Description
During this such a data relating to business transformation in heterogeneous environments the impact of market development.
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BUSINESS TRANSFORMATION IN HETEROGENEOUS ENVIRONMENTS:
THE IMPACT OF MARKET DEVELOPMENT AND FIRM STRENGTH ON GROWTH
AND RETRENCHMENT RECONFIGURATION
Abhirup Chakrabarti
Desautels Faculty of Management
McGill University
1001 Sherbrooke Street West
Montreal, Quebec H3A1G5, Canada
Tel: +1-514-398-4007
Fax: +1-514-398-3896
Email: [email protected]
Elena Vidal
Fuqua School of Business
Duke University
1 Towerview Dr. Box 90120
Durham, NC 27708, USA
Tel: +1-919-768-2700
Email: [email protected]
Will Mitchell
Fuqua School of Business
Duke University
Durham, NC 27708, USA
Tel: +1-919-660-7994
Fax: +1-919-681-2818
Email: [email protected]
Version 2G - 29 April 2010
Keywords: Growth, acquisitions, divestiture, asset reconfiguration, institutional environment
1
BUSINESS TRANSFORMATION IN HETEROGENEOUS ENVIRONMENTS:
THE IMPACT OF MARKET DEVELOPMENT AND FIRM STRENGTH ON GROWTH
AND RETRENCHMENT RECONFIGURATION
Abhirup Chakrabarti, McGill University
Elena Vidal and Will Mitchell, Duke University
ABSTRACT
Asset reconfiguration activities – including business acquisitions, internal growth, and asset
divestitures – are important mechanisms for business transformation. While studies of firms
operating in developed markets have explored the incidence and performance impact of asset
reconfiguration, reconfiguration remains poorly understood in the context of developing markets,
in which firms formulate and implement strategy with limited market infrastructure. This study
argues that weaker market infrastructure inhibits resource reconfiguration, constraining the
ability of weak firms to retrench and of strong firms to grow. In turn, we argue that market
development increases reconfiguration activities while enhancing the benefits of adding assets
but limiting benefits from divesting assets. We examine the extent and impact of reconfiguration
activity in the context of 1,256 publicly traded firms based in eight South East Asian countries –
Hong Kong, Indonesia, Korea, Malaysia, the Philippines, Singapore, Taiwan, and Thailand –
from 1990 to 1999.
2
Asset reconfiguration activities, including business acquisitions, internal investments, and
asset divestitures, are important means for businesses to transform their resources in competitive
environments. An established literature has demonstrated that the various forms of asset
reconfiguration influence firm performance (Capron, 1999; Karim & Mitchell, 2000, 2004;
Moliterno & Wiersema, 2007). The studies show that the motivation to reconfigure a firm’s
resource base can come from two sources: financial distress, where struggling firms face
pressure to reconfigure resources in attempts to increase their operating efficiency (Bibeault,
1982; Robbins & Pearce, 1992), and financial strength, where strong firms proactively
reconfigure resources to improve their competitive position (Flickinger, 2009; Hopkins, 1991;
Montgomery & Thomas, 1988). To date, though, studies primarily focus on firms operating in
countries with well-established market infrastructure, without considering how market
development itself affects both firms’ ability to undertake different forms of resource
reconfiguration and how reconfiguration affects firm performance in different environments.
This study argues that stronger market infrastructure facilitates resource reconfiguration, helping
weak firms to retrench and strong firms to grow, and in turn, that market development enhances
the benefits of adding assets but limits the benefits of divesting assets.
We frame the study by drawing on studies of asset reconfiguration, especially the
resource-based and dynamic capabilities theories of business strategy (Helfat et al., 2007;
Penrose, 1959; Wernerfelt, 1984), and on studies of institutional development (Khanna &
Palepu, 1999; North, 1990). Reconfiguration is an important aspect of resource development.
Resources are tangible and intangible productive factors that provide the basis for firm-level
competitive advantage and superior returns (Barney, 1986; Wernerfelt, 1984). Resources are
valuable when they are unique, durable, difficult to trade, and inimitable (Barney, 1986;
3
Wernerfelt, 1984), as long as firms apply them appropriately in the context of their market
environments (Andrews, 1971; Grant, 1991). Dynamically, though, firms can sustain value only
when they regularly reconfigure their existing resource base (Amit & Shoemaker, 1993; Capron,
Dussuage, & Mitchell, 1998b; Dierickx & Cool, 1989). In order to stay competitive or recover
from difficult positions, firms often need to obtain new resources (Caves, 1982; Teece, 1982),
employ existing resources in new business applications (Penrose, 1959), and eliminate under-
performing assets (Capron, Mitchell, & Swaminathan, 2001). Building on the traditional
approach to reconfiguration, we distinguish between growth and retrenchment reconfiguration.
We define growth reconfiguration as obtaining new assets via internal development and/or
external acquisition. In parallel, we define retrenchment reconfiguration as divesting assets. In
any given period, firms may focus on a particular form of reconfiguration or may undertake both
growth and retrenchment reconfiguration as complements. The core point is that the ability to
reconfigure resources is an important part of firm strategy.
The level of institutional development in an economy can directly affect firms’ incentives
and ability to undertake business activities such as growth and retrenchment reconfiguration, as
well as shape the benefits of the reconfiguration activities. Firms often face less competitive
pressure and incur higher transactions costs in markets that lack commercial infrastructure
(Granovetter, 1985; North, 1990: Nelson, 1995). Hence, greater market development will
encourage and facilitate reconfiguration (Khanna & Palepu, 1999). Moreover, market
development can interact with firm strength in shaping the two types of reconfiguration –
facilitating retrenchment reconfiguration by weak firms and growth reconfiguration by strong
firms. In turn, greater market development may shape the benefits of reconfiguration, enhancing
the benefits of growth reconfiguration while limiting benefits from retrenchment configuration.
4
We test and extend the arguments in the context of 1,256 publicly traded firms based in
eight South East Asian countries – Hong Kong, Indonesia, Korea, Malaysia, the Philippines,
Singapore, Taiwan, and Thailand – from 1990 to 1999. South East Asian firms have been active
in resource reconfiguration since at least the 1990s, exhibiting high growth rates (Wan & Yiu,
2009) and substantial performance disruption (Chakrabarti, Singh, & Mahmood, 2007). The
sample and period comprise countries at various stages of economic and institutional
development, allowing us to examine the extent and impact of retrenchment and growth
reconfiguration strategies in different environmental contexts. We examine both the absolute
magnitude of reconfiguration that the firms undertake (reconfiguration mass) and the distribution
of different types of reconfiguration (reconfiguration mode share). By examining questions about
reconfiguration mass, mode share, and subsequent performance, we seek to develop a better
understanding of how firms transform themselves in different environmental contexts.
BACKGROUND
Asset Reconfiguration
Growth and retrenchment are important elements in the organization change process,
improving firm performance if implemented successfully but disrupting performance if
implemented unsuccessfully. Acquisitions help firms develop new capabilities and obtain new
resources while preventing obsolescence and organizational inertia (Rosenkopf & Nerkar, 2001;
Vermeulen & Barkema, 2001). Acquiring firms can redeploy managerial and financial resources
to and from target firms (Capron, Dussauge, & Mitchell, 1998a), changing more extensively than
non-acquiring firms (Karim & Mitchell, 2000) and developing processes that facilitate future
expansion (Capron & Mitchell, 2007). However, lack of experience (Capron & Mitchell, 2008;
5
Haleblian & Finkelstein, 1999) or post-acquisition integration problems (Helfat et al., 2007) can
undermine the success of acquisition implementation.
Similarly, growth based on creating assets internally can add value or create
organizational problems. Internal growth allows firms to develop resources or skills while
exploiting and protecting their specific knowledge (Caves, 1974; Helfat, 1994). Given the
absence of post-expansion integration problems in internal growth, new routines are better
understood than those developed through acquisition-based growth (Karim & Mitchell, 2004).
Yet, firms implementing internal growth can be slow to change, risking conflict and stagnation
(Capron and Mitchell, 2009).
Asset divestiture is an important part of the reconfiguration process, allowing firms to
release financial and managerial resources. By divesting, firms can increase efficiency by
reducing excess capacity (Anand & Singh, 1997) and obtaining financial resources for
reinvestment in the organization (Brown, James, & Mooradian, 1994). Therefore, divestiture is
an important step in the reconfiguration process (Hoskisson, Johnson, & Moesel, 1994; Jensen &
Ruback, 1983). Divestiture is also associated with organizational decline, however, potentially
disrupting a firm’s existing activities and accelerating existing problems (Cameron, Whetten, &
Kim, 1987). In each case – acquisition, internal development, and divestiture – the presence or
lack of external market institutions will affect the balance of benefits and costs from the
reconfiguration activities.
Market Development
The institutional environment of the firm is characterized by formal and informal
constraints that structure human and economic interaction (Alston, Eggerston, & North, 1996;
North, 1990; Scott, 1995), with substantial influence on business strategy formation and
6
implementation (Hoskisson, Eden, Lau, & Wright, 2000; Leff, 1978). We define market
infrastructure as the availability of market-based socio-economic institutions that facilitate
commercial activity, such as labor markets (Nelson, 1995; Mahmood & Mitchell, 2004), capital
markets (Lerner, 2002), legal transparency (Djankov, La Porta, Lopex-De-Silanes, & Shleifer,
2003), and commercial value chains (Anand & Khanna, 2000). In turn, underdeveloped markets
are those with only a limited degree of market infrastructure.
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The extent of market infrastructure determines the opportunities, incentives, and
transactions costs of economic interactions (North, 1990). Recent studies have discussed how
firms differ in their strategy formation across environments characterized by strong and weak
market-based institutions, highlighting both the benefits and challenges for firms operating in
developing markets (Hoskisson et al., 2000). Studies show that firms devise structures and
strategies to fill institutional voids, deriving superior rents in the process (Khanna & Palepu,
1997; Kock & Guillen, 2001; Leff, 1978). At the same time, firms also experience greater stress
operating in environments that increase the difficulty of managing processes under conditions of
environmental uncertainty (Bruton, Ahlstrom, & Wan, 2003; Chakrabarti et al., 2007). In spite of
recent advances and the clear importance of market infrastructure (Shenkar & von Glinow, 1994),
there has been limited systematic analysis of the impact of institutional underdevelopment on
firm strategy and performance (Hoskisson et al., 2000; Singh, 2007).
Institutionally developing market environments are characterized by market failures that
impede the smooth functioning of commercial activities and increase the costs of transactions
(Choi, Lee, & Kim, 1999). Market underdevelopment hinders the flow of information, finance,
and human resources (Aldrich & Auster, 1986b; Tybout, 2000). Developing markets are
1
For simplicity, we refer to the polar cases of “underdeveloped” and “developed” markets, although we recognize
that the concept of market infrastructure falls on a continuum and will measure market development accordingly.
7
characterized by underdeveloped communications infrastructures that restrict the flow of
information. Firms in developing markets have inadequate financial reporting capabilities,
matching the low disclosure requirements by regulatory authorities and stock exchanges.
Financial intermediaries – including analysts, banks, venture capitalists, financial press, and
mutual funds – are weaker, restricting the flow of capital from savers to users (Levine & Zervos,
1998). In addition, institutionally developing environments are characterized by shortages of
general and financial management skills (Khanna & Palepu, 1997).
Public policy is another important aspect that distinguishes developed from developing
market environments (Henisz & Zellner, 2003). Governments in developing markets often
under-enforce laws, while governments in more developed markets display a greater
commitment to uphold laws. In underdeveloped markets, judicial systems are often inefficient,
implying weak and uncertain enforcement of laws and business contracts. Product markets in
such environments are characterized by limited enforcement of liability laws, little dissemination
of information, and few consumer activist organizations. Markets are highly directed by
governments, which often have substantial levels of corruption (Goldsmith, 1999) and tend to
prioritize political goals over economic goals. Such priorities can further distort the efficient
functioning of markets (Pfeffermann & Kisunko, 1999).
Prior research shows that strategy formulation and implementation differ across firms
operating in developing and developed markets. Firms in developing markets deal with
asymmetric information to a greater extent due to poor reporting standards and unmonitored
capital markets. The lack of financial intermediaries and poorly developed and unregulated
banking sectors imply limited availability of capital that might be crucial for reconfiguration
activities (Van Wijnbergen, 1997). Labor market conditions limit the availability of managerial
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talent and a flexible and skilled work force for firms (Filatotchev, Wright, & Bleaney, 1999). In
addition, firms deal with limited enforcement of laws, such as those involving intellectual
property rights (La Porta, Lopez-de-Silanes, Shleifer, & Visnhy, 1997; Litwack, 1991) and laws
that set irrational subsidies and price ceilings (Khanna & Palepu, 1997); the lack of enforcement
limits incentives to expand. In parallel, politically motivated and populist laws may forbid firms
to retrench. Market underdevelopment therefore creates a constrained environment for strategy
formulation and implementation.
A limited set of studies has explored this distinction. Some studies argue that mainstream
strategy provides limited insights into strategy in developing markets and that firms in
developing markets pursue distinct strategies not evident in developed market environments
(Khanna & Yafeh, 2007; Peng & Heath, 1996), such as the significant involvement of family
communities (Bruton et al., 2003) and business groups (Guillen, 2001; Khanna & Rivkin, 2001;
Peng & Heath, 1996). Other studies consider how strategies from developed markets extend to
developing markets (Khanna & Palepu, 1997), focusing on the importance of size and
diversification (Khanna & Rivkin, 2001) as well as access to non-market benefits (Henisz &
Zellner, 2003). In spite of recent advances, though, it is not clear to what extent strategy
formation and implementation generalizes across markets at different levels of development
(Hoskisson et al., 2000; Peng & Pleggenkuhle-Miles, 2009; Singh, 2007), and how firms evolve
with market and institutional development (Galvez & Tybout, 1985).
Asset reconfiguration, in particular, remains poorly understood in the context of
developing markets. The limited set of studies offers mixed arguments and limited evidence.
Some prior studies suggest that firms in developing markets might be able to generate rents by
reconfiguring and expanding their asset base (Khanna & Palepu, 1997). In contrast, other studies
9
suggest that firms face difficulties managing resource exchange processes in such environments
(Chakrabarti et al., 2007), such that market failure can increase the difficulty of asset
reconfiguration. Therefore, arguments that emphasize the value of size, diversification, and
access to non-market benefits in underdeveloped markets, are countered by arguments that
emphasize the difficulty of implementing reconfiguration in developing market environments.
We now turn to considering how market underdevelopment will influence the incidence of asset
reconfiguration and the performance benefits that stem from reconfiguration.
PROPOSITIONS
Proposition 1: Reconfiguration Activity
We consider how two factors – market development and firm strength – will affect
reconfiguration activity. By greater reconfiguration activity we mean greater addition or
divestiture of assets as a proportion of a firm’s assets at the beginning of a given period. We
expect lesser development of market infrastructure to deflate reconfiguration activity, both by
placing less competitive pressure on firms and by creating constraints on reconfiguration. Less
developed market environments tend to have fewer independent firms and greater reliance on
political connections (Granovetter, 1985); the lower competitiveness is the source of potential
rents from business expansion (Khanna & Palepu, 1997). However, that same lack of
competition means that firms will face less pressure to reconfigure. Hence, while firms in less
developed markets will have opportunities to add and divest assets, the pressure to do so will be
substantially less than in more developed markets with stronger competition.
Moreover, each type of reconfiguration will be more difficult in underdeveloped
environments. Internal development will face constraints due to lack of supporting resources. An
important prerequisite for successful internal development is the availability of complementary
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assets (Mitchell, 1989) and skilled personnel (Penrose, 1959), which are often scarce in less
developed markets (Peng & Heath, 1996; Puffer, 1992; Sharma, 1993). Business groups and
other established firms in less developed markets often develop internal talent markets to
overcome this barrier (Khanna & Palepu, 1997), but firms will still face barriers in obtaining
assets to complement internal development efforts.
Asset acquisitions and divestitures also face difficulties when commercial infrastructure
is weak. Acquiring firms generally manage valuation difficulties and opportunistic behavior by
contracting parties, which has the potential to reduce their ability to buy, sell, and license discrete
resources (Capron et al., 1998b). Such difficulties are particularly relevant when resources are
subject to asymmetric information (Arikan, 2005; Reuer & Ragozzino, 2008), and when patent
or other appropriability mechanisms are weak (Chi, 1994; Grossman & Hart, 1986; Rumelt, 1987;
Williamson, 1985). The potential for opportunism may lead to market failures in exchanging
discrete resources, whether by sale or by license (Caves, 1982; Rugman, 1981; Williamson,
1985). Resource scarcity, information asymmetries, and weak infrastructure constrain the sale
and purchase of organizational assets (Litwack, 1991), and hence the use of acquisition-based
growth as an expansion strategy in less developed markets (Peng & Heath, 1996).
In parallel, divestiture is also difficult in less developed markets. The limits to
commercial infrastructure such as lack of active financial markets and enforceable property
rights inhibit the ability secure the transfer of ownership across firms (Jensen & Ruback, 1983).
Firms operating in less developed markets will find it more costly to dispose their resources as
part of their retrenchment reconfiguration, owing to the higher transaction costs in those markets.
Moreover, incentives to dispose of unproductive assets will often be lower in underdeveloped
markets, in which political support can protect weak firms from competition. In turn, as markets
11
develop, benefits that derive from political support decline (Khanna & Palepu, 1999), increasing
the importance of retrenchment reconfiguration that helps firms improve operating efficiency.
These arguments lead to the first prediction, which we state as a general proposition.
Empirically, we will examine each element of reconfiguration.
Proposition 1a: The more developed the market infrastructure in a country, the more
actively that firms based in that country will undertake growth and/or retrenchment
reconfiguration during a given period.
We now consider how firm strength will influence the extent of reconfiguration. In
general, stronger firms are more likely to be active with growth reconfiguration and weaker firms
with retrenchment reconfiguration (Hofer, 1980; Pearce & Robbins, 1993; Schendel & Patton,
1976), although there are at least moderate countervailing pressures. Strong firms have more
resources and longer time horizons than struggling firms, which means that stronger firms have
the time and space to add new assets. Strong firms face less pressure to reconfigure, however, so
there is no assurance that they will take advantage of their opportunities. Struggling firms will
often need to sell assets, implying that they will tend to be more likely to undertake retrenchment
reconfiguration than stronger firms, although they may also be able to reinvest their financial
gains in developing new resources and/or purchasing external assets in search of new sources of
profitability. Although there is some ambiguity about how profitability directly affects
reconfiguration activity, the more interesting question is whether market development will shape
the way that firm strength affects reconfiguration.
We expect weak firms to become disproportionately more active in retrenchment
reconfiguration as markets become increasingly developed. Struggling firms face strong
incentives to divest assets, in attempting to become more efficient and raise resources that will
allow them time to attempt to recover (Bibeault, 1982; Ketchen & Palmer, 1999; Robbins &
Pearce, 1992). As markets develop, the ubiquitous network and group-related resources such as
12
internal capital markets generally decline in value (Galvez & Tybout, 1985; Khanna & Palepu,
1999, 2000). Weaker firms are likely to develop stronger incentives to implement retrenchment
reconfiguration in an attempt to adapt to the environmental change, because they are affected to a
greater degree with the decline in the value of their existing resource base. In addition,
retrenchment reconfiguration becomes more feasible as markets develop and become more
competitive (DeWitt, 1998; Morrow, Johnson, & Busenitz, 2004). Weak firms operating in
developing market environments will face particularly strong barriers in the face of high
transaction costs that limit resale markets due to the time pressure that they face, their weak
bargaining positions, and their limited financial resources. With market development, therefore,
retrenchment becomes critical, but also feasible for weaker firms, increasing their ability to
undertake retrenchment reconfiguration.
Proposition 1b: The more developed the market infrastructure in a country, the more
actively that weaker firms based in that country will undertake retrenchment
reconfiguration during a given period.
In parallel, we expect stronger firms to become disproportionately active in growth
reconfiguration as markets become more developed. If firms operating in less developed
environments possess resources that have limited value in developed environments (Galvez &
Tybout, 1985), resource acquisition by individual firms will also increase in importance as
markets develop. For example, network and group structures allow developing market firms to
combine labor, capital, technology, and market distribution resources (Guillen, 2001). Network
and group structures lose value with market development (Khanna & Palepu, 1999), implying
that individual firms need to acquire such resources in order to compete as markets develop
(Hoskisson et al., 2000). Strong firms have more resources with which to pursue growth
reconfiguration by developing new assets internally and acquiring assets from other firms.
Strong firms in developed markets have strong incentives to seek to undertake expansion
13
because of the higher levels of competition in those environments. Market development
facilitates expansion by reducing the barriers to transactions that the firms need to undertake the
growth activities. Therefore, the combination of greater ease of buying and selling assets and
greater need to become competitive in developed markets leads to the next general proposition.
We state this core logic as a general proposition; we will examine both internal development and
acquisition-based growth reconfiguration in the analysis.
Proposition 1c: The more developed the market infrastructure in a country, the more
actively that stronger firms based in that country will undertake growth reconfiguration
during a given period.
Proposition 2: Performance Following Reconfiguration
A substantive literature has established the performance impact of retrenchment and
growth reconfiguration in developed market environments, recognizing the value as well as the
limits of these strategies. Retrenchment reconfiguration increases profitability as firms eliminate
underperforming assets and achieve financial stability (Pearce & Robbins, 1994), while
potentially disrupting the firm’s existing organization leading to degenerative outcomes
(Cameron et al., 1987). Growth reconfiguration helps firms obtain new resources (Capron et al.,
1998a), while potentially leading to post-expansion problems that undermine the expected gains
from expansion (Capron et al., 2001). Notwithstanding the varying effects of these strategies, a
stream of research exploring turnaround in organizations has established the value of these
strategies when applied appropriately to the context of organizational transformation (Pearce &
Robbins, 1993). Active growth reconfiguration is an important aspect of firm response to
competitive challenges in developed market environments, allowing firms to change and adapt to
external conditions, as well as to develop processes that facilitate future expansion (Capron &
Mitchell, 2007). An intriguing question, however, is whether the growth and retrenchment
14
reconfiguration strategies have disproportionate impacts at different stages of market
development.
We expect growth reconfiguration to have stronger benefits in more developed markets
than in less developed markets. Growth reconfiguration involves multiple activities that incur
transaction costs. Growing firms identify feasible acquisition targets or greenfield investment
opportunities, integrate new resources with existing resources, create markets for new products,
produce and distribute additional output, and synchronize the new activities with existing
corporate strategy, all of which engender costs to growth (Marris, 1963; Penrose, 1959; Slater,
1979). For acquisition activities to be rewarding, firms require adequately regulated financial
markets to facilitate information flows, adequate and capable managerial resources to drive post-
expansion management, and well-enforced property rights to lower the problems associated with
transfer of ownership. Developing markets, which lack institutions facilitating these activities,
will therefore constrain and increase the cost of activities and reduce the profitability of growth
reconfiguration.
Proposition 2a: The more developed the market infrastructure in a country, the greater
the performance benefits of growth reconfiguration during a given period.
In contrast, we expect retrenchment reconfiguration to have fewer performance benefits
in more developed markets. Retrenching firms face two challenges that disrupt performance in
developed markets, which are characterized by higher levels of competition. First, retrenching
firms become smaller and are consequently left with diminished competitive ability. Smaller
firms have smaller market shares in input and output markets (Barnett & Amburgey, 1990), are
less able to under-price competitors, and are less able to engage in competitive behavior such as
enduring losses to out-compete other firms (Aldrich & Auster, 1986a). Second, retrenching firms
have to overcome greater constraints to subsequently grow and recover. Given the limited span
15
and scope of activities, small firms may not have access to adequate information that will allow
them to locate and choose targets best suited to their objectives, and may not be able to
implement the extent of expansion that is necessary to obtain the lower costs of large-scale
operations (Penrose, 1959). In addition, firms that implement retrenchment reconfiguration may
lack the internal resources and capabilities necessary to successfully integrate new assets.
Without such integration, the new assets may conflict with each other and with existing assets,
leading to performance decline rather than performance improvement (e.g. Chakrabarti &
Mitchell, 2005; Haspeslagh & Jemison, 1991; Zollo & Singh, 2004).
Proposition 2b: The more developed the market infrastructure in a country, the less the
performance benefits of retrenchment reconfiguration during a given period.
In sum, we argue that market development will shape the extent to which firms
reconfigure their resources and, in turn, benefit from their reconfiguration activities. Greater
market development will facilitate reconfiguration (P1a), with weak firms being likely to take
advantages of increasing ease of retrenchment reconfiguration (P1b) and strong firms best able to
take advantages of increasing opportunities for growth reconfiguration (P1c). Firms will gain
greater benefits from growth reconfiguration in developed markets (P2a), but market
development will deflate the benefits of retrenchment reconfiguration (P2b).
DATA
We analyze firms operating in the manufacturing sector in eight countries of East and
South Asia during the period of 1990 to 1999: Hong Kong, Indonesia, Malaysia, the Philippines,
Singapore, South Korea, Taiwan, and Thailand. Our sample consists of 1,256 publicly traded
firms.
2
We obtained data about the firms and countries from multiple sources. The Worldscope
2
Distribution: Malaysia (23% of unique firms, 25% of firm-years), Korea (17%, 16%), Hong Kong (14%, 13%),
Taiwan (14%, 12%), Singapore (10%, 10%), Thailand (10%, 12%), Indonesia (8%, 8%), Philippines (3%, 3%). We
16
Global Research database provided firm-level financial and business segment information. The
Economist Intelligence Unit Country Data and the Country Indicators databases provided macro-
economy data for the countries in our sample.
Primary Variables
We measured asset reconfiguration for any given firm in a given year based on data
reported in the Worldscope Database. We used two approaches for operationalizing
reconfiguration. First, a set of “reconfiguration mass” variables measures the absolute degree of
each type of asset change that firms undertake in a year, as a proportion of each firm’s total
assets. Second, a set of “mode share” variables measures the share of each type of
reconfiguration (external growth, internal development, divestiture) within total reconfiguration
activities that the firm undertook during the year.
The reconfiguration mass measures are the primary variables for the study because they
address how actively the firms seek to change their current businesses. We defined the mass of
reconfiguration in a given year as a proportion of total firm assets (A
0
) at the end of the prior
year. External growth reconfiguration is net assets from acquisitions in any given year (E
1
) as a
proportion of total assets (E
1
/A
0
). Internal development reconfiguration is total growth minus
the net assets from acquisitions (I
1
) in any given year over the total assets (I
1
/A
0
). Growth
reconfiguration (GR
1
) is the sum of external growth and internal development over total assets
([E
1
+I
1
]/A
0
=GR
1
/A
0
). Asset divestiture, which is the equivalent of Retrenchment reconfiguration
(RR
1
), is disposal of fixed assets over total assets (D
1
/A
0
). We were able to obtain all four
reconfiguration variables (GR
1
, E
1
, I
1
, RR
1
) for four of the eight countries (Hong Kong,
Indonesia, Malaysia, and Singapore). For the other four countries (South Korea, the Philippines,
also collected data on 1,900 firms based in Japan, which we excluded so that the country would not swamp the
results (sensitivity analysis that included the Japanese companies found similar results).
17
Taiwan, and Thailand,), we obtained only divestiture (RR
1
) and total growth reconfiguration
(GR
1
), while being unable to separate GR
1
into its E
1
and I
1
components. Therefore, the analysis
includes subsamples in addition to the full models.
The mode share measures provide a complementary approach that addresses where the
firms focus their reconfiguration attention. Total reconfiguration (R
1
) is the sum of growth
reconfiguration and retrenchment reconfiguration (R
1
=GR
1
+RR
1
). External growth mode share
is net assets from acquisitions over total asset reconfiguration (E
1
/R
1
). Internal development
mode share is net assets from internal development over total asset reconfiguration (I
1
/R
1
).
Growth reconfiguration mode share is external growth plus internal development over total
reconfiguration (GR
1
/R
1
). Asset divestiture mode share is disposal of fixed assets over the total
assets total asset reconfiguration (RR
1
/R
1
).
We used profitability based on return on assets (ROA) for the performance variables.
Firm strength is the return on assets for the previous year of the study period (ROA
0
).
Performance benefit is the return on assets in each year of the study period (ROA
1
). ROA is a
suitable performance measure because it records the degree to which a firm was able to generate
profits from the resources in which it had invested. In our sample, ROA had a correlation of 0.9
with the earnings before interest and taxes (EBIT). We do not use stock market measures of
performance because financial markets in emerging markets often exhibit substantial
inefficiencies, so that changes in stock market valuations may not reflect changes in the
underlying asset-based performance level of the firm. We measured firm performance at the end
of the year during which growth occurred. Conceptually, this time structure assumes that
reconfiguration has a rapid impact. Empirically, the structure helps reduce more complicated
alternative causes that might occur during longer periods after the reconfiguration year.
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We derived the measure of Market development from the EIU Country Indicators
Database, which reports on political, institutional, and regulatory aspects of the countries in the
study. We calculated a simple average of seven EIU ratings: Overall business environment;
Infrastructure (telecoms, transport, energy, and office space measures); Labor market
(availability of skilled labor, incidence of strikes); Political environment (political stability,
institutional effectiveness); Policy towards private enterprise (protection of property rights,
government attitude towards competition); Financing (extent of distortions in financial markets,
openness of banks); and Political environment for foreign investment (government policy, risk of
expropriation). Each of the seven ratings derives from a scale of 1 (bad/low) to 10 (good/high).
With this measure, Hong Kong had the highest institutional development scale, followed by
Singapore, Taiwan, Malaysia, South Korea, Thailand, Indonesia, and the Philippines.
3
Table 1
compares the measure of market development to seven other market orientation measures. The
table shows only minor variations in the rank order of the rating of institutional environments
across the countries and there are high correlations among the measures (the mean correlation of
the Market development variable with the other seven indices is r=0.87).
***** Table 1 about here *****
Control Variables
We operationalized control variables for diversification, international operations, current
ratio, business groups, calendar years, and industry effects. Diversification used an entropy
measure (Jacquemin & Berry, 1979; Palepu, 1985; Raghunathan, 1995). Entropy is:
3
The World Business Environment Survey is a common index of country-specific institutional development, but
surveyed only five of the eight countries during the study period.
i
N
i
i
P
P E
1
ln
1
?
=
=
19
where P
i
is the share of the i
th
segment of the firm’s total sales (the entropy measure has a 0.98
correlation with the Hirshman Herfindahl Index measure of diversification). Worldscope reports
segment data only for 1994, so that the entropy variable is time constant. International
operations is a time-constant 0-1 dummy variable indicating whether a firm had operations
outside its home country during the period. Current ratio (current liabilities/total liabilities)
measured each firm’s short-term exposure in each year. Business group member is a time-
constant 0-1 dummy variable denoting whether a firm belonged to a group, because more
activity could be associated with firms that are a part of a conglomerate in the East Asian region.
We used dummy variables to control for Years, which helps pick up differences that might
reflect the Asian financial crisis of the late 1990s. We defined six 0-1 dummy variables based on
the Standard International Trade Classifications (SITC) to control for industry effects.
4
We also
measured firm size (log assets), but found that it correlated highly with the other control
variables, including firm strength, international operations, current ratio, business group member,
and diversification (the result were robust to including firm size). Table 2 summarizes the
descriptive statistics. The independent variables were largely independent of each other.
***** Table 2 about here *****
RESULTS
P1a and P1b: Reconfiguration Activity
We used linear regression with firm random effects to test the propositions.
5
Table 3
reports the tests of propositions 1a, 1b, and 1c, which focus on how market development shapes
the way that firm strength affects reconfiguration activity. Models 1 to 4 report reconfiguration
4
The six industrial sectors were (1) Drugs, cosmetics, and health; (2) End product heavy manufacturing; (3) End
product light manufacturing; (4) Intermediate products; (5) Raw materials, and (6) Other.
5
Firm fixed effects analysis is not possible because several of the variables are time invariant, including the market
development variable. A Hausman test based on models with time-varying variables that compared random to fixed
effects models was insignificant, suggesting the random effects approach is appropriate.
20
mass analyses for all eight countries. Models 5 and 6 then report reconfiguration mass results for
the four countries with distinct internal and external growth data. Model 7 reports
reconfiguration mode share results for the full sample, comparing the proportion of growth
reconfiguration relative to retrenchment reconfiguration.
***** Table 3 about here *****
The results support P1a in terms of retrenchment reconfiguration (RR) mass (models 1
and 2, p < 0.01), as well as growth reconfiguration (GR) mass (model 3, p < 0.05; model 4, p
During this such a data relating to business transformation in heterogeneous environments the impact of market development.
1
BUSINESS TRANSFORMATION IN HETEROGENEOUS ENVIRONMENTS:
THE IMPACT OF MARKET DEVELOPMENT AND FIRM STRENGTH ON GROWTH
AND RETRENCHMENT RECONFIGURATION
Abhirup Chakrabarti
Desautels Faculty of Management
McGill University
1001 Sherbrooke Street West
Montreal, Quebec H3A1G5, Canada
Tel: +1-514-398-4007
Fax: +1-514-398-3896
Email: [email protected]
Elena Vidal
Fuqua School of Business
Duke University
1 Towerview Dr. Box 90120
Durham, NC 27708, USA
Tel: +1-919-768-2700
Email: [email protected]
Will Mitchell
Fuqua School of Business
Duke University
Durham, NC 27708, USA
Tel: +1-919-660-7994
Fax: +1-919-681-2818
Email: [email protected]
Version 2G - 29 April 2010
Keywords: Growth, acquisitions, divestiture, asset reconfiguration, institutional environment
1
BUSINESS TRANSFORMATION IN HETEROGENEOUS ENVIRONMENTS:
THE IMPACT OF MARKET DEVELOPMENT AND FIRM STRENGTH ON GROWTH
AND RETRENCHMENT RECONFIGURATION
Abhirup Chakrabarti, McGill University
Elena Vidal and Will Mitchell, Duke University
ABSTRACT
Asset reconfiguration activities – including business acquisitions, internal growth, and asset
divestitures – are important mechanisms for business transformation. While studies of firms
operating in developed markets have explored the incidence and performance impact of asset
reconfiguration, reconfiguration remains poorly understood in the context of developing markets,
in which firms formulate and implement strategy with limited market infrastructure. This study
argues that weaker market infrastructure inhibits resource reconfiguration, constraining the
ability of weak firms to retrench and of strong firms to grow. In turn, we argue that market
development increases reconfiguration activities while enhancing the benefits of adding assets
but limiting benefits from divesting assets. We examine the extent and impact of reconfiguration
activity in the context of 1,256 publicly traded firms based in eight South East Asian countries –
Hong Kong, Indonesia, Korea, Malaysia, the Philippines, Singapore, Taiwan, and Thailand –
from 1990 to 1999.
2
Asset reconfiguration activities, including business acquisitions, internal investments, and
asset divestitures, are important means for businesses to transform their resources in competitive
environments. An established literature has demonstrated that the various forms of asset
reconfiguration influence firm performance (Capron, 1999; Karim & Mitchell, 2000, 2004;
Moliterno & Wiersema, 2007). The studies show that the motivation to reconfigure a firm’s
resource base can come from two sources: financial distress, where struggling firms face
pressure to reconfigure resources in attempts to increase their operating efficiency (Bibeault,
1982; Robbins & Pearce, 1992), and financial strength, where strong firms proactively
reconfigure resources to improve their competitive position (Flickinger, 2009; Hopkins, 1991;
Montgomery & Thomas, 1988). To date, though, studies primarily focus on firms operating in
countries with well-established market infrastructure, without considering how market
development itself affects both firms’ ability to undertake different forms of resource
reconfiguration and how reconfiguration affects firm performance in different environments.
This study argues that stronger market infrastructure facilitates resource reconfiguration, helping
weak firms to retrench and strong firms to grow, and in turn, that market development enhances
the benefits of adding assets but limits the benefits of divesting assets.
We frame the study by drawing on studies of asset reconfiguration, especially the
resource-based and dynamic capabilities theories of business strategy (Helfat et al., 2007;
Penrose, 1959; Wernerfelt, 1984), and on studies of institutional development (Khanna &
Palepu, 1999; North, 1990). Reconfiguration is an important aspect of resource development.
Resources are tangible and intangible productive factors that provide the basis for firm-level
competitive advantage and superior returns (Barney, 1986; Wernerfelt, 1984). Resources are
valuable when they are unique, durable, difficult to trade, and inimitable (Barney, 1986;
3
Wernerfelt, 1984), as long as firms apply them appropriately in the context of their market
environments (Andrews, 1971; Grant, 1991). Dynamically, though, firms can sustain value only
when they regularly reconfigure their existing resource base (Amit & Shoemaker, 1993; Capron,
Dussuage, & Mitchell, 1998b; Dierickx & Cool, 1989). In order to stay competitive or recover
from difficult positions, firms often need to obtain new resources (Caves, 1982; Teece, 1982),
employ existing resources in new business applications (Penrose, 1959), and eliminate under-
performing assets (Capron, Mitchell, & Swaminathan, 2001). Building on the traditional
approach to reconfiguration, we distinguish between growth and retrenchment reconfiguration.
We define growth reconfiguration as obtaining new assets via internal development and/or
external acquisition. In parallel, we define retrenchment reconfiguration as divesting assets. In
any given period, firms may focus on a particular form of reconfiguration or may undertake both
growth and retrenchment reconfiguration as complements. The core point is that the ability to
reconfigure resources is an important part of firm strategy.
The level of institutional development in an economy can directly affect firms’ incentives
and ability to undertake business activities such as growth and retrenchment reconfiguration, as
well as shape the benefits of the reconfiguration activities. Firms often face less competitive
pressure and incur higher transactions costs in markets that lack commercial infrastructure
(Granovetter, 1985; North, 1990: Nelson, 1995). Hence, greater market development will
encourage and facilitate reconfiguration (Khanna & Palepu, 1999). Moreover, market
development can interact with firm strength in shaping the two types of reconfiguration –
facilitating retrenchment reconfiguration by weak firms and growth reconfiguration by strong
firms. In turn, greater market development may shape the benefits of reconfiguration, enhancing
the benefits of growth reconfiguration while limiting benefits from retrenchment configuration.
4
We test and extend the arguments in the context of 1,256 publicly traded firms based in
eight South East Asian countries – Hong Kong, Indonesia, Korea, Malaysia, the Philippines,
Singapore, Taiwan, and Thailand – from 1990 to 1999. South East Asian firms have been active
in resource reconfiguration since at least the 1990s, exhibiting high growth rates (Wan & Yiu,
2009) and substantial performance disruption (Chakrabarti, Singh, & Mahmood, 2007). The
sample and period comprise countries at various stages of economic and institutional
development, allowing us to examine the extent and impact of retrenchment and growth
reconfiguration strategies in different environmental contexts. We examine both the absolute
magnitude of reconfiguration that the firms undertake (reconfiguration mass) and the distribution
of different types of reconfiguration (reconfiguration mode share). By examining questions about
reconfiguration mass, mode share, and subsequent performance, we seek to develop a better
understanding of how firms transform themselves in different environmental contexts.
BACKGROUND
Asset Reconfiguration
Growth and retrenchment are important elements in the organization change process,
improving firm performance if implemented successfully but disrupting performance if
implemented unsuccessfully. Acquisitions help firms develop new capabilities and obtain new
resources while preventing obsolescence and organizational inertia (Rosenkopf & Nerkar, 2001;
Vermeulen & Barkema, 2001). Acquiring firms can redeploy managerial and financial resources
to and from target firms (Capron, Dussauge, & Mitchell, 1998a), changing more extensively than
non-acquiring firms (Karim & Mitchell, 2000) and developing processes that facilitate future
expansion (Capron & Mitchell, 2007). However, lack of experience (Capron & Mitchell, 2008;
5
Haleblian & Finkelstein, 1999) or post-acquisition integration problems (Helfat et al., 2007) can
undermine the success of acquisition implementation.
Similarly, growth based on creating assets internally can add value or create
organizational problems. Internal growth allows firms to develop resources or skills while
exploiting and protecting their specific knowledge (Caves, 1974; Helfat, 1994). Given the
absence of post-expansion integration problems in internal growth, new routines are better
understood than those developed through acquisition-based growth (Karim & Mitchell, 2004).
Yet, firms implementing internal growth can be slow to change, risking conflict and stagnation
(Capron and Mitchell, 2009).
Asset divestiture is an important part of the reconfiguration process, allowing firms to
release financial and managerial resources. By divesting, firms can increase efficiency by
reducing excess capacity (Anand & Singh, 1997) and obtaining financial resources for
reinvestment in the organization (Brown, James, & Mooradian, 1994). Therefore, divestiture is
an important step in the reconfiguration process (Hoskisson, Johnson, & Moesel, 1994; Jensen &
Ruback, 1983). Divestiture is also associated with organizational decline, however, potentially
disrupting a firm’s existing activities and accelerating existing problems (Cameron, Whetten, &
Kim, 1987). In each case – acquisition, internal development, and divestiture – the presence or
lack of external market institutions will affect the balance of benefits and costs from the
reconfiguration activities.
Market Development
The institutional environment of the firm is characterized by formal and informal
constraints that structure human and economic interaction (Alston, Eggerston, & North, 1996;
North, 1990; Scott, 1995), with substantial influence on business strategy formation and
6
implementation (Hoskisson, Eden, Lau, & Wright, 2000; Leff, 1978). We define market
infrastructure as the availability of market-based socio-economic institutions that facilitate
commercial activity, such as labor markets (Nelson, 1995; Mahmood & Mitchell, 2004), capital
markets (Lerner, 2002), legal transparency (Djankov, La Porta, Lopex-De-Silanes, & Shleifer,
2003), and commercial value chains (Anand & Khanna, 2000). In turn, underdeveloped markets
are those with only a limited degree of market infrastructure.
1
The extent of market infrastructure determines the opportunities, incentives, and
transactions costs of economic interactions (North, 1990). Recent studies have discussed how
firms differ in their strategy formation across environments characterized by strong and weak
market-based institutions, highlighting both the benefits and challenges for firms operating in
developing markets (Hoskisson et al., 2000). Studies show that firms devise structures and
strategies to fill institutional voids, deriving superior rents in the process (Khanna & Palepu,
1997; Kock & Guillen, 2001; Leff, 1978). At the same time, firms also experience greater stress
operating in environments that increase the difficulty of managing processes under conditions of
environmental uncertainty (Bruton, Ahlstrom, & Wan, 2003; Chakrabarti et al., 2007). In spite of
recent advances and the clear importance of market infrastructure (Shenkar & von Glinow, 1994),
there has been limited systematic analysis of the impact of institutional underdevelopment on
firm strategy and performance (Hoskisson et al., 2000; Singh, 2007).
Institutionally developing market environments are characterized by market failures that
impede the smooth functioning of commercial activities and increase the costs of transactions
(Choi, Lee, & Kim, 1999). Market underdevelopment hinders the flow of information, finance,
and human resources (Aldrich & Auster, 1986b; Tybout, 2000). Developing markets are
1
For simplicity, we refer to the polar cases of “underdeveloped” and “developed” markets, although we recognize
that the concept of market infrastructure falls on a continuum and will measure market development accordingly.
7
characterized by underdeveloped communications infrastructures that restrict the flow of
information. Firms in developing markets have inadequate financial reporting capabilities,
matching the low disclosure requirements by regulatory authorities and stock exchanges.
Financial intermediaries – including analysts, banks, venture capitalists, financial press, and
mutual funds – are weaker, restricting the flow of capital from savers to users (Levine & Zervos,
1998). In addition, institutionally developing environments are characterized by shortages of
general and financial management skills (Khanna & Palepu, 1997).
Public policy is another important aspect that distinguishes developed from developing
market environments (Henisz & Zellner, 2003). Governments in developing markets often
under-enforce laws, while governments in more developed markets display a greater
commitment to uphold laws. In underdeveloped markets, judicial systems are often inefficient,
implying weak and uncertain enforcement of laws and business contracts. Product markets in
such environments are characterized by limited enforcement of liability laws, little dissemination
of information, and few consumer activist organizations. Markets are highly directed by
governments, which often have substantial levels of corruption (Goldsmith, 1999) and tend to
prioritize political goals over economic goals. Such priorities can further distort the efficient
functioning of markets (Pfeffermann & Kisunko, 1999).
Prior research shows that strategy formulation and implementation differ across firms
operating in developing and developed markets. Firms in developing markets deal with
asymmetric information to a greater extent due to poor reporting standards and unmonitored
capital markets. The lack of financial intermediaries and poorly developed and unregulated
banking sectors imply limited availability of capital that might be crucial for reconfiguration
activities (Van Wijnbergen, 1997). Labor market conditions limit the availability of managerial
8
talent and a flexible and skilled work force for firms (Filatotchev, Wright, & Bleaney, 1999). In
addition, firms deal with limited enforcement of laws, such as those involving intellectual
property rights (La Porta, Lopez-de-Silanes, Shleifer, & Visnhy, 1997; Litwack, 1991) and laws
that set irrational subsidies and price ceilings (Khanna & Palepu, 1997); the lack of enforcement
limits incentives to expand. In parallel, politically motivated and populist laws may forbid firms
to retrench. Market underdevelopment therefore creates a constrained environment for strategy
formulation and implementation.
A limited set of studies has explored this distinction. Some studies argue that mainstream
strategy provides limited insights into strategy in developing markets and that firms in
developing markets pursue distinct strategies not evident in developed market environments
(Khanna & Yafeh, 2007; Peng & Heath, 1996), such as the significant involvement of family
communities (Bruton et al., 2003) and business groups (Guillen, 2001; Khanna & Rivkin, 2001;
Peng & Heath, 1996). Other studies consider how strategies from developed markets extend to
developing markets (Khanna & Palepu, 1997), focusing on the importance of size and
diversification (Khanna & Rivkin, 2001) as well as access to non-market benefits (Henisz &
Zellner, 2003). In spite of recent advances, though, it is not clear to what extent strategy
formation and implementation generalizes across markets at different levels of development
(Hoskisson et al., 2000; Peng & Pleggenkuhle-Miles, 2009; Singh, 2007), and how firms evolve
with market and institutional development (Galvez & Tybout, 1985).
Asset reconfiguration, in particular, remains poorly understood in the context of
developing markets. The limited set of studies offers mixed arguments and limited evidence.
Some prior studies suggest that firms in developing markets might be able to generate rents by
reconfiguring and expanding their asset base (Khanna & Palepu, 1997). In contrast, other studies
9
suggest that firms face difficulties managing resource exchange processes in such environments
(Chakrabarti et al., 2007), such that market failure can increase the difficulty of asset
reconfiguration. Therefore, arguments that emphasize the value of size, diversification, and
access to non-market benefits in underdeveloped markets, are countered by arguments that
emphasize the difficulty of implementing reconfiguration in developing market environments.
We now turn to considering how market underdevelopment will influence the incidence of asset
reconfiguration and the performance benefits that stem from reconfiguration.
PROPOSITIONS
Proposition 1: Reconfiguration Activity
We consider how two factors – market development and firm strength – will affect
reconfiguration activity. By greater reconfiguration activity we mean greater addition or
divestiture of assets as a proportion of a firm’s assets at the beginning of a given period. We
expect lesser development of market infrastructure to deflate reconfiguration activity, both by
placing less competitive pressure on firms and by creating constraints on reconfiguration. Less
developed market environments tend to have fewer independent firms and greater reliance on
political connections (Granovetter, 1985); the lower competitiveness is the source of potential
rents from business expansion (Khanna & Palepu, 1997). However, that same lack of
competition means that firms will face less pressure to reconfigure. Hence, while firms in less
developed markets will have opportunities to add and divest assets, the pressure to do so will be
substantially less than in more developed markets with stronger competition.
Moreover, each type of reconfiguration will be more difficult in underdeveloped
environments. Internal development will face constraints due to lack of supporting resources. An
important prerequisite for successful internal development is the availability of complementary
10
assets (Mitchell, 1989) and skilled personnel (Penrose, 1959), which are often scarce in less
developed markets (Peng & Heath, 1996; Puffer, 1992; Sharma, 1993). Business groups and
other established firms in less developed markets often develop internal talent markets to
overcome this barrier (Khanna & Palepu, 1997), but firms will still face barriers in obtaining
assets to complement internal development efforts.
Asset acquisitions and divestitures also face difficulties when commercial infrastructure
is weak. Acquiring firms generally manage valuation difficulties and opportunistic behavior by
contracting parties, which has the potential to reduce their ability to buy, sell, and license discrete
resources (Capron et al., 1998b). Such difficulties are particularly relevant when resources are
subject to asymmetric information (Arikan, 2005; Reuer & Ragozzino, 2008), and when patent
or other appropriability mechanisms are weak (Chi, 1994; Grossman & Hart, 1986; Rumelt, 1987;
Williamson, 1985). The potential for opportunism may lead to market failures in exchanging
discrete resources, whether by sale or by license (Caves, 1982; Rugman, 1981; Williamson,
1985). Resource scarcity, information asymmetries, and weak infrastructure constrain the sale
and purchase of organizational assets (Litwack, 1991), and hence the use of acquisition-based
growth as an expansion strategy in less developed markets (Peng & Heath, 1996).
In parallel, divestiture is also difficult in less developed markets. The limits to
commercial infrastructure such as lack of active financial markets and enforceable property
rights inhibit the ability secure the transfer of ownership across firms (Jensen & Ruback, 1983).
Firms operating in less developed markets will find it more costly to dispose their resources as
part of their retrenchment reconfiguration, owing to the higher transaction costs in those markets.
Moreover, incentives to dispose of unproductive assets will often be lower in underdeveloped
markets, in which political support can protect weak firms from competition. In turn, as markets
11
develop, benefits that derive from political support decline (Khanna & Palepu, 1999), increasing
the importance of retrenchment reconfiguration that helps firms improve operating efficiency.
These arguments lead to the first prediction, which we state as a general proposition.
Empirically, we will examine each element of reconfiguration.
Proposition 1a: The more developed the market infrastructure in a country, the more
actively that firms based in that country will undertake growth and/or retrenchment
reconfiguration during a given period.
We now consider how firm strength will influence the extent of reconfiguration. In
general, stronger firms are more likely to be active with growth reconfiguration and weaker firms
with retrenchment reconfiguration (Hofer, 1980; Pearce & Robbins, 1993; Schendel & Patton,
1976), although there are at least moderate countervailing pressures. Strong firms have more
resources and longer time horizons than struggling firms, which means that stronger firms have
the time and space to add new assets. Strong firms face less pressure to reconfigure, however, so
there is no assurance that they will take advantage of their opportunities. Struggling firms will
often need to sell assets, implying that they will tend to be more likely to undertake retrenchment
reconfiguration than stronger firms, although they may also be able to reinvest their financial
gains in developing new resources and/or purchasing external assets in search of new sources of
profitability. Although there is some ambiguity about how profitability directly affects
reconfiguration activity, the more interesting question is whether market development will shape
the way that firm strength affects reconfiguration.
We expect weak firms to become disproportionately more active in retrenchment
reconfiguration as markets become increasingly developed. Struggling firms face strong
incentives to divest assets, in attempting to become more efficient and raise resources that will
allow them time to attempt to recover (Bibeault, 1982; Ketchen & Palmer, 1999; Robbins &
Pearce, 1992). As markets develop, the ubiquitous network and group-related resources such as
12
internal capital markets generally decline in value (Galvez & Tybout, 1985; Khanna & Palepu,
1999, 2000). Weaker firms are likely to develop stronger incentives to implement retrenchment
reconfiguration in an attempt to adapt to the environmental change, because they are affected to a
greater degree with the decline in the value of their existing resource base. In addition,
retrenchment reconfiguration becomes more feasible as markets develop and become more
competitive (DeWitt, 1998; Morrow, Johnson, & Busenitz, 2004). Weak firms operating in
developing market environments will face particularly strong barriers in the face of high
transaction costs that limit resale markets due to the time pressure that they face, their weak
bargaining positions, and their limited financial resources. With market development, therefore,
retrenchment becomes critical, but also feasible for weaker firms, increasing their ability to
undertake retrenchment reconfiguration.
Proposition 1b: The more developed the market infrastructure in a country, the more
actively that weaker firms based in that country will undertake retrenchment
reconfiguration during a given period.
In parallel, we expect stronger firms to become disproportionately active in growth
reconfiguration as markets become more developed. If firms operating in less developed
environments possess resources that have limited value in developed environments (Galvez &
Tybout, 1985), resource acquisition by individual firms will also increase in importance as
markets develop. For example, network and group structures allow developing market firms to
combine labor, capital, technology, and market distribution resources (Guillen, 2001). Network
and group structures lose value with market development (Khanna & Palepu, 1999), implying
that individual firms need to acquire such resources in order to compete as markets develop
(Hoskisson et al., 2000). Strong firms have more resources with which to pursue growth
reconfiguration by developing new assets internally and acquiring assets from other firms.
Strong firms in developed markets have strong incentives to seek to undertake expansion
13
because of the higher levels of competition in those environments. Market development
facilitates expansion by reducing the barriers to transactions that the firms need to undertake the
growth activities. Therefore, the combination of greater ease of buying and selling assets and
greater need to become competitive in developed markets leads to the next general proposition.
We state this core logic as a general proposition; we will examine both internal development and
acquisition-based growth reconfiguration in the analysis.
Proposition 1c: The more developed the market infrastructure in a country, the more
actively that stronger firms based in that country will undertake growth reconfiguration
during a given period.
Proposition 2: Performance Following Reconfiguration
A substantive literature has established the performance impact of retrenchment and
growth reconfiguration in developed market environments, recognizing the value as well as the
limits of these strategies. Retrenchment reconfiguration increases profitability as firms eliminate
underperforming assets and achieve financial stability (Pearce & Robbins, 1994), while
potentially disrupting the firm’s existing organization leading to degenerative outcomes
(Cameron et al., 1987). Growth reconfiguration helps firms obtain new resources (Capron et al.,
1998a), while potentially leading to post-expansion problems that undermine the expected gains
from expansion (Capron et al., 2001). Notwithstanding the varying effects of these strategies, a
stream of research exploring turnaround in organizations has established the value of these
strategies when applied appropriately to the context of organizational transformation (Pearce &
Robbins, 1993). Active growth reconfiguration is an important aspect of firm response to
competitive challenges in developed market environments, allowing firms to change and adapt to
external conditions, as well as to develop processes that facilitate future expansion (Capron &
Mitchell, 2007). An intriguing question, however, is whether the growth and retrenchment
14
reconfiguration strategies have disproportionate impacts at different stages of market
development.
We expect growth reconfiguration to have stronger benefits in more developed markets
than in less developed markets. Growth reconfiguration involves multiple activities that incur
transaction costs. Growing firms identify feasible acquisition targets or greenfield investment
opportunities, integrate new resources with existing resources, create markets for new products,
produce and distribute additional output, and synchronize the new activities with existing
corporate strategy, all of which engender costs to growth (Marris, 1963; Penrose, 1959; Slater,
1979). For acquisition activities to be rewarding, firms require adequately regulated financial
markets to facilitate information flows, adequate and capable managerial resources to drive post-
expansion management, and well-enforced property rights to lower the problems associated with
transfer of ownership. Developing markets, which lack institutions facilitating these activities,
will therefore constrain and increase the cost of activities and reduce the profitability of growth
reconfiguration.
Proposition 2a: The more developed the market infrastructure in a country, the greater
the performance benefits of growth reconfiguration during a given period.
In contrast, we expect retrenchment reconfiguration to have fewer performance benefits
in more developed markets. Retrenching firms face two challenges that disrupt performance in
developed markets, which are characterized by higher levels of competition. First, retrenching
firms become smaller and are consequently left with diminished competitive ability. Smaller
firms have smaller market shares in input and output markets (Barnett & Amburgey, 1990), are
less able to under-price competitors, and are less able to engage in competitive behavior such as
enduring losses to out-compete other firms (Aldrich & Auster, 1986a). Second, retrenching firms
have to overcome greater constraints to subsequently grow and recover. Given the limited span
15
and scope of activities, small firms may not have access to adequate information that will allow
them to locate and choose targets best suited to their objectives, and may not be able to
implement the extent of expansion that is necessary to obtain the lower costs of large-scale
operations (Penrose, 1959). In addition, firms that implement retrenchment reconfiguration may
lack the internal resources and capabilities necessary to successfully integrate new assets.
Without such integration, the new assets may conflict with each other and with existing assets,
leading to performance decline rather than performance improvement (e.g. Chakrabarti &
Mitchell, 2005; Haspeslagh & Jemison, 1991; Zollo & Singh, 2004).
Proposition 2b: The more developed the market infrastructure in a country, the less the
performance benefits of retrenchment reconfiguration during a given period.
In sum, we argue that market development will shape the extent to which firms
reconfigure their resources and, in turn, benefit from their reconfiguration activities. Greater
market development will facilitate reconfiguration (P1a), with weak firms being likely to take
advantages of increasing ease of retrenchment reconfiguration (P1b) and strong firms best able to
take advantages of increasing opportunities for growth reconfiguration (P1c). Firms will gain
greater benefits from growth reconfiguration in developed markets (P2a), but market
development will deflate the benefits of retrenchment reconfiguration (P2b).
DATA
We analyze firms operating in the manufacturing sector in eight countries of East and
South Asia during the period of 1990 to 1999: Hong Kong, Indonesia, Malaysia, the Philippines,
Singapore, South Korea, Taiwan, and Thailand. Our sample consists of 1,256 publicly traded
firms.
2
We obtained data about the firms and countries from multiple sources. The Worldscope
2
Distribution: Malaysia (23% of unique firms, 25% of firm-years), Korea (17%, 16%), Hong Kong (14%, 13%),
Taiwan (14%, 12%), Singapore (10%, 10%), Thailand (10%, 12%), Indonesia (8%, 8%), Philippines (3%, 3%). We
16
Global Research database provided firm-level financial and business segment information. The
Economist Intelligence Unit Country Data and the Country Indicators databases provided macro-
economy data for the countries in our sample.
Primary Variables
We measured asset reconfiguration for any given firm in a given year based on data
reported in the Worldscope Database. We used two approaches for operationalizing
reconfiguration. First, a set of “reconfiguration mass” variables measures the absolute degree of
each type of asset change that firms undertake in a year, as a proportion of each firm’s total
assets. Second, a set of “mode share” variables measures the share of each type of
reconfiguration (external growth, internal development, divestiture) within total reconfiguration
activities that the firm undertook during the year.
The reconfiguration mass measures are the primary variables for the study because they
address how actively the firms seek to change their current businesses. We defined the mass of
reconfiguration in a given year as a proportion of total firm assets (A
0
) at the end of the prior
year. External growth reconfiguration is net assets from acquisitions in any given year (E
1
) as a
proportion of total assets (E
1
/A
0
). Internal development reconfiguration is total growth minus
the net assets from acquisitions (I
1
) in any given year over the total assets (I
1
/A
0
). Growth
reconfiguration (GR
1
) is the sum of external growth and internal development over total assets
([E
1
+I
1
]/A
0
=GR
1
/A
0
). Asset divestiture, which is the equivalent of Retrenchment reconfiguration
(RR
1
), is disposal of fixed assets over total assets (D
1
/A
0
). We were able to obtain all four
reconfiguration variables (GR
1
, E
1
, I
1
, RR
1
) for four of the eight countries (Hong Kong,
Indonesia, Malaysia, and Singapore). For the other four countries (South Korea, the Philippines,
also collected data on 1,900 firms based in Japan, which we excluded so that the country would not swamp the
results (sensitivity analysis that included the Japanese companies found similar results).
17
Taiwan, and Thailand,), we obtained only divestiture (RR
1
) and total growth reconfiguration
(GR
1
), while being unable to separate GR
1
into its E
1
and I
1
components. Therefore, the analysis
includes subsamples in addition to the full models.
The mode share measures provide a complementary approach that addresses where the
firms focus their reconfiguration attention. Total reconfiguration (R
1
) is the sum of growth
reconfiguration and retrenchment reconfiguration (R
1
=GR
1
+RR
1
). External growth mode share
is net assets from acquisitions over total asset reconfiguration (E
1
/R
1
). Internal development
mode share is net assets from internal development over total asset reconfiguration (I
1
/R
1
).
Growth reconfiguration mode share is external growth plus internal development over total
reconfiguration (GR
1
/R
1
). Asset divestiture mode share is disposal of fixed assets over the total
assets total asset reconfiguration (RR
1
/R
1
).
We used profitability based on return on assets (ROA) for the performance variables.
Firm strength is the return on assets for the previous year of the study period (ROA
0
).
Performance benefit is the return on assets in each year of the study period (ROA
1
). ROA is a
suitable performance measure because it records the degree to which a firm was able to generate
profits from the resources in which it had invested. In our sample, ROA had a correlation of 0.9
with the earnings before interest and taxes (EBIT). We do not use stock market measures of
performance because financial markets in emerging markets often exhibit substantial
inefficiencies, so that changes in stock market valuations may not reflect changes in the
underlying asset-based performance level of the firm. We measured firm performance at the end
of the year during which growth occurred. Conceptually, this time structure assumes that
reconfiguration has a rapid impact. Empirically, the structure helps reduce more complicated
alternative causes that might occur during longer periods after the reconfiguration year.
18
We derived the measure of Market development from the EIU Country Indicators
Database, which reports on political, institutional, and regulatory aspects of the countries in the
study. We calculated a simple average of seven EIU ratings: Overall business environment;
Infrastructure (telecoms, transport, energy, and office space measures); Labor market
(availability of skilled labor, incidence of strikes); Political environment (political stability,
institutional effectiveness); Policy towards private enterprise (protection of property rights,
government attitude towards competition); Financing (extent of distortions in financial markets,
openness of banks); and Political environment for foreign investment (government policy, risk of
expropriation). Each of the seven ratings derives from a scale of 1 (bad/low) to 10 (good/high).
With this measure, Hong Kong had the highest institutional development scale, followed by
Singapore, Taiwan, Malaysia, South Korea, Thailand, Indonesia, and the Philippines.
3
Table 1
compares the measure of market development to seven other market orientation measures. The
table shows only minor variations in the rank order of the rating of institutional environments
across the countries and there are high correlations among the measures (the mean correlation of
the Market development variable with the other seven indices is r=0.87).
***** Table 1 about here *****
Control Variables
We operationalized control variables for diversification, international operations, current
ratio, business groups, calendar years, and industry effects. Diversification used an entropy
measure (Jacquemin & Berry, 1979; Palepu, 1985; Raghunathan, 1995). Entropy is:
3
The World Business Environment Survey is a common index of country-specific institutional development, but
surveyed only five of the eight countries during the study period.
i
N
i
i
P
P E
1
ln
1
?
=
=
19
where P
i
is the share of the i
th
segment of the firm’s total sales (the entropy measure has a 0.98
correlation with the Hirshman Herfindahl Index measure of diversification). Worldscope reports
segment data only for 1994, so that the entropy variable is time constant. International
operations is a time-constant 0-1 dummy variable indicating whether a firm had operations
outside its home country during the period. Current ratio (current liabilities/total liabilities)
measured each firm’s short-term exposure in each year. Business group member is a time-
constant 0-1 dummy variable denoting whether a firm belonged to a group, because more
activity could be associated with firms that are a part of a conglomerate in the East Asian region.
We used dummy variables to control for Years, which helps pick up differences that might
reflect the Asian financial crisis of the late 1990s. We defined six 0-1 dummy variables based on
the Standard International Trade Classifications (SITC) to control for industry effects.
4
We also
measured firm size (log assets), but found that it correlated highly with the other control
variables, including firm strength, international operations, current ratio, business group member,
and diversification (the result were robust to including firm size). Table 2 summarizes the
descriptive statistics. The independent variables were largely independent of each other.
***** Table 2 about here *****
RESULTS
P1a and P1b: Reconfiguration Activity
We used linear regression with firm random effects to test the propositions.
5
Table 3
reports the tests of propositions 1a, 1b, and 1c, which focus on how market development shapes
the way that firm strength affects reconfiguration activity. Models 1 to 4 report reconfiguration
4
The six industrial sectors were (1) Drugs, cosmetics, and health; (2) End product heavy manufacturing; (3) End
product light manufacturing; (4) Intermediate products; (5) Raw materials, and (6) Other.
5
Firm fixed effects analysis is not possible because several of the variables are time invariant, including the market
development variable. A Hausman test based on models with time-varying variables that compared random to fixed
effects models was insignificant, suggesting the random effects approach is appropriate.
20
mass analyses for all eight countries. Models 5 and 6 then report reconfiguration mass results for
the four countries with distinct internal and external growth data. Model 7 reports
reconfiguration mode share results for the full sample, comparing the proportion of growth
reconfiguration relative to retrenchment reconfiguration.
***** Table 3 about here *****
The results support P1a in terms of retrenchment reconfiguration (RR) mass (models 1
and 2, p < 0.01), as well as growth reconfiguration (GR) mass (model 3, p < 0.05; model 4, p