the impact of performance distress on agressive competitive behavior

7/28/2019 The Impact of Performance Distress on Agressive Competitive Behavior

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MANAGERIAL AND DECISION ECONOMICSMwimjc. Deci.s. Earn. 2 3 : 3 0 1 -3 1 6 (2 0 0 2 )

DOI: IO.lOO2/mde.K)67The Impact of Performance Distress onAggressive Competitive Behavior:A Reconciliation of Conflicting Views^Walter J. Ferrier"'*, Cormac Mac Fhionnlaoich^,Ken G. Smith" and Curtis M. Grimm''

'' Gatton College of Bu.sines.s and Econom ics. University of Kentucky. Lexington. K Y. USA^ Smurfit Gradu ate Sehool of Bu.sine.s.s, University College Dublin. Blaekroek, Coun ty Dublin. Ireland'^ R. H. Smith S chool of Business. University of Maryland. College Park. M D. USA

Prior research on how ex ante performance impacts competitive behavior has led to conflictingconclusions. Prospect theory, for example, suggests that poor performance promotesaggressive behavior, whereas threat-rigidity theory predicts the opposite. We attempt toreconcile these conflicting views hy incorporating a contingenc y perspective that em piricallytests, specifically, how top management team heterogeneity and a favorable industry contextmoderate the relationship between poor performance and competitive aggressiveness. Ourfindings suggest that performance-distressed firms managed hy heterogeneous top manage-ment teams are less likely to compete aggressively. However, contrary to predictions,performance-distressed firms comp eting in competition-buffered industries are more likely tocom pete aggressively. Copy right 200 2 John Wiley & Sons , Ltd.

INTRODUCTIONIn today's dynamic competitive environment,some market-leading firms are able to sustaintheir strong market positions, above-averageprofits, and shareholder wealth by competingaggressively, proactively, and forcefully initiatingand responding to competitive attacks (D'Aveni,1994; Ferrier, 2000, 2001; Ferrier and Lee, forth-coming; Lee et al., 2000). Indeed, dominant firmssuch as Intel, Microsoft, and Wal-Mart are notedfor their aggressive behavior, which has resulted ina strong market position for these firms. This viewof competition is most closely associated withSchumpeter (1950) and the Austrian school ofeconomics. For the Austrians, and certainly thesema rket-le adin g firms, ' .. .the term competition

*Correspondence to: Gatlon College of Business and Econom-ics, University of Kentucky, Lexington, KY 40506-0034, USA.E-mail: [email protected]

undoubtedly conveys the notion of men vigorouslycompeting with another, each striving to deliver aperformance that outdistances his rivals' in their'incessant race to get or to keep ahead of oneano ther ' (Kirzner, 1973, pp. 89-90 , 20).

However, it is surprising to observe that othermarket-leading firms have failed to take anaggressive competitive stance vis-a-vis rivals. Forinstance, ' IBM was slow to enter the personalcomputer market, permitting Microsoft and Intelto appropriate most of the industry's value andwealth. Similarly, Sears, constrained by its weakfinancial condition, failed to adapt to changes inthe discount retail industry, losing out to Wal-Mart, Indeed, despite the apparent advantagesthat accrue to market-leading firms, they fall preyto challengers far more often than is commonlythought (e.g.. Caves and Porter, 1978; Ferrier et al.,1999; Mu eller, 1986; Weiss and Pascoe , 1983),Moreover, once decline begins, it precipitates intoa 'downward spiral' from which few firms are able

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302 W.J. FERRIER ETALto recover (see Furman and McGahan, this issue;Hambrick and D'Aveni, 1998).

Despite a wealth of research in strategicmanagement and decades of research in I/Oeconomics and finance that has traditionallyconsidered financial and market performance asstrategic outcomes, another important, yet under-developed area of study explores how pastperformance influences the firm's future action(Thompson, 1967). Indeed, given the prevalence ofhard-hitting rivalry and the dethronement ofmarket-leading firms, it is important to explorewhy firms that experience financial or marketshare declinein relative or absolute termsarenot motivated or able to attempt the strategicchanges necessary to rebound. Further, empiricalresearch has yielded conflicting results. On the onehand, some studies suggest that successful firmscompete more aggressively and proactively (e.g.,Cha t topadhyay et al., 2001; Chevalier, 1995;Daily, 1994; Staw et al., 1981; Young et al.,1996). On the other hand, other studies have foundthat firms that experience decline are motivated tocompete more aggressively (e.g.. Bowman, 1982;Ferrier, 2001; Fiegenb aum , 1990; Fiegenbaum andThomas, 1988; Hambrick et al., 1996; Lant et al.,1992; Miller and Chen, 1994).

Given the opposing views in the literature andthe inconsistent empirical results, we believe it isimportant to reconcile the various viewpoints. Inparticular, when the predictive validity of ourtheories is under controversy, the underlyingparadigm which supports the theory becomesopen to question (Kuhn, 1970). Moreover, giventhe normative orientation of most strategy re-search, such reconciliation is para m oun t. Th us, thefundamental research questions examined hereare: Do market-leading firms that experienceperformance distress compete more or less aggres-sively than market-leading firms which experiencegood performance? What are the key managerial,organizational, and environmental contingenciesthat influence the performance-strategy relation-ship?

Prefatory Note on Key ConceptsBecause we draw from a wide range of theoreticalperspectives and a rich, yet varied body ofempirical research, we feel compelled to clearlyelucidate the key conceptual foundations of ourstudy. Further, because our research questions are

so fundamental to our understanding of therelationship between the financial- and marketrelated feedback managers often attribute totheir past strategies and the development andimplementation of future strategy, it is our aimto define (and subsequently measure) theseconcepts in the widest, most generalizable termpossible.

Perfortnatwe distress. Recognizing the multidimensional, complex nature of the performanceconstruct, researchers have argued that multipleand/or multidimensional measures of performanceshould be used to advance and add breadth to ouunderstanding of the relationship between firmbehavior and performance (Bagozzi and Philips1982; Ch akrav arthy , 1986; Lum pkin and Dess1996). Also, it is important to move beyondframing performance as an absolute measure osuccessful strategic outcomesprofit as opposedto loss; growth as opposed to decline (McKinley1993; Kahneman and Tversky, 1979). Indeed, firmbehavior may lead to favorable outcomes on oneperformance dimension and unfavorable outcomeon a different performance dimension (Lumpkinand Dess, 1996). For example, proactive andaggressive product innovation may enable a firmto rapidly gain market share. However, such innovation may require costly investments in R&Dactivities that may diminish short-run profitabilityIndeed, firms that adopt an emphasis on increasingmarket share at all cost are likely to be less profitable than firms that set profit-oriented strategiobjectives in developing strategy (Armstrong andCollopy, 1996).

Therefore, consistent with these views, we aimto test whether strategic behavior is influenced bytwo distinct measures of poor ex ante performancethat capture elements of a firm's internal financiacondition as well at its market position vis-a-vis itmain rivals. First, we use Altman's Z-score,multidimensional, composite measure of profitability, cash flow, slack, and stock market factor(Altm an, 1968; Ch akra varth y, 1986). We believthat poor performance on any single performancindicator does not provide a sufficiently stronginformational cue that signals to man agers that thfull breadth of their strategy is not yieldingexpected results. Instead, owing to its comprehensiveness, low Altman's Z-scores cannot escapmanagerial notice. For the remainder of thipaper, we define financial distress as low AltmanZ-scores.

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PERFORMAN CE DISTRESS AND COMPETITIVE BEHAVIOR 303Second, market share gain is a key organiza-tional objective and a measure of relative standingthat managers often believe to be associated withbetter performance (Armstrong and Collopy,1996). Further, declines in market shareespe-cially among market-leading firmsmay also giverise to psychological or emotional attachments tomaintaining (if not increasing) market share. Forexample, after being dethroned as the No. 1athletic shoe company by Nike in 1991, ReebokCEO, Paul Freeman, 'vowed to re-take the lead'(Ferrier, 1997). Thus, we consider market shareerosion as an important dimension of performancedistress.Competitive aggressiveness. Building on theAustrian view of competition, the idea of compe-titive aggressiveness serves as the conceptual coreamong three related streams within strategic

management research. First, research within cor-porate entrepreneurship views strategy, in general,and competitive action, in particular, as behaviorthat is overt, demonstrable, and aggressive to-wards competitors and is carried out to improvecompetitive position and outperform competitorsin the marketplace (Covin and Slevin, 1991;Lumpkin and Dess, 1996). In particular, compe-titive aggressiveness is defined as the firm's'propensity to directly and intensely challenge itscompetitors to improve its competitive position;. . . to outperform comp etitors in the marke tplacebeating co mpe titors to the p unch; . . .being re-sponsive to competitive challenges' (Lumpkin andDess, 1996, pp. 148-149). Aggressive firms, rela-tive to conservative firms, have higher scores onvariables representing the following constructs:external financing, service, warranties, advertising,innovative marketing, price, product quality,patents, innovative operations (Covin and Slevin,1991).

Second, the idea of aggressiveness is consistentwith several of the 'New 7-Ss' of hypercompetition(D'Aveni, 1994), especially the speed of competi-tive attacks and a simultaneous and sequentialstrategic thrusts consisting of multiple eompetitivestrategies and tactics. Here, aggressive firmsquickly, proactively, and forcefully try to out-maneuver rivals in the marketplace.Third, researchers in the competitive dynamicsstream within strategic management have devel-oped theory and empirical methods centering on afine-grained conceptualization of firm strategy ascompetitive action (see Smith et al., 1992, 2001;

Grimm and Smith, 1997 for overviews of thisresearch stream). Consistent with corporate en-trepreneurship and the hypercompetition viewsof aggressiveness, the nwnher of cotnpetitiveactions as well as the timinglspeed with whichthey are implementedin terms of either aninitiated attack or a response to a rival'sattackwere found to be the strongest, mostconsistent, and robust constructs within thecompetitive dynamics stream (e.g., Chen andHam brick, 1995; Chen and M acM illan, 1992;Ferrier, 2000, 2001; Ferrier et al., 1999; Hambricket al., 1996; Lee et al., 2000; Smith et al., 1991,1996, 1997; Young et al., 1996, in press).

COMPETING THEORETICALPERSPECTIVES

For the present research, we consider a firm'sfinancial and market scorecards as importantdrivers of decision-making that affects the firm'schoices about how to competethat is, to beeither aggressive or more passive in its competitivebehaviors. In particular, we contend that thelink between financial distress and market shareerosion and the competitive behavior of market-leading firms operates through managerial deci-sion-making or strategic choice (Child, 1972).In this section, we offer two competing hypoth-eses that relate to the direct relationship betweenour two indicators of performance distress andcompetitive aggressiveness. We base our argu-ments on several important behavioral anddecision-making theories that articulate howperformance feedback is interpreted by m anagersand influences competitive behavior. The firstset of arguments relates to how performancedistress increases the level of competitive aggres-siveness; the second set builds the case that

performance distress reduces aggressiveness. Wediscuss each in turn.

Performance Distress Induces CompetitiveAggressivenessProspect theory. Performance distress may haveimportant psychological consequences in terms ofhow firms respond to their perception of externalmarket threats or internal performance decline(Bowman, 1982; Chat top adhyay et al., 2001;

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304 W.J. FERRIER r/(L.Kahneman and Tversky, 1979; Fiegenbaum,1990). According to prospect theory, decisionmakers operating in the domain of losses (ordecline) are risk seeking, while decision makersprotecting gains are risk averse (Kahneman andTversk y, 1979; Tversky and K ahn em an, 1981).Early research on the behavior of weak firmssuggests that ' troubled firms' are more prone torisk-seeking behavior (Bowman, 1982), whileresearch by Fiegenbaum and Thomas (1988) andFiegenbaum (1990) found that organizationsbehaved as risk takers when performance fellbelow a particular benchmark or referencepoint. Conversely, when performance exceededthe performance reference point, firms were riskavoiders.

Broadly, the findings of these studies areconsistent with the notion that successful market-leading firms are likely to engage in risk-aversebehaviors and compete passively. Conversely,firms suffering performance distress engage inrelatively more aggressive behavior.Corporate finance theory. In concordance withprospect theory, the corporate finance literaturealso suggests that firms experiencing performancedistress have incentives to engage in aggressiveproduct market strategies. For instance, Branderand Lewis (1986) argue that as firms take on moredebt, they will have an incentive to pursue risky,

aggressive output strategies that result in higherreturns under favorable market conditions andlower returns under unfavorable market condi-tions. Given the limited liability provisions ofequity financing, these higher returns accrue toequity holders, while the lower returns accrue todebt holders. Thus, equity holders gain morefrom aggressive, rather than passive behavior inthe product market. This argument is furthersupported by Maksimovic and Zechner whostate that 'firms with high debt levels choosetechnologies [competitive strategies] with riskycash flows', thus implying that financial distressacts as an incentive to engage in more aggressivecompetitive behaviors (1991, p. 1621, bracketsadded) .In sum, corporate finance theory reasons that ascompared to their healthy counterparts, decisionmakers in distressed firms are likely to engage inaggressive competitive behavior in the area ofpricing and output decisions.Organizational learning theory. The literature onorganizational learning suggests that as organiza-

tions evolve and grow, they tend to develop a seof routinized behaviors, thereby reducing thsearch for alternative problem-solving technique(Nelson and Winter, 1982; Lant et al., 1992Miller, 1990). Literature on strategic persistence suggests that, over time, past success magive rise to complacency and a persistent reliancon well-learned organizational routines, thuinhibiting competitive action and strategichange (Audia et al., 2000; Lant et al., 1992Miller, 1990; Miller and Chen, 1994). Converselypoor performance provides the firm with stronincentives to aggressively search out new approaches to compete more effectively in thmarketplace (Nelson and Winter, 1982; Milleand Chen, 1994).

In summary, the three theoretical views outlinedabove support the hypothesis that poor-performing large firms are likely to exhibit aggressivcompetitive behavior. In particular:

Hypothesis la:Financial distress will be positively related tocompetitive aggressiveness.Hypothesis Ib:Market share erosion will be positively related tocompetitive aggressiveness.

Performance Distress Reduces CompetitiveAggressiveness

Notwithstanding the theories that motivatHypotheses la and Ib, a set of alternativtheoretical perspectives from organizationatheory and dominant firm behavior suggests counter propositionthat performance distresreduces competitive aggressiveness.Threat-rigidity theory. Threat-rigidity theor

suggests that there may be a general tendency fodecision makers to behave rigidly in threateningsituations. For example, when individuals arplaced in threatening situations, they tend to relon a habituated, dominant response set (Zajonc1966). Similarly, groups engaged in decisionmaking may reduce their flexibility followincrisis, sealing off new information and controllindeviant responses (Janis, 1972).Staw et al. (1981) are the most influentiacontributors to the 'decline inhibits adaptationschool at the organizational level. These author

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PERFORMANCE DISTRESS AND COMPETITIVE BEHAVIOR 305argue that threat, such as that represented bydeteriorating financial condition and/or marketshare erosion, leads decision makers to restrictinformation processing, centralize control, andconserve resources. Indeed, several other authorshave identified a short-term orientation on thepart of decision makers under conditions ofdistress, such as short-term responses to imme-diate crises. Smart and Vertinsky (1984) suggestthat fewer sources of information are consulted ina crisis, which explains why there are fewersolutions available. Researchers have also de-scribed the tendency of decision makers to narrowcognitive processes and respond rigidly duringcrises (e.g., Cameron et al, 1987; Daily, 1994;D'Av eni, 1989; D'Aveni and M acM illan, 1990;Starbuck et at., 1978).

In summary, performance distress is expectedto increase rigidity, reduce information flows,increase conservatism, and thereby constrainthe organization's capacity to adapt (Daily,1994; McKinley, 1993), which increasesstrategic paralysis (D'Aveni, 1989). This, then,implies that performance distress will giverise to passive or conservative competitive beha-vior.

Dominant firm behavior. Within industrial orga-nization (I/O) economics, the literature on domi-nant firm behavior and dynamic limit pricingoffers still another view suggesting that distressedmarket-leading firms may be less aggressive.This research stream examines the specificbehaviors of market-leading industry incumbentson both their ability to limit entry and tomaintain a position of market leadership (Schererand Ross, 1990). Indeed, it is widely recognized inIO economics and strategic management thatmarket-leading firms often enjoy economies ofscale and scope, entry barriers, experience curveeffects, lower marginal costs, strong resourcepositions (including financial resources), marketposition, and reputations (Grimm and Smith,1997; Scherer and Ross, 1990). Yet, in order tomaintain their market-leading position, such firmsmay undertake aggressive, deterrent behaviorssuch as: predatory pricing (e.g., Gaskins, 1971;Leblan c, 1992), pro duc t proliferation (e.g., Schm a-lensee, 1983), advertising (Comanor and Wilson,1974), and increasing scale or capacity (e.g.,Spence, 1977). Thus, healthy market-leading firmsare motivated to carry out a pattern of aggressivebehaviors.

In sum, both the threat-rigidity and dominantfirm behavior theoretical views lend support to thefollowing hypotheses:Hypothesis 2a:Financial distress experienced by leading firms willbe negatively related to competitive aggressiveness.Hypothesis 2b:Market share erosion will be negatively related tocompetitive aggressiveness.

Towards a Reconciliation of ConflictingPerspectives: A Contingency FrameworkConsidering the inconsistent theoretical predic-tions and recognizing the strong underlyingresearch traditions that support these competingviews, we are challenged to reconcile these oppos-ing views. Quite possibly, both of the initialpropositionsdistress induces aggressiveness ver-sus distress attenuates aggressivenessare correctunder certain conditions. Thus, we attempt toreconcile these countervailing arg um ents by adop t-ing a contingency perspective. Indeed, Baum andDutton (1996) assert that an investigation of firmcontext can add much to understanding howstrategic processes work. Accordingly, we aim toexamine the moderating effect of context variablesat two levels: the managerial level and the externalenvironment or industry level. These moderatedrelationships are depicted in Figure 1.

Drawing from research on learning, decision-making, and organizational change, there are threeimplicit, yet essential influences on strategic actionand change (Chen, 1996). These are: factors thatinfluence the awareness of the context andchallenges stemming from competitive interdepen-dence, factors which induce or impede the motiva-tion to take action, and the cognitive and resource-based factors which influence the firm's ability totake action. For the current research, we arguethat these three implicit drivers serve as arefractive filter, of sorts, that attenuates the rolethat performance distress plays as an informa-tional cue or signal. Consequently, we argue thatthe relationship between performance distress andcompetitive aggressiveness is moderated by topmanagement heterogeneity and the extent to whichfirms compete in a competition-buffered industry.Top management team (TMT) heterogeneity.Upper echelons and strategic decision-makingtheory suggest that the composition of the TMT



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306 W.J . FERRIER ET AL.

PerformanceDistre.ss

TM THeterogeneity

AWARENESSCompelit iveAggressiveness

Competition-buffered \Industry *.'Figure 1. Implicit factors tiiat impact strategic decision-making.

influences three key managerial activities: problemsensing facilitated by greater awareness, interpre-tation and enactment of environmental cues andsignals, and decision-making that capably matchesperceived problems with strategic solutions (Ama-son, 1996; Barr et al., 1992; Cyert and M arch,1963; Finkelstein and Hambrick, 1996; Hambrickand Mason, 1984; Kiesler and Sproull, 1982).Thus, depending on the composition of the TMT,performance distress is a key informational cuethat will be interpreted and processed differentlyby firms in the decision-making process, which, inturn, impacts the firm's level of competitiveaggressiveness.

Heterogeneous TMTs often develop a conflic-tual decision-making style characterized bydebate, devil's advocacy, and dialectical inquiry(Mitroff and Emshoff, 1979; Simons et al., 2000).Further, TMT heterogeneity reduces agreement-seeking behaviors, and reduces both social cohe-sion and informal c om mun ication in the context ofstrategic decision-making (Knight et al., 1999;Simons et ah, 2000; Smith et al., 1994). We believethat such characteristics of the decision-makingprocess are likely to impact the firm's level ofcompetitive aggressiveness. Indeed, the 'upper-echelons approach would acknowledge thatthe human and social biases, filters, and idiosyn-cratic processes at the top of the organizationsubstantially influence competitive behavior'(Hambrick et al., 1996, p. 660; Hambrick andMason, 1984).

Prior research found that heterogeneous TMTsdecide on and implement competitive actions (andresponses) slower than homogeneous TMTs(Hambrick et al., 1996). Similarly, Ferrier (2001)found that heterogeneous TMTs were less capableof sustaining competitive attacks of significantduration. However, no research to date has

explored the interactive effects of T M T hete rogeneity and performance distress on competitivebehavior. Thus, we believe that performancedistress will magnify or exacerbate the conflictuadecision-making processes and their attendanoutcomes described above. More specificallywhen faced with performance distress (as opposedto achieving a high level of success), a heterogeneous TMT will be even more likely tovigorously and comprehensively debate the various causes of poor performance, as well apossible courses of action. Consequently, decision-making speed and the firm's ability to carryout a large number of competitive actions arlikely to be diminished. Therefore, we predict:Hypothesis 3a:Financial distress will be negatively related tocompetitive aggressiveness for leading firms withheterogeneous TMTs.Hypothesis 3b:Market share erosion will be negatively related tocompetitive aggressiveness for leading firms withheterogeneous TMTs.

Competition-buffered industry context. Similar tour logic regarding the interaction between performance distress and TMT heterogeneity abovewe believe that performance distress will serve as aless important informational signal and input inthe decision-making process when characteristicof a favorable industry context are prevalentAccording to the s t ructure-conduct-performancview within I/O economics, high levels of industrgrowth, barriers to entry, and industry concentration each buffer industry participants from intenscompetition (Scherer and Ross, 1990). Furtherprior research in strategic management suggestthat industry characteristics influence manageriaawareness and perception related to intensity o

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PERFORMANCE DISTRESS AND COMPETITIVE BEHAVIOR 307competition within a industry which, in turn,influences the firm's strategic choices (Dessand Beard, 1984; Keats and Hitt, 1988; Sutcliffe,1994). Consistent with Chen's (1996) framework,these industry characteristics are also likelyto influence the firm's motivation to competeaggressively.

First, managers equate industry growth withmunificence (Dess and Beard, 1984), which is lesslikely to provide feedback that disrupts managers'causal explanations between the efficacy of theirown market actions and positive competitiveoutcomes (Harper, 1994; Lant et al., 1992). Slowgrowth, on the other hand, is likely to increase theintensity of competition, which reduces industryprofitability. This, in turn, motivates strategicaggressiveness and change (Fombrun and Gins-berg, 1990; Porter, 1980; Smith et al, 1992).Indeed, prior research in competitive dynamicssuggests that firms in low-growth industriesrespond to competitive challenges more quickly(Smith et al, 1992) and carry out an unpredictablesequence of competitive actions (Ferrier, 2001).

Second, industry concentration reduces the levelof intra-industry competition (see Scherer andRoss, 1990). Indeed, Young et al (1996) foundthat higher levels of industry concentration re-sulted in fewer competitive moves carried outamong incumbent firms. Thus, a high level ofindustry concentration also reduces the firm'smotivation to compete aggressively.

Third, the intensity of rivalry is also diminishedas a result of high levels of capital intensity, R&Dintensity, and advertising intensity (Scherer andRoss, 1990). Such barriers to entry were found tohave a positive impact on industry performanceprincipally because the intensity of competitionamong incumbents does not increase due to entry(Caves, et al, 1984). Therefore, firms competing inindustries characterized as having high barriers toentry are also less motivated to compete aggres-sively.

In sum, we predict that firms experiencingperformance distress that compete in a competi-tion-buffered industry environmenthigh levels ofgrowth, concentration, and/or barriers to entrywill compete less aggressively.Hypothesis 4a:Financial distress will be negatively related tocompetitive aggressiveness for leading firms com-peting within competition-buffered industries.

Hypothesis 4b:Market share erosion will be negatively related tocompetitive aggressiveness for leading firms com-peting within com petition-buffered indus tries.

M E T H O D SSample

The focus of this study is to examine the relation-ship between leading firms' past performanceand com petitive aggressiveness, given TM T het-erogeneity and industry factors as importantcontingencies. Thus, we aimed to develop aresearch design, sample, and as set of measuresbased on content analysis of published historiesabout the competitive actions of market-leadingfirms (Ginsberg, 1988). Our sample and thecompetitive actions carried out by each firm arebased on that from prior research in competitivedynamics (Ferrier, 2001; Ferrier et al, 1999).Because the strategies of the largest, market-leading firms are likely to be the most observable(Fombrun and Shanley, 1990), the sample consistsof US market share leading firms among theEortune 500, which were ranked N o. 1 or N o. 2 intheir respective industries, as listed in Ward'sBusiness Directory.

Second, to ensure that each firm's competitiveactions were directed towards the line of businesson which these firms are most highly dependent(Chen, 1996), only those classified as dominant orsingle business firms were selected (i.e., firmshaving Rumelt's (1974) specialization ratios great-er than 0.70).

Finally, we eliminated firms from the sample ifthey did not have TMT data listed in Dun andBradstreet Reference Book of Corporate Manage-ments throughout the 1987-1993 time panel. Thus,the sample consists of pooled, 7-year cross-sectional data base of pairs of marke t-leading firms(ranked Nos. 1 and 2) across 39 different indus tries(i.e., 273 firm-years as the unit of analysis).

Dependent VariablePrior research in competitive dynamics definescompetitive actions as: externally directed, specific,and observable competitive moves initiated by afirm to enhance its relative competitive position(Ferrier, 2001; Ferrier et al, 1999; Smith et al,1991; Young et al, 1996). As noted above, we used



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308 W.J . FERRIER ET ALthe competitive actions and resultant actioncategories developed in previous competitivedynamics research (Ferrier, 2001; Ferrier et al.,1999). Using structured content analysis (Jauchet al., 1980), these authors identified and categor-ized the competitive actions of each firm into sixspecific action categoriespricing actions, market-ing actions, new product actions, capacity-relatedactions, service actions, and overt signalingactionsbased on the appearance of one of thekeywords listed in Table I in the headlines andabstracts of news reports found in the US series ofE&S Predicasts. The final data set contains a totalof 4617 product-market actions. Table 1 lists thekeywords used in the content analysis codingprocess and several example headlines from thenews reports.

As noted above, the selection of these categoriesis consistent with the view that business strategyinvolves the firm's collection of competitive tacticsthat includes, among other things: new products,service, warrantees, advertising, price policy, etc.(Covin and Slevin, 1991). Further, using thekeywords listed in Table 1, two academic expertsseparately re-coded a representative sample{N = 300) of actions into each of the six categorieslisted above. The reliability of this categorizationprocess was tested using Perreault and Leigh's(1989) index of reliability, which yielded an indexvalue of 0.91 indicating a high degree of reliability(Rust and Cooil, 1994).

Competitive aggressiveness. As noted above, ourdefinition of competitive aggressiveness accounts

for number of competitive actions carried out by firm in a given yea r, as well as the spe ed/delay witwhich the firm responds to rivals' competitivactions. Therefore, we calculated the number oactions as the total number of competitive actionthat a firm undertakes in a given year (Ferrier et at1999; Smith et al., 1997; Young et al., 1996).

For each firm in the sample, we calculateresponse speed/delay as the annual average in thnumber of days elapsed between the dates of eaccompetitive action carried out in a given year byfor example, the N o. 1 firm and the dates of thcom petitive action ca rried o ut by the No . 2 firmthat chronologically precede them. High scoreindicate, for instance, that the No. 1 firm is slow trespond to its rival 's competitive actions (morelapsed time between action and response); lowscores indicate that the No. 1 firm is quick trespond (less elapsed time between action anresponse). However, whereas previous researcmeasured response times within action-reactiodyads (e.g.. Smith et al., 1991), our measuraccounts for cases where a firm carried out twor more successive moves before its rival responded to the attacker's series of actions (seFerrier, 2000, 2001; Ferrier et al., 1999). In succases, we used the chronological midpoint in thiseries (i.e., uninterrupted sequence) of the firm'competitive actions to capture elapsed time.

Finally, we calculated competitive aggressivenesas the firm's number of competitive actions divideby its average response speed/delay. High scoresuggest that firms are competitively aggressive, a

Table I. ActionAction type

Types, Coding Keywords, and ExampleContent analysis coding scheme

HeadlinesExamples of headlines

Pricing actions

Marketing actions

Product actions

Capacity actions

Service actions

Signaling actions

Keyword.r. price, rate, discount,rebateKeywords: ads, spot, promote,distribute, campaignKeywords: introduce, launch,unveil, rolls out[with product or service]Keywords: raises, boosts, increases[with capacity or output]Keyword.^: service, warrantee,guarantee, financingKeywords: vows, promises,says, seeks, aims

FedEx offers rate discounts on 2nd dayshort haul serviceUnited launched ads to counterAmerican 's campaignMerck introduces Mevacor, to reduceserum cholesterol

Mobil raises lube stock capacity 10% viarecent improvementsSears offers KidVantage frequent buyerwarran tee programReebok's Fireman vows to retake lead inathletic shoe market by end 1995



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PERFORMANCE DISTRESS AND COMPETITIVE BEHAVIOR 309they carry out more total actions in a fast pace.Low scores indicate that firms carry out few totalactions and respond slowly.

Independent VariablesFinancial distress. Here, we used Altman's Z-score,which is a weighted composite of financialindicators relating to profitability, revenue, slackresources, and market return (Altman, 1968;Ch akra varth y, 1986) . Althou gh this is a com monpredictor of bankruptcy, it is also an importantmultidimensional measure of strategic perfor-mance (Chakravarthy, 1986). High Z-scores in-dicate a condition of strong financial health; lowZ-scores indicate financial distress. We used thelagged, reverse-coded Altman's Z-score (i.e., 1 X Z) as our measure of financial distress inour analyses. Data for this measure were collectedfrom Cotnpustat.

Market share erosion. Consistent with priorresearch, we calculated market share erosion asthe negative year-to-year change in percent of firmsales to total industry sales in the focal firm'sprimary industry (Caves and Ghemawat, 1992;Ferrier, 2001; Ferrier et al., 1999). This measurealso accounts for market share gain, measured asthe positive annual change in market share. Datafor this measure were also collected from Cotnpu-stat and Ward's Business Directory.Although our sample consists of market shareleaders (i.e.. N o. 1 or 2) within their respectiveindustries, it exhibits remarkable variation withrespect to both financial distress and market shareerosion. More specifically, of the 273 firm-yearsincluded in the analyses, we found Z-scores greaterthan 3.0 for 127 firm-years (54% of sample) andZ-scores less than 3.0 for 107 firm-years (46% ofsample). Prior research suggests that Z-scores of3.0 or lower signify cause for concern, whereasZ-scores of less than 1.8 suggest serious financial

crisis.Similarly, we found that market-leading firm inour sample experienced a loss of market share(avg. loss = 1.3 po ints , s.d. = 8.4 po ints ) in 111firm-years (47% of sample) and gained marketshar e (avg. gain = 1.3 poin ts, s.d. = 6.6 poi nts) in123 firm-years (53% of sample).Top management team heterogeneity. We usedWiersema and Bantel 's (1992) approach of mea-suring educational and functional heterogeneity todevelop a two-dimensional composite measure of

TMT management team heterogenei ty . Accord-ingly, we defined the TMT as those individuals atthe highest level of managementthe chairman,vice chairmen, CEO, president, CFO, andCOOas well as the next highest level identifiedby Dun and Bradstreet Reference Book of Corpo-rate Managements (1987-93 volumes).To calculate TMT educational heterogeneity,we used Blau's (1977) index of heterogeneityacross six different degree categories: business,science, liberal arts, engineering, law, and other.High scores suggest that the TMT is educationallydiverse. We also used Blau's index to calculatefunctional background heterogeneity, wherebyfunctional experience was categorized as engineer-ing /R & D, finance/accounting, legal, hum an re-sources management, manufacturing, logistics,purchasing, public relations, and general manage-

ment. High scores indicate that the TMT iscom posed of mem bers with different functionalbackgrounds .Consistent with prior research, we calculatedoverall TM T heterog eneity as the sum of the twostandardized individual TMT heterogeneity mea-sures noted above (see Amason et al. (1997), forthe conceptual arguments related to this compositemeasure; see Ferrier (2001), for an empiricalapplication). High scores for this compositeTMT measure indicate that the TMT possesses,overall, a diverse set of experiences, cognitiveperspectives, and backgrounds. Low compositeTMT scores suggest that the TMT's membersare similar with respect to experience andbackground .Competition-buffered industry environment. Thisconcept is represented as three distinct commonmeasures of industry growth and structure. Wecalculated a simple itulustry growth rate for eachindustry-year (year t) as the percentage changein industry gross sales from that of the previousyear (year / - 1) for each 4-digit SIC in dustr y.

We used a Herfindahl Index for industryconcentration for each 4-digit SIC industry foreach year over the 7-year time panel. Becausedifferent industries are likely to possess differententry barrier characteristics (Mueller, 1986), weused a composite measure of each industry'sbarriers to entry. This was calculated as thesum of the year-by-year pooled industrymeans for investments in R&D, selling activities,and total assets (Ferrier et al., 1999; Young et al.,1996).Copyright 2002 John Wiley & Sons, Ltd. Manage. Decis. Econ. 23: 301-316 (2002)


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310 W.J. FERRIER ET ALData used to calculate these industry context

measures were collected from Compustat andWard's Business Directory.

Control VariableTMT size. To control for the influence of TMTsize on decision-making processes, we included itas a control variable in the analyses. Consistentwith the definition of the TMT above, this wasrepresented as the simple count of TMT membersin each firm-year.

Tab le 2 reports the descriptive statistics andcorrelation coefficients among the variables in-cluded in the analysis.

ANALYSIS AND RESULTSBecause our data set is a cross-sectional timepanel, we used the PROC MIXED regressiontechnique in SAS, which allowed us to model thelinear regression error term of each model intoseparate components that account for serialcorrelation and random firm-level effects (Wolfin-ger et al., 1991). We report the estimates for bothfirm random error and serial correlation (ARl) foreach model in Table 3.

Tab le 3 repo rts the results for three sep aratemodels.^ Linear regression m odel 1 rep orts thedirect effects of each of the variables of interest,whereas moderated hierarchical regressionmodels 2 and 3 report the interaction terms.Both interaction models exhibit a predictiveand explanatory efficiency over and above thatof the less restricted model, as evidenced by a

significant chan ge in - 2 log likelihood (tested by significant chi-square value) relative to the direceffects of model 1. How ever, although the lv alu efor the interaction term s reported for m odels 2 an3 are meaningful, the lvalues for the direct effectvariables that comprise the interaction terms arinfluenced by the linear transformations (i.einteractions) of those variables (Cohen, 1978Therefore, we do not report the significance levelfor the direct effects variables in models 2 and 3 iorder to discourage unjustified interpretation othose variables.As argued above, we developed a set ocompeting hypotheses that facilitate a critical tesof the relationship between performance distresand competitive aggressiveness. In particulaHypotheses la and lb predicted that performancdistress and market share decline would b

positively related to competitive aggressiveneswhereas Hypotheses 2a and 2b predicted negative relationship between these dimensions operformance distress and competitive aggressiveness. Upon examination of the coefficients fofinancial distress (b = -0 .137 , p


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P E R F O R M A N C E D I S T R E S S A N D C O M P E T I T IV E B E H A V I O R .311

Table 3. Regression Results: Determinants of Competitive Aggressiveness (N = 234)"Model 1 Model 2 Model 3

Financial distressMarket share erosionTMT heterogeneityIndustry growthIndustry concentrationBarriers to entry*"TMT sizeInterceptInteraction termsFinancial distress x TMT heterogeneityFinancial distress x Ind. growthFinancial distress x Ind. concentrationFinancial distress x barriers to entryMa rket share erosion x TM T heterogeneityMarket share erosion x Ind. growthMarket share erosion x Ind. ConcentrationMarket share erosion x barriers to entryModel - 2 log likelihoodEst. of firm random errorAR(1)"Values are non-standardized coefficients accompanied by standard errors. One-tailed tests were used, which aredirectionally predicted in the hypotheses: V


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312 W.J. FERRIER ET ALthese firms carried out fewer total actions and wereslower to respond to (and initiate) cotnpetitiveattacks and challenges than high-performing firms.Thus , we believe that our focus on competitiveaction represents a significant step toward recon-ciling the conflicting views highlighted above.

However, our findings relating to the moderatedeffects of the performance-strategy relationshipconstitute one of the first empirical efforts toreconcile the current debate by exploring organi-zational and environinental contingencies. Inparticular, we found that although performance-distressed firms find themselves under pressure toimprove performance, those managed by hetero-geneous TMTs become more paralyzed thanperformance-distressed firms managed by homo-geneous TMTs. Consistent with prior research,heterogeneous TMTs are more likely to debateand less likely to develop a consensus about thecauses of and strategic responses to poor perfor-mance (Knight et al., 1999; Simons et al., 2000).Consequently, under crisis, heterogeneous TMTsare less capable of quickly deciding on andimplementing a sufficient number of competitiveactions and responses than homogeneous TMTs(Ferrier, 2001).

However, our findings involving the character-istics of the industry environment (as moderators)were generally opposite of expectations. Morespecifically, we reasoned that market-leading firms(performance-distressed or not) that competed incompetition-buffered industries would be les.smotivated to compete vigorously than firms thatcotnpeted in industries that were mature ordeclining, fragtnented, and were prone to attacksby new entrants. We expected that this orientationtoward complacency stemmed from the fact thattnanagers of market-leading firms believed thatperformance distress was perhaps a temporaryphenomenon and not generally attributed to thecompetitive pressures of the marketplace. Instead,we found that both high levels of industryconcentration and barriers to entry stronglymotivated managers of performance-distressedfinns to compete more as opposed to lessaggressively.In concentrated industries, market-leading firms(Nos. 1 and 2) are necessarily tnore 'd otn ina nt' intertns of market share held vis-a-vis lower rankedrivals than market-leading firms in fragmentedindustries. Similarly, given high barriers to entry,market-leading firms are not likely to be attacked

by new entrants. Consequently, managers operformance-distressed market-leading firms incompetition-buffered industries seem to makeboth internal and external attributions relatedto their distressed state. On the one handthey know they should be doing better, recognizing perhaps that past strategies have noyielded expected results. On the other handthey adopt the view that their direct competitorparticularly smaller firmsare eating theilunch, so to speak. This, in turn, may leadthem to adopt a 'competitor orientation' tharepresents a shift in the emphasis of theistrategy toward customers and especially rival(Armstrong and Collopy, 1996). Either way, crisibegets aggressive action.

High rates of industry growth, however, reinforced manager's complacency orientationConsistent with our predictions, performancedistressed firms competing in growth industriewere far mo re docile than perform ance-distress edfirms in low-growth or declining industries. Apparently, managers perceive growth as rootn-forall, thereby dampening the motivation to takeaggressive corrective strategic action followingpoor performance.

Overall, our findings relating to the impact oindustry context on strategy suggest that managerperceive, process, and act upon signals within theenvironmental context differently, as suggested inrecent research (Chattopadhyay et al., 2001)Future research could perhaps combine oueinphasis on actual competitive behavior with amanagerial cognition approach to flesh out theattributions and motivations associated withdecline and subsequent competitive behavior in amore fine-grained and focused tnanner.Our study contributes to the advancement ostrategy theory in two important respectsAlthough different theoretical optics have indeedadvanced the debate as to the impact of performance on firm behavior, the literature has heretofore lacked a point of integration andconvergence between these disparate perspectivesBy incorporating a contingency perspectiveour study represents a new effort toward thuntangling of the cotnplex ways that ex antperformance motivates competitive behavior. Importantly, we find that depending on key factorrelating to the firm's organizational and environrnental context, either of the competing theoriehighlighted above is valid.

Cop yright 2002 John Wiley & Sons, Ltd. Manage. Decis. Econ. 23: 301-316 (2002


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PERFORMANCE DISTRESS AND COMPETITIVE BEHAVIOR 313Second, our study helps to bridge the gap

between theory development and empirical testingof the performance-competitive behavior relation-ship by using constructs and measures that hadnot been previously combined. As such, our studyis among the first to empirically test the direct andmoderating relationships between financial distress(Z-score), market share erosion, elements of thefirm's organizational and environmental context,and a firm's actual competitive behavior.

Managerial ImplicationsOur results also offer new insight for managersregarding the consequences of prior success ordecline. For example, there is little doubt thatmanagers of distressed firms face pressures toimprove performance. However, consistent withthe predictions of threat-rigidity theory, forexample, we find broad support for the notionthat performance-distressed firms are likely tobecome competitively docile, as they focus in-wardly toward financial and efficiency concerns(D'Aveni, 1989). Yet, our findings suggest thatmanagers should consider how both the industryand organizational context impact performance-distressed firms' ability and motivation to competeaggressively. For instance, TMT heterogeneityreinforces and magnifies the general threat-rigidityresponse. Indeed, as Jackson (1992) argues,heterogeneous teams better at creating, homoge-neous teams better at deciding. So, when con-fronted with a performance-distressed com petitor,for example, managers should base their expecta-tions of the rival's competitive behavior, in part,on whether the TMT has the capability to quicklyand confidently decide on a set of strategicresponses while maintaining a focus on themarket .

By contrast, important industry characteristicsseem to negate the threat-rigidity response to poorperformance. In other words, market-leading firmsthat experience poor performance while competingin competition-buffered industriesco nditionsthat, for all intents and purposes, should favorsuccessare strongly motivated to compete ag-gressively in an attempt to facilitate a rebound.These findings are consistent with some discussionin the popular press. For example, it is thefinancially distressed airlines that 'create evengreater havoc' by intensifying the competitivepressures within the industry {Fortune, March 23,

1992, p. 70). Indeed, the airlines industry may becharacterized as being somewhat concentrated andhaving relatively high barriers to entry.

Limitations and Avenues for Future ResearchAlthough this research advances our understand-ing, it also has limitations. First, we examinedbroadly defined characteristics of the industry andorganizational context as potential moderators ofpast performance on competitive behavior. Ac-cordingly, we opted for increased breadth, simpli-city, and generalizability by selecting these generalfactors in lieu of an in-depth treatment of any oneparticular context area or domain. Future researchshould fruitfully examine how either industrystructure and/or firm characteristics moderate theeffects of financial condition on competitivebehavior in a more fine-grained and detailedresearch design.

Second, our research sample includes large,market-leading firms. Further, firms in our sampleare not broadly diversified. One obvious extensionwould be to study the relationship between pastperformance and competitive behavior in smallerfirms. Or, future studies could explore the compe-titive relationship between small, niche-playingfirms and large, distressed firms. Also, perfor-mance distress may not be uniform across all of adiversified firm's geographic or business units.Future studies could explore, for example, theextent to which business unit performance impactsstrategic maneuvering and resource diversion (e.g.,M c G r a t h et al., 1998) or purposeful multimarketcontact (e.g., Gimeno, this issue).

Third, concentrating on a broad set of compe-titive actions limits our ability to examine specifickinds of competitive behavior among rivals (suchas pricing behavior) in greater detail. This wouldalso be another direction in which to extend theresearch. Another natural extension would be toaddress a greater variety of contingency variables.Some possible variables to consider includeindicators of strategic turnaround and corporategovernance. Furthermore, future research mightexamine non-linear relationships between perfor-mance and competitive behavior.In conclusion, our findings suggest that a firm'spast performance is an important predictor of itscompetitive behavior. However, our results alsosuggest that the relationship is very complex and



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314 W.J. FERRIER ET AL.depends, in part, on important organization- andindustry-level conditions.

NOTES1. An earlier version of this paper was presented at theAcademy of Management Annual Meeting, August1998, Business Policy and Strategy Division, SanDiego, CA.2. A ltm an 's Z-score is calculated as follows: Z = 0.012X\ + 0.014^-2 + 0.033^-3 +0.0 06X , + 0.999^5 , whe re,X\ = Working Capital/Total Assets; X2 = RetainedEarnings/Total Assets; X^ = Earning Before Interestand Tax/Total Assets; X4 = Market Value of Equity/Book Value of Liabilities; an d A's = Sales/T otalAssets.3. We also ran each of these models using the majorcomponents of Altman's Z-score: ROA, working

capital to total assets, and equity to debt. In eachcase, at least two Z-score components producedresults consistent with those reported in Table 3.We also ran these models using the two individualcomponents of the composite TMT heterogeneitymeasure: functional heterogeneity and educationalheterogeneity. In each model, at least one of theinteraction terms involving functional and educa-tional heterogeneity was significant and consistentwith our reported results.

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the impact of performance distress on agressive competitive behavior

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