Embracing the Second Best? Synchronization of Reform Speeds, Excess High Discretion Slack, and Performance of Transition Economy Firms

• Published date: 01 May 2014
• Date: 01 May 2014
• DOI: http://doi.org/10.1111/j.2042-5805.2014.1075.x

EMBRACING THE SECOND BEST?

SYNCHRONIZATION OF REFORM SPEEDS, EXCESS

HIGH DISCRETION SLACK, AND PERFORMANCE OF

TRANSITION ECONOMY FIRMS

ELITSA R. BANALIEVA*

International Business & Strategy Group, D’Amore-McKim School of

Business, Northeastern University, Boston, Massachusetts, U.S.A.

I extend the institution-based view by adopting a horse race perspective on pro-market reforms.

Specifically, I study how the synchronizationof reform speeds (the extent of coordination across

a country’s reform rates of implementation) affects the performance of transition economy

firms. I suggest that synchronized faster reforms (the horse race) yield mutually reinforcing and

complementary benefits that enhance firm performance. Additionally, I propose that greater

excess high discretion slack (the degree of internally generated excess liquidity a firm has after

external demands on the firm’s financial resources are met) further strengthens this positive

relationship because it allows firms to pursue aggressively the market opportunities that

proliferate in the rapidly transforming economy. Tests on a sample of 211 firms from 14

transition economies during 1991 to 2009 support this framework. Copyright © 2014 Strategic

Management Society.

INTRODUCTION

‘One cannot cross an abyss in two jumps.’

David Lloyd-George, British Prime Minister

(Dajani, 2005: 113)

The fall of communism in the early 1990s trig-

gered a formidable institution-building effort across

many countries. To transition from their centrally

planned heritage to a free enterprise system, for-

merly communist countries had to embark on estab-

lishing market-based institutions from scratch

(Bevan, Estrin, and Meyer, 2004; Kriauciunas and

Kale, 2006). To achieve this, the transition econo-

mies adopted pro-market reforms: policies designed

to enhance market principles in key areas like enter-

prise restructuring, trade and financial liberalization,

and infrastructure development (Bevan et al., 2004;

EBRD, 2010). Consequently, some countries gal-

loped into a horse race of ‘radial’ reforms (i.e.,

‘achieving proportional reductions in all distortions

at the same time,’ Braga de Macedo and Martins,

2008: 142), and proceeded by implementing simul-

taneous faster (i.e., synchronized faster) or gradual

(i.e., synchronized slower) reforms.1Yet other coun-

tries implemented some reforms much faster (i.e.,

asynchronized faster) or much slower (i.e.,

asynchronized slower) than the rest of the reforms.

These different rates of transition have been

debated. First, economists have questioned whether

a rapid (shock therapy) or gradual speed of reform is

Keywords: institution-based view; synchronization of reform

speeds; excess high discretion slack; performance; transition

economy firms

*Correspondence to: Elitsa R. Banalieva, International

Business & Strategy Group, D’Amore-McKim School of

Business, Northeastern University, Boston, MA 02115-5000,

U.S.A. E-mail: e.banalieva@neu.edu

1For greater clarity of presentation, I use ‘reforms’ and ‘pro-

market reforms’ interchangeably.

Global Strategy Journal

Global Strat. J., 4: 104–126 (2014)

Published online in Wiley Online Library (wileyonlinelibrary.com). DOI: 10.1111/j.2042-5805.2014.1075.x

Copyright © 2014 Strategic Management Society

better for countries. Some have argued that shock

therapy prevents reform reversals and allows for a

big enough jump over the institutional abyss

(Havrylyshyn, 2007; Lipton and Sachs, 1990).

Others have countered that gradual reforms secure a

longer adjustment period (Godoy and Stiglitz, 2007;

Murrell, 1992). Second, economists have also

debated if different scopes of reforms (i.e., the extent

of implementation of free market principles in a

country in a given year) are complementary such that

‘the return of doing one reform is enhanced when

other reforms are in place’ too (Braga de Macedo

and Martins, 2008: 142). While some have noted that

countries can reach a ‘first best’ outcome from pur-

suing such a coordinated strategy of radial shock

therapy throughout the economy (Braga de Macedo

and Martins, 2008; Chang, Kaltani, and Loayza,

2009; Gates, Milgrom, and Roberts, 1996; Rocha,

2009), others have suggested that countries can

embrace the ‘second best’ outcome of coordinated

gradual reforms if the first best outcome is unreach-

able (Foster and Sonnenschein, 1970; McKinnon,

1993).

While these debates have persisted at the country-

level, strategy research has duly noted that ‘improv-

ing knowledge about firm behavior in these

[transition economy] countries has become more

important both for theory and practice’ (Kriauciunas

and Kale, 2006: 661). How the synchronization of

reform speeds (extent of coordination across a coun-

try’s reform rates of implementation since start of

transition) affects firm performance remains

underexplored in extant literature (Gates et al.,

1996). The few existing empirical firm-level studies

have focused on reform scope (Chari and David,

2012; Cuervo-Cazurra and Dau, 2009; Park, Li, and

Tse, 2006), suggesting it can increase firm perfor-

mance due to improved incentive mechanisms

(Cuervo-Cazurra and Dau, 2009; Park et al., 2006)

or hurt the persistence of superior profits due to

increased competition (Chari and David, 2012).

The scope of reforms offers a snapshot of a coun-

try’s institutions, as it does not capture the extent of

coordination across the reform rates of implementa-

tion (i.e., the synchronization of reform speeds). In

line with recent management research (e.g., Jones

and Coviello, 2005), I suggest that the synchroniza-

tion of reform speeds provides a useful evolutionary

understanding of how pro-market reforms since the

start of transition have affected the performance of

firms continuing their existence under the new

market reality. In so doing, this article addresses an

important call in the literature, noting that time is

‘seldom positioned as a primary conceptual dimen-

sion to which explicit behavior may be tagged and

understood’ (Jones and Coviello, 2005: 288).

Accordingly, the central research question of this

article is: how the synchronization of reform speeds

affects the performance of transition economy firms

that have continued existing under the new market

reality. In analyzing this question, I extend the

institution-based view of the firm (Meyer et al.,

2009; Peng, Wang, and Jiang, 2008) by adopting a

horse race perspective of the pro-market reforms in a

country’s reform portfolio. Furthermore, while the

institution-based view has emphasized that institu-

tions matter, it has paid less attention to how transi-

tion economy firms adapt to their changing

institutional environments. In fact, ‘interactions

between national economic institutions and enter-

prise level organizational strategies are still under-

researched’ (Bevan et al., 2004: 44). Hence, I also

study how these firms adapt to the synchronization

of reform speeds through a specific mechanism: i.e.,

by balancing the internal supply of financial

resources with the external demand on these

resources, which I refer to as excess high discretion

slack.

SYNCHRONIZATION OF REFORM

SPEEDS AND PERFORMANCE OF

TRANSITION ECONOMY FIRMS

Prior research on the institution-based view of

the firm

The institution-based view has emphasized that

institutions matter for firms’ strategies (North, 1990;

Peng et al., 2008). The institution-based view

becomes particularly relevant in transition econo-

mies, as they were once under government control

and the state had to establish market-based institu-

tions from scratch. Pro-market reforms are the

mechanism through which countries have been

accomplishing this institutional transition to a free

enterprise system. Specifically, pro-market reforms

are policies that promote ‘macroeconomic stability,

market economy, and outward orientation’

(Williamson and Haggard, 1994: 529). They aim to

reduce the active involvement of the state in the

economy and open the country to market-based

supply and demand mechanisms (Williamson,

1990).

Synchronization of Reform Speeds 105

Copyright © 2014 Strategic Management Society Global Strat. J., 4: 104–126 (2014)

DOI: 10.1111/j.2042-5805.2014.1075.x