Determinants of Firm Performance: The Relative Importance of economic and Organizational Factors TORIo Gary S. Hansen; Birger Wernerfelt Strategic Management Journal, Vol. 10, No 5(Sep. -Oct., 1989), 399-411 Stable url: http://links.jstor.org/sici?sici=0143-2095%02819890 10%2910%3A5%3C399%3 ADOFPTR%3E20CO%3B2-A trategic Management Journal is currently published by John Wiley Sons Your use of the jStOR archive indicates your acceptance of JSTOR,'s Terms and Conditions of Use, available at http://www.jstor.org/about/terms.htmlJstOr'sTermsandConditionsofUseprovidesinpartthatunlessyou have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://wwwjstor.org/journals/jwiley.html Each copy of any part of a STOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission jStOR is an independent not-for-profit organization dedicated to creating and preserving a digital archive of scholarly journals. For more information regarding JSTOR, please contact support @ jstor. org http://www」]stor.org Wed nov204:08:03200
Strategic Management Journal, Vol. 10, 399-411(1989) DETERMINANTS OF FIRM PERFORMANCE: THE RELATIVE IMPORTANCE OF ECONOMIC AND ORGANIZATIONAL FACTORS GARY S HANSEN Graduate School of Management, University of Washington, Seattle, Washington U. SA BIRGER WERNERFELT Alfred P. Sloan School of Management, Massachusetts Institute of Technology, Cambridge, Massachusetts, U.S.A We decompose the inter firm variance in profit rates into economic and orga e model from each paradig we find that bol actors are of firm performance. Further findings are the ects are d that organizational factors explain about twice 如 INTRODUCTION Theory or empirical evidence of linl performance abound within each paradigm, but In the business policy literature there are two surprisingly little has been done to integrate the major streams of research on the determinants two and evaluate the relative effect of each on of firm performance. One is based primarily firm profitability. Notable exceptions are recent importance of external market factors in deter- kani (1988), Miller (1986), White(1986), White mining firm success. The other line of research and Hammermesh(1981), and Lenz(1981), who builds on the behavioral and sociological paradigm discussed and/or evaluated a limited number of and sees organizational factors and their fit with contingent relationships between economic and the environment as the major determinants of administrative factors. No work has been done success. Within this school of thought, little direct however, to assess the relative importance of attention is given to the firms competitive these two sets of explanatory factor position. Similarly, economics traditionally has In h an integrated disregarded factors internal to the firm. examination of firm profitability. Utilizing a d behavioral data base I The following statement, from Buzzell and Gale(1987), is we construct and test three models of firm typical. 'Our treatment of strategy is also confined to performance, first an example from an economic In contrast, some other elements of strategies cannot be perspective, second an example from an organi- dimensions that can be measured in reasonably clear terms readily measured, or perhaps measured at all. There has zational perspective and the third an integration differences unquestionably affect performance. But we know economic and organizational componen to its ms of their cultures, and such the inter-firm variance in prc of no way to measure the key policies, management Before describing the study we would like to or personality factors that shape corporate cultures. make two things clear. First, we do not propose that would be equally difficult to quantify or even to synthesize all economic and organizational theories of firm performance. We have taken an 0143-2095/89060399-13506 Received 17 September 1987 C 1989 by John Wiley Sons, Ltd Revised /7 January 1989
400 G. S. Hansen and B. Wernerfelt example from each class of models. We will argue considered in the literature, We divide these into that these examples are somewhat representative the three classes mentioned above. Each is but they are, nonetheless, only examples. Readers discussed in turn simplistic may well expect a more complex ample to capture more of the variance in firm Industry variables profits. This problem of selecting a representative A long tradition, most often associated with Bain model seems particularly acute for the organi -(1956) is concerned with identifying properties e because of its numerous of industries contributing to above-average pre theories and levels of analysis found in the itability. A large set of variables (growth, literature, but that model actually does better in concentration, capital intensity, advertising inten our sample. Second, we use accounting rates of sity, etc. ) have performed differently in different return as our measure of performance. Within studies, but the overall importance of these the economic tradition these have been the factors is beyond dispute(Ravenscraft, 1983). In subject of some debate(Bentson, 1985), but they a study such as ours, where interest is focused are still commonly used, and arguments have on the importance of industry per se, rather than been raised in their defense(Long and Ravens- on characteristics of more or less attractive craft, 1984; Jacobson, 1987). The choice of profit industries, the effect of industry can be captured rates is less obvious vis-a-vis the organizational by the average industry profits. A recent study literature. While profits have been used within by Schmalensee (1985) shows that differences that tradition, so has a large number of other between industries as measured by average concepts of performance(e. g. satisfaction, sur- industry return on assets account for almost vival, etc. ) If the organizational model had all the explained variance in business unit erformed less well, this would have been a performance serious problem In the next two sections we present economic and organizational models. We then Variables relating the firm to its competitors describe our data and give the results, ending The key member of this class is relative market with a discussion of the implications of our share, a variable which has been widely used in findings strategy and is emphasized PIMS(PIMS, 1977; Buzzell and Gale, 1987) Originally perceived as the source of market ECONOMIC MODEL OF FIRM power(Shepherd, 1972) market share and more PERFORMANCE specifically relative market share as viewed for this study serves as a proxy for some firm-specific Industrial organization economics has proven relative competitive advantage resulting from extremely useful to researchers of strategy content learning effects and other firm specific assets in providing a basic theoretical perspective on(Karnani, 1984) the infiuence of market structure on firm strategy nd performance. While there is a range of inants of firm-level Firm variables profitability include: (1)characteristics of the We complete our model with firm size. This industry in which the firm competes;(2) the most often interpreted as a source of organi firms position relative to its competitors; and(3) zational costs(Shepherd, 1972), or X-inefficiencies the quality or quantity of the firm's resources. (Leibenstein, 1976). From a strategy perspective Scherer (1980: Ch. 9) surveyed many of the we note that size also may be an indicator of pecific models of both industry- and firm-level diversification, which by and large has been performance, and Porter's review(1981)describes found to affect performance negatively(Rumelt he influence of the IO paradigm on business 1982; Porter, 1987; Wernerfelt and Montgomery Our economic model, while only an exampl Overall, the typical economic model of firm includes several of the explanatory variables performance explains from 15 to 40 percent of
Determinants of Firm Performance the variance in profit rates across firms. Apart be over-differentiated in one area and under from random effects. measurement errors, and differentiated in another, but on the whole be o forth, one can suggest at least three expla- just about right? In contrast, firm performance nations for the remaining variance. First, there is an aggregate phenomenon may be important economic variables, the extent One research stream which has attempted to of which cannot be measured (e. g. assets that capture the multidimensional aspect of these are specific to an industry or a trading partner). significant organizational ph Second, the true' model may be such that of structure, motivation, group dynamics, job intervening economic variables differ from case enrichment, decision-making, leadership, goal to case, making aggregate analysis difficult. Third, setting and planning, etc.is that of organi- with very few exceptions (e.g. Armour and zational climate. Long a prominent concept Teece, 1978), organizational factors are not within the organizational sciences, organizational considered in this literature climate was originally defined as follows The concept of climate provides a useful bridge ORGANIZATIONAL MODEL OF FIRM between theories of individual motivation and PERFORMANCE behavior. on one hand. and organizational theories, on the other. Organizational climate, as defined here, refers to the perceived subjective Perhaps even more than their economist counter- effects of the formal system, the informal parts, organizational researchers have developed tyle of the managers and other important a wide variety of models of performance. While environmental factors on the attitudes, beliefs, are rich in the breadth and depth of their studies 1900,)ular oa dons of the people who work the organization behavior and theory literatures of organization structures, systems, and people, the variety of conjectures and empirically tested And more recently as models makes aggregation difficult. For example just determining the appropriate construct of the perceived properties or characteristics found performance or effectivene in the work el vironment that result from ranging from employee satisfaction to shareholder actions taken consciously or unconsciously by wealth(Cameron, 1986; Goodman and Pennings an organization and that presumably affect ubsequent behavior(Steers and Lee, 1983: 82) 1977; Steers, 1975). In broad terms this stream of research suggests that managers can influence Just as geographic regions have different the behavior of their employees(and thus the climates' as a result of the immediate interaction performance of the organization) by taking into of t account factors such as the formal and informal rain/snow to make them favorable or unfavorable structure, the planning, reward, control and climates for living, so can a firm have as the information systems, their skills and personalities, interaction of its facilities, structures, systems and the relation of these to the environment That and people a favorable or unfavorable work is, managers influence organizational outcomes by climate establishing context, and that context is the 196Os. and still a major result of a complex set of psychological, sociologi- concept today, climate uniquely refers to a broad cal. and physical interactions class of organizational and perceptual variables The difficulty in working with such multifaceted that reflect individual-organizational interactions developing, collecting and aggregating appro- Steers and Lee. 1983: Field and Abelson.1982 priate measures(Bonoma, 1985; Bower, 1982). James and Jones, 1979; Schneider,1975;Litwin Many constructs within the literature are ditficult and Stringer, 1968). It is important because it to measure and those which are relatively easier provides a conceptual link between analysis at to capture are otten at the micro (individual) the organizational level and at the employee level. For example, can we say that a firm on vel, precisely the requirements of this stud the whole is bureaucratic just because it has Unlike objective measures of organization everal levels to its hierarchy? Can a firr ructures such as 'M-form' or systems such
402 G.S. Hansen and B. Wernerfelt capital budgeting policies, climate as measured climate across departments in the by employee response to questionnaires reflects zation, the departmental effects are much weaker the individual's per ceptions of that employe 41-42) organizational effects(Drexler, 1977 han ti bout the effect or presence or nature of certain organizational phenomena. Climate is not tructure-size,production processes, arrange Denison(1982), using the same climate instru ments, or number of levels. Structure may ment with substantially more firms, also demon influence human behavior, but it is not necessary strated that climate measures were more appro- to examine human behavior to describe an priate at the organizational level rather than at organization's structure. Additionally, the same the group or individual levels. Glick's(1985) structures in different organizations may produce review of the psychological and organizational very different climates (Springer and Gable, climate literature and the empirical corrections 980)as structure is only one of the many he makes to Drexler's work leads him to conclude factors that significantly infuence the worker's Thus, the concrete conclusion is that Drexler's Numerous studies have demonstrated how reliable measures of organizational clima.a- perceptions of his or her work environment aggregated perceptual measures are indee changes in organizational structures, systems and Given constraints on data access it was not practices have altered climate measures and possible to duplicate the above tests for this hence individual performance(Pritchard and study; nor was it deemed necessary, given these Karasick, 1973; Litwin and Stringer, 1968; For- prior tests of the same instrument shand and Gilmer, 1964). Lawler et al.(1974) Of course, there are many competing theories studied 117 research laboratories and demon- and concepts of firm-level performance and no strated that both organizational structure(span of single construct has emerged in the literature control, size, levels) and organizational processes We will interpret a positive association between (performance reviews, budgeting, collaboration) overall firm climate and profitability as support re more closely associated with climate meas- for one theory of organizational determinants of ures than with performance(both subjective and performance. It is possible to interpret the climate objective) measures, and that organizational scores in light of competing theories. That is climate was directly linked to performance. Other high climate scores may indicate that the key more clinical efforts have shown linkages between contingencies are satisfied, or that corporate managerial practices and attributes or dimensions culture is appropriate to the environment, etc of organization climate and firm performance (Denison, 1984). If one subscribes to such an ditional climate model of firm performance from our models are biased towards zero. We To empirically validate that climate was indeed use the climate data because they have some a firm-level construct, Drexler(1977)examined significant history in the literature 1256 work groups representing 6996 individuals many elements of organizational phenomena,are 21 organizations to test the strength of the appropriate for analysis at the firm level,are organizational climate construct at the organi- largely infuenced by managerial actions and are zational level rather than at a departmental available for a reasonable number of representa or some sub-organizational level. His findings tive firms strongly support the use of our measures of organizational climate for firm or organizational analvSIS DATA AND MEASURES The results reported in this study should encour- The sample includes 60 Fortune 1000 firms ge those researchers who consider organi representing both dominant and lesser members zational climate to be an organizational attribute A large share of the variance in measures of of the ese firms togetl limate that describe organization-wide cor comprise over 300 lines of business as determined at the four-digit SIC level. While the sample is While there are differences in organization not large, it is clearly representative of major