industries with more extensive interdependencies; and industries with more extensive interdependencies have a more positively skewed performance distribution. We find that the effect of interdependencies on average industry profitability is similar in scale to the effect of patent protection and industry growth rates, placing interdependency squarely among the strategy field's central concepts. Copyright © 2009 John Wiley & Sons, Ltd.     

Strategy,human capital investments,business‐domain capabilities,and performance: a study in the global software services industry

Research summary : In knowledge‐based industries, continuous human capital investments are essential for firms to enhance capabilities and sustain competitive advantage. However, such investments present a dilemma for firms, because human resources are mobile. Using detailed project‐level operational, financial, and human capital data from a leading multinational firm in the global IT services industry, this study finds that deliberate investments in improving general human capital can help firms develop superior capabilities and maintain high profits. This paper identifies two types of capabilities essential for success in this industry—technological and business‐domain capabilities—and provides empirical evidence justifying such investments. Theoretical and practical implications of capability‐seeking general human capital investments are discussed. Managerial summary : The primary managerial implication of this research is that capability‐seeking investments in developing general human capital through strategic learning (training and internal certifications) can enhance firm performance. Although investing in general human capital is risky, the firm considered this a strategic necessity in order to thrive in the fast paced IT services industry. By leveraging general technological skills in combination with business‐domain knowledge to address customer's business problems firms can earn and sustain higher profits. Our study also demonstrates how a developing‐country firm responded to strong competitive challenge from global rivals possessing superior capabilities by upgrading the capabilities of its employees through internal development. In doing so the firm was able to narrow the capability gap vis‐à‐vis its foreign peers and expand its business globally. Copyright © 2016 John Wiley & Sons, Ltd.     

Competitive heterogeneity,cohorts, and persistent advantage

Research summary: Juxtaposing competing theories of whether superior profits endure, this article investigates differences in the rates at which firms' profit advantages persist following a significant regulatory change in the rules governing industry competition. Such a change creates two cohorts of firms, Entrants that lack experience in the industry and Incumbents that competed in the industry before the regulatory shift. The findings show that both cohorts' profit advantages persist, but at different rates: Superior performing Incumbents sustain an advantage longer than superior performing Entrants. This result is counterintuitive since Entrants are not constrained by a legacy of competing under the prior regime. Overall, the findings indicate that stages of a firm's development and of an industry's evolution are critical to understanding how long superior profits persist. Managerial summary: State and federal institutions employ regulations in an attempt to address market failures and to create a stable set of market and nonmarket relationships among relevant actors. A byproduct of this stability is decreased competition, and in turn, reduced incentives for firms to develop efficient operations. One might expect then that deregulation would fundamentally disrupt incumbent firms' abilities to develop and sustain a profit advantage. We find the reverse: Over time, some firms in the Incumbent cohort develop persistent, albeit temporary, profit advantages despite an onslaught of Entrants. Thus, while deregulation shakes out inefficient firms, it may strengthen, rather than threaten the profit trajectories of incumbent firms over time. Advantages developed by superior performing Entrants also endure, but for a shorter duration relative to Incumbents. Copyright © 2015 John Wiley & Sons, Ltd.     

Equity‐based incentives and collaboration in the modern multibusiness firm

Research summary : This paper examines the role of equity‐based incentives in fostering cross‐business‐unit collaboration in multibusiness firms. We develop a formal agency model in which headquarters offers equity and profit incentives to business‐unit managers with the objective of maximizing total expected firm returns. The resulting compensation contract provides a rich mechanism for aggregating value from collaborative interactions across business units, aligning managers' efforts with the firm's growth prospects and organization structure and managing the dual risks in profits and firm market value. The inclusion of equity incentives elicits higher levels of own‐unit and collaborative efforts over the profits‐only contract. Our results suggest that equity‐based incentives are most beneficial when profitability is uncertain relative to long‐term growth prospects, in firms pursuing related diversification strategies, and in periods of rising equity markets. Managerial summary : Equity‐based compensation such as restricted stock grants and options are increasingly common, not only for CEOs and other top executives, but also for business unit managers and other non‐C‐suite employees. The paper studies the role of such “global” incentives in enabling multibusiness firms to benefit from cross‐unit collaboration. Results from our model show that managerial contracts that include appropriate levels of equity incentives, in addition to profit‐based incentives, generate higher own‐unit and collaborative efforts. We also find that equity incentives are likely to be most beneficial for large firms in high‐growth sectors, for firms pursuing a related diversification strategy, and in periods of rising stock markets. The model can also provide useful guidance on designing return‐maximizing compensation contracts for business unit managers in different firm, organizational, and industry contexts. Copyright © 2015 John Wiley & Sons, Ltd.     

OPEN VERSUS CLOSED FIRMS AND THE DYNAMICS OF INDUSTRY EVOLUTION*

We develop a model of industry evolution in which firms choose proprietary standards (closed firm) or adopt a common standard (open firm). A closed entrant can capture multiple profits whereas an open entrant faces lower entry barriers: The odds of closed entry (relative to open entry) decrease with price and eventually open entry becomes more likely. While initially closed firms have better survival because they can offset losses in one component with profits from another, the situation is reversed when prices fall below a threshold. These entry and exit dynamics can lead the industry away from its long run equilibrium.     

Opportunity costs,industry dynamics,and corporate diversification: Evidence from the cardiovascular medical device industry, 1976–2004

This paper examines how demand conditions across alternative markets impact diversification decisions and firm performance by influencing the opportunity costs of deploying non‐scale free capabilities. Using data within the cardiovascular medical device industry, this study shows that: (1) firms with a larger stock of pre‐entry innovation experience are more likely to diversify; (2) firms in a current market with greater relative demand maturity are more likely to diversify; (3) diversification is associated with a performance decrease in the current market; and (4) diversification is associated with a performance increase at the corporate level. These findings shed new light on the self‐selection process of corporate scope, the conceptualization of firm capabilities, and the connection between industry dynamics and resource deployment. Copyright © 2013 John Wiley & Sons, Ltd.     

Threat of falling high status and corporate bribery: Evidence from the revealed accounting records of two South Korean presidents

Research Summary: Social status and its dynamics may be an important predictor of which firms will engage in large‐scale bribery. Prior theory is incomplete, however, and prior studies have lacked comprehensive and reliable data on firm‐level bribery decisions. We offer a new theoretical prediction and a novel data set on high‐level corruption in South Korea, where the accounting records of two presidents in the 1987–1992 era were exposed to after‐the‐fact legal and public scrutiny. We find that, controlling for a range of alternative explanations, the threat of falling high status—that is, the combination of longstanding high social status with current‐period mediocre economic performance relative to that of industry peers—is a statistically and economically meaningful predictor of increases in the amount of large‐scale corporate bribery. Managerial Summary: What leads companies to engage in large‐scale bribery of senior politicians? Our concept of “threat of falling high status” refers to a circumstance where companies that have historically enjoyed high status through their owner families’ elite marriage networks experience mediocre economic performance relative to their peers. We show that this threat of falling high status is a notable determinant of large‐scale corporate bribery of senior politicians, using court data on corporate bribery of two South Korean presidents during 1987–1992. The implication of our study is twofold. Companies can strengthen internal control systems to avoid any large‐scale illegal activities at a higher level. Law enforcement agencies can also implement targeted monitoring programs to preempt illegal activities among companies facing the threat of falling high status.     

Why Do Firms Enter a New Product Market? A Two‐Dimensional Framework for Market Entry Motivation and Behavior

What are the energetic forces that induce established firms to enter new product markets? While most previous research has explained the economic profits expected from a new product market as firms' distinctive motivation for market entry, some recent studies also emphasize interfirm competition and benchmarking activities as another important factor that motivates firms' new market entry. To explain the established firms' diverse new product market entry behaviors, this study presents a two‐dimensional scheme of entry motivation in terms of the degrees of target market profit focus and competitor focus. The first dimension captures the economic motivation of firms' new market entry that ranges from focusing on the direct expected profits from the target market to considering more strategic/indirect benefit incentives. The second dimension captures the degree of firms' external motivation for entry affected by competitors that ranges from independent entry decisions to fully competitor‐oriented entry decisions. Using multiple‐industry survey data, the current study empirically verifies that these two entry motivation dimensions explain a great portion of actual firms' new product market entry behaviors and that they are independent of each other. Subsequently, this study validates that firms' operational size and their environmental factors like perceived technological uncertainty and competitive intensity upon new market entry affect the degrees of the two dimensions of firms' new product market entry motivation. More specifically, large firms less emphasize target‐market profits than small firms, and when perceived technological uncertainty is high, potential market entrants become less target market profit focused but more competitor focused. Under a highly competitive new market condition, firms focus on both target‐market profits and competitors. Based on the analysis of new market entry motivation dimensions, the current study proposes a new typology of established firms' market entry behaviors. The suggested typology represents the four different types of new product market entrants and examines specific characteristics and entry strategies for each type of potential entrants. This entry‐motivation framework should provide a deeper understanding of the backgrounds of entry behaviors and assist firms in developing appropriate entry strategies and in advantageously responding to rival firms' actions with regard to entry.     

Capabilities,technologies, and firm exit during industry shakeout: Evidence from the global solar photovoltaic industry

Research Summary: Explanations of entrants’ survival in an emerging industry are premised on pre‐entry capabilities or technology entry choices prior to the emergence of the dominant design. We consider how these drivers interact to strengthen or nullify firms’ pre‐entry advantage, and facilitate adaptation as the industry evolves. We also expand the treatment of exit by separating dissolution from acquisition, in which firms’ capabilities continue to be utilized in the industry. Studying a recent shakeout in the global solar photovoltaic industry, we find that pre‐entry capabilities and technology choices act in a complementary manner for some firms, thereby enhancing survival, and as buffers against exit for others. Nearly half of exits were via acquisitions, and technology choice at entry played an important role in determining how firms exited. Managerial Summary: New industries are often characterized by intense technology competition that culminates in a dominant technology followed by industry shakeout. Although prior research underscores the central role of technology choice and firm capabilities to survival, we do not actually know how firms with different capabilities and who have made competing technology choices survive an industry shakeout. In this article, we show how entrants’ capabilities and technology choices can act in a complementary manner for some firms, enhancing their chance of survival, and as buffers against failure for others. Moreover, we explain why some firms that do exit are acquired, when others are dissolved.     

Strategic factor markets,scale free resources,and economic performance: The impact of product market rivalry

This paper analyzes how scale free resources, which can be acquired by multiple firms simultaneously and deployed against one another in product market competition, will be priced in strategic factor markets, and what the consequences are for the acquiring firms' performance. Based on a game‐theoretic model, it shows how the impact of strategic factor markets on economic profits is influenced by product market rivalry, preexisting competitive (dis)advantages, and the interaction of acquired resources with those preexisting asymmetries. New insights include the result that resource suppliers will aim at (and largely succeed in) setting resource prices so that the acquiring firms earn negative strategic factor market profits—sacrificing some of their preexisting market power rents—by acquiring resources that they know to be overpriced. Copyright © 2014 John Wiley & Sons, Ltd.     

Interfirm differences in scale economies and the evolution of market shares

Evolutionary and resource‐based theories imply that firms in an industry with different resources and capabilities may differ in critical characteristics of their production functions, such as economies of scale. This paper measures these inter‐firm differences in economies of scale and examines how they affect the subsequent evolution of the market share distribution in the money market mutual fund industry. The findings indicate that fund families with larger marginal benefits to increasing their scale do subsequently gain market share at the expense of their rivals, but that this effect diminishes as the fund family ages, perhaps as a consequence of imitation. Copyright © 1999 John Wiley & Sons, Ltd.     

Corporate reputation and sustained superior financial performance

Good corporate reputations are critical because of their potential for value creation, but also because their intangible character makes replication by competing firms considerably more difficult. Existing empirical research confirms that there is a positive relationship between reputation and financial performance. This paper complements these findings by showing that firms with relatively good reputations are better able to sustain superior profit outcomes over time. In particular, we undertake an analysis of the relationship between corporate reputation and the dynamics of financial performance using two complementary dynamic models. We also decompose overall reputation into a component that is predicted by previous financial performance, and that which is ‘left over’, and find that each (orthogonal) element supports the persistence of above‐average profits over time. Copyright © 2002 John Wiley & Sons, Ltd.     

A new methodology linking concentration dynamics to current and steady-state profits:Examining Korean industrial policy during take-off

We model the dynamics of industrial structure and market power using Korean manufacturing data during the take-off period (1978–82). Structure–Conduct–Performance [SCP] methodologies have been criticized for using accounting data and because a few superior firms may have greater shares and greater profits. Both are argued to present possible spurious correlations between concentration and profits. This paper follows earlier work which shows that market structure responds to observed accounting profits as if these were accurate indices of real profits, and not as if leading firms are perceived to have unmatchable advantages. The methodological contribution of this model is a new latent variable for steady-state profits derived from the speed of structural adjustment. Long run profits are identified by the hypothesis that structural adjustment will be more rapid when industries are farther from steady-state levels. We analyze the long run profits latent variable, finding strong support for this hypothesis. The speed of adjustment is greater for positive and negative deviations from steady-state structure. We show that the profits and structural adjustment relationship is non-monotone. The SCP criticisms above are based on spurious correlations which are monotone in profits and structure. Positing spurious correlations which are at the same time monotone in structure and non-monotone in structural adjustment seems less plausible than accepting the SCP results which are consistent with both. Our analysis also is new in that it is the first direct econometric analysis of Korean industrial policy during its take-off years. We note that in Korea, unlike elsewhere, Industrial Policy was hypothesized to lead to concentration and market power in the popular press and by professional economists. Ours is the first direct econometric analysis of this hypothesis, and we find it supported.     

From core to periphery and back: A study on the deliberate shaping of knowledge flows in interfirm dyads and networks

We study 892 Italian motorcycle industry projects carried out via 184 different buyer–supplier and supplier‐supplier relationships to provide evidence on the knowledge dynamics occurring in dyads and networks and to understand the underexplored but important (perhaps even dominant) leading role that some firms play in the evolution of networks and interfirm learning processes. We develop a multiphase model which, from a multilevel perspective addressing different relational subsets, suggests how firms can best organize to generate and exchange knowledge efficiently. We argue that extant theoretical perspectives can profitably draw on our findings to strengthen their dynamic components and help them explain the widely diffused ‘exploring through partner’ strategies more effectively. Copyright © 2013 John Wiley & Sons, Ltd.     

MARKET COMPETITION,R&D AND FIRM PROFITS IN ASYMMETRIC OLIGOPOLY*

We investigate a Cournot model with strategic R&D investments wherein efficient low‐cost firms compete against less efficient high‐cost firms. We find that an increase in the number of high‐cost firms can stimulate R&D by the low‐cost firms, while it always reduces R&D by the high‐cost firms. More importantly, this force can be strong enough to compensate for the loss that arises from more intense market competition: the low‐cost firms' profits may indeed increase with the number of high‐cost firms. An implication of this result is far‐reaching, as it gives low‐cost firms an incentive to help, rather than harm, high‐cost competitors. We relate this implication to a practice known as open knowledge disclosure, especially Ford's strategy of disclosing its know‐how publicly and extensively at the beginning of the 20th century.     

The persistence of abnormal returns at industry and firm levels: Evidence from Spain

We apply structural equation models to longitudinal data on profits of firms within industries to study the persistence of abnormal returns. We obtain a two‐way variance decomposition for abnormal returns: at firm vs. industry levels, and at permanent vs. transitory components. This decomposition enables us to assess the relative importance of the fundamental components of abnormal returns discussed in the literature. The method is applied to a panel of 5,000 Spanish firms observed over the period 1995–2000. We conclude that: (a) there are significant and permanent differences between profit rates at both industry and firm levels; (b) variation of abnormal returns at firm level is greater than at industry level; and (c) firm and industry levels do not differ significantly regarding rates of convergence of abnormal returns. Copyright © 2007 John Wiley & Sons, Ltd.     

R&D investment dynamics in agglomerations under weak appropriability regimes: Evidence from Indian R&D labs

What are the dynamics of R&D investment when firms agglomerate in environments with weak intellectual property rights protection? Specifically, do foreign and domestic firms present equal opportunities for free riding by domestic firms in such environments? We examine the impact on local firms' R&D investment from knowledge spillovers originating from co‐located foreign and domestic firms within and across industries. Building on fieldwork in India, we predict free riding by local firms on nearby foreign and local firms. Furthermore, we expect local firms to free ride more from other local firms within their industry and from foreign firms across industries. Analyzing a sample of 3,475 R&D lab investment decisions during 2003–2010 in India, we find that local firms free ride from other local firms both within and across industries. Copyright © 2014 John Wiley & Sons, Ltd.     

Exploring firm characteristics that differentiate leaders from followers in industry merger waves: a competitive dynamics perspective

Research in strategic management has shown that the timing of firm participation in a merger wave matters, as early movers have been shown to outperform later ones. However, while the consequences of the timing of action within a merger wave have been assessed, the causes that drive these timing effects remain unknown. We draw on the competitive dynamics perspective to investigate firm‐level factors that influence the large‐scale strategic behavior of leading or following within industry merger waves. We develop hypotheses based on the competitive dynamics argument that the awareness‐motivation‐capability of firms will influence the timing of competitive action. Consistent with this perspective, we show that a firm's strategic orientation, its structure, and its resource base influence the timing of firm entry in merger waves. Copyright © 2012 John Wiley & Sons, Ltd.     

Stepping across for social approval: Ties to independent foundations' boards after financial restatement

Research Summary: Integrating research on independent philanthropy and organizational misconduct, we argue that affiliations with independent foundations provide social approval benefits for firms that restate their financials. We use a panel of S&P 500 companies from 2004 to 2011 to investigate the addition of foundation board ties by restating firms. CEOs of restating firms add more new foundation board ties than CEOs of non‐restating firms, while existing corporate philanthropy and greater corporate reputation diminish this effect. We also find that new ties to foundations boards influences media tenor for restating firms more than it does for non‐restating peers. Our study offers a nuanced analysis of the post‐crisis actions of restating firms relative to non‐restating peers and highlights the relevance of ties to nonprofit boards for corporate governance. Managerial Summary: Firms oftentimes fire their top executives in the aftermath of misconduct, but such response is itself disruptive for the firm's operations. Instead, we suggest that forging ties to independent foundations can help firms in such contexts without unsettling effects. Our results show that, after a restatement event, CEOs of misconduct firms are especially likely to join new foundation boards as trustees and thus seem to be aware of the benefits of these associations. CEOs from firms with existing in‐house philanthropy or a high reputation do not join as many new foundations' boards of trustees. We also find that new firm‐foundation links are promptly and positively evaluated by the media, thus helping misconduct firms regain social approval.