The Limited Shock Value of a Growth Strategy
When countries are hit by economic shocks, individual firms can sit still, retrench to try to ride out the storm, or grow to improve their market position. While some evidence suggests reconfiguring for growth during a shock improves firm performance, Abhirup Chakrabarti of Smith School of Business offers a cautionary tale. His research, focused on manufacturers reacting to the Asian economic shock of 1997, shows that firms trying to gain an edge by growing were more likely to fail during shocks. As well, retrenching firms were no more likely to survive than were firms that stood still.
Country-wide economic shocks are game-changing events for companies, testing the mettle of even the most agile of corporate leaders. As unanticipated and disruptive changes to the external environment, shocks present both threats and opportunities: demand may dry up or capital become scarce yet distressed competitors can be acquired on favourable terms.
In such situations, firms that don’t want to sit still can reconfigure in one of two ways: retrench to try to ride out the storm or grow to improve their market position. Some evidence has shown that reconfiguring for growth during a shock improves firm performance. For Abhirup Chakrabarti, assistant professor of strategy and organizations at Smith School of Business, this evidence is puzzling. After all, economic shocks involve a collar-tightening period of capital constraint, shrunken markets, and disrupted supply chains. This is precisely when radical organizational change such as growth could, at least in the short term, limit greater efficiencies and increase the risk of firm failure.
“Firms trying to grow often make it worse for themselves,” says Chakrabarti. “Target’s timing coming into Canada is one example. It’s not an easy thing to do when times are good, so how can it be an easy thing when the effect of a recession is still in our minds?”
Lessons from the Asian Shock of 1997
Chakrabarti set out to empirically examine the restructuring strategies observed during deep downturns. His study looked at the performance of manufacturing firms based in seven Asian economies between 1994 and 1999, just before and after the Asian economic shock of 1997. It looked at relationships among growth reconfiguration, firm performance, and firm survival.
His study found that both growth and retrenchment strategies had limited value. But, interestingly, firms trying to gain an edge by growing were more likely to fail during shocks, while retrenching firms were no more likely to survive than were firms that stood still.
Chakrabarti dug deeper by introducing variables such as financial slack, the level of diversification, and the maturity of the host country’s governing and legal institutions.
He found that firms with greater financial slack and less diversified operations as well as those operating in countries with mature legal and governing systems were more likely to access growth opportunities during shocks.
But this well-meaning strategy did not guarantee positive outcomes. Firms trying to grow that had limited financial slack and that were less diversified were particularly hard hit during the Asian economic shock. On a positive note, firms operating in institutionally developed environments were more likely to grow during the shock, and were less at risk of firm failure following the shock.
How Quickly Will Growth Strategies Kick In?
Chakrabarti says asset growth during economic shocks can be seen as a defensive rather than aggressive strategy; it’s often about positioning the firm for the post-shock world. “But they have to keep in mind that to pursue this requires a financial commitment, and there’s a lag,” he says. “You spend the money first and the dividends come much later. That’s where things can get messy.”
Chakrabarti is interested in extending his study to determine what happens when a firm experiences economic shock a second time. How did its leaders interpret past events? “We’ve already found that the second time the shock hit, they were very careful about growth because they learned the lesson,” he says.
He is also in the process of developing a study of the Canadian environment. Canada has experienced five external economic shocks over the past 35 years: tight credit controls in the U.S. in 1980; the Gulf War in 1990; the technology shock in 2001; the housing bubble in 2008; and the oil price shock in 2014. (OECD countries experienced 122 recessions between 1960 and 2007, 20 of which involved a sudden stop in capital flow.)
Canadian firms are among the most avid acquirers in the world but the results are less than positive. Data that Chakrabarti examined suggest that the financial performance of Canadian firms has fallen steadily over the decades while business failure rates have risen. He suspects recurrent shocks may have catalyzed this decline, but also that organization-level resilience could be a foundation of overall economic resilience to external shocks.
— Alan Morantz