Organizational Decline and its Effect on Investments in Innovation

Table of Contents

List of Tables and Figures

List of Abbreviations

1 Introduction
1.1 Organizational Decline
1.2 Organizational Innovation
1.3 Problem Statement and Research Questions
1.4 Analysis Plan and Value Added
1.5 Structure of the Study

2 Theoretical Foundations of the Decline-Innovation Relationship
2.1 Necessity is the Mother of Rigidity
2.2 Necessity is the Mother of Invention
2.3 Necessity – Mother of Invention or Rigidity?
2.3.1 Linking Organizational Decline and Innovative Activities
2.3.2 The Moderating Effect of Threat of Bankruptcy
2.3.3 The Moderating Effect of Organizational Slack

3 Research Design and Methodology
3.1 Research Design
3.2 Sample Selection and Data Collection
3.3 Variables
3.4 Analysis Procedure

4 Results
4.1 Univariate Analysis
4.2 Bivariate Analysis
4.3 Multivariate Analysis

5 Discussion and Conclusion
5.1 Theoretical Implications
5.2 Practical Implications
5.3 Limitations and Future Research
5.4 Conclusion

References

Appendix

List of Tables and Figures

Table 1: Sample Composition by Industry

Table 2: Overview Variables

Table 3: Overview Regression Models

Table 4: Descriptive Statistics

Table 5: Correlation Matrix

Table 6: Regression Results for Change in RD Search Intensity

Table 7: Determinants of Investments in Innovation (1980 – today)

Table 8: Effects of Organizational Decline (1980 – today)

Figure 1: Conceptual Model

Figure 2: Output Kruskal-Wallis Test

List of Abbreviations

illustration not visible in this excerpt

1 Introduction

“Failure is the fact of life from which most organizations cannot escape […]. Yet, while most managers know they are at risk of failure, they try to shun the subject, rather than actively seek to guard against it” (Wilkinson Mellahi, 2005, p. 233).

Despite the fact that far more organizations fail than succeed in the course of years, the study of organizational decline and failure has always been considered subordinate in contrast to organizational success (Hughes, Hughes, Morgan, 2010; Mellahi Wilkinson, 2010). For that reason and due to the latest global economic crisis that has thrown corporate decline and failure into sharp relief (Gillespie Dietz, 2009), the study at hand attempts to shed more light on corporates’ reactions to organizational decline. More precisely, this work investigates firms’ research and development (RD) spending behaviour in response to performance below aspirations.

The following chapter provides a general starting point for the present analysis. It introduces the fundamental subject areas of organizational decline and innovation with regard to the purpose of the study and portrays the problem statement as well as the analysed research question. Furthermore, it gives an initial insight into the analysis plan and displays the added value of the study. Finally, this introductory part informs about the subsequent structure of the study.

1.1 Organizational Decline

In the academic literature, there is no generally accepted definition of organizational decline (Whetten, 1987). Accordingly, various terms such as organizational death, exit, retrenchment, setback, or failure have been used interchangeably to describe the antonym of corporations’ growth and success (Mellahi Wilkinson, 2004, 2010). While most scholars refer to the construct of organizational decline as a decrease in a firm’s resource base (Cameron, Whetten, Kim, 1987; D'Aveni, 1989; Filatotchev Toms, 2003; Trahms, Ndofor, Sirmon, 2013; Whetten, 1987), others consider it as a deterioration in a firm’s adaptiveness to its environment (Greenhalgh, 1983; Greenhalgh, Lawrence, Sutton, 1988; Weitzel Jonsson, 1989), a reduction in a firm’s legitimacy (Carmeli Schaubroeck, 2006), or a downturn in size and performance (McKinley, 1987). Despite this broad range of definitions, there is still a common thread concerning the meaning of decline as a situation that threatens a firm’s capacity to act, increases its vulnerability and consequently endangers its (long-term) viability.

Following this overall understanding of organizational decline and referring to Mellahi and Wilkinson (2010) as well as Schick and Ponemon (1993), this study defines organizational decline as a deterioration in a firm’s ability to compete in its environment and an associated performance downturn below a (perceived) critical threshold that may threatens its viability. This broad definition integrates several crucial characteristics and assumptions: First, it distinguishes decline from downsizing. In this study, organizational decline is understood as an involuntary, unintended decrease in firms’ resources and performance, whereas downsizing involves reductions in business size and scope based on intentional decisions made by managers (D'Aveni, 1989; McKinley, Latham, Braun, 2014). Second, it draws a distinction between organizational decline and crisis. While a crisis is characterised by firm conditions close to demise (D'Aveni, 1989), organizational decline merely signifies that performance has fallen short of a reference level such as firms’ last year results or competitors’ performance (Greve, 2003). Thus, organizational decline cannot generally be equated with organizational crisis, even though it may evolve into a life-threatening situation. Third, the definition avoids anticipating the final outcome of a decline situation. Although decline generally has negative impacts, its consequence depends on how it is managed and may be positive, i.e. organizations may learn from decline and come out of it strengthened (Miner, Kim, Holzinger, Haunschild, 1999). Finally, the causes of decline are not specified by the definition. Consequently, decline situations may be caused by both organizational and environmental factors (Mellahi Wilkinson, 2004).

The research on organizational decline had not been very comprehensive before Whetten (1980) called for more research on this “important and ultimately unavoidable concern of organizations” (p. 577). Responding to this exhortation, however, literature on firm decline has grown exponentially. While the majority of studies published in the 1980s are theoretical treatises on the definition and framework of decline (Cameron, Kim, Whetten, 1987), empirical examinations have been prevailing since the 1990s. These works focus predominantly on three topics: the causes of organizational decline, the consequences of organizational decline, and the responses to organizational decline (Bozeman, 2010; Mone, McKinley, Barker, 1998).

Scholars usually agree that the causes of decline originate either from a firm’s external or internal environment (Morrow Jr, Sirmon, Hitt, Holcomb, 2007; Short, Ketchen, Palmer, Hult, 2007) and that the consequences of decline are characterized by a diminished effectiveness as well as a low employee satisfaction and commitment (Cameron, Kim, et al., 1987; Whetten, 1987). In terms of firms’ response to decline, however, various research streams evolved. While some scholars directed their attention to layoffs (Brockner, 1992) or increases in structure and process flexibility (Rosenblatt, Rogers, Nord, 1993), other focused their investigations on retrenchment and strategic actions (Ndofor, Vanevenhoven, Barker, 2013). Yet another research stream is concerned with managers’ consideration of investments in innovation as a suitable factor to face organizational decline (e.g. Bolton, 1993; Bowen, Rostami, Steel, 2010; Chen, 2008; Greve, 2003; Latham Braun, 2009).

1.2 Organizational Innovation

Organizational innovation, which is highly correlated with firms’ RD search intensity (Ulku, 2007), is typically considered as a facilitator for the modification of organizational routines (Chen Miller, 2007). Thus, it is essential for firm’s adaptation to environmental as well as for firm renewal (Nohria Gulati, 1996). In this manner, innovation improves a firm’s effectiveness and consequently brings it into a competitive favourable position that finally may lead to superior performance (Damanpour Gopalakrishnan, 2001; Damanpour, Walker, Avellaneda, 2009; Geiger Cashen, 2002; Jiménez-Jiménez Sanz-Valle, 2011)

At its core, the term innovation comprises the idea of “newness” (Bowen et al., 2010). Consequently, almost all scholars refer to this aspect in their definitions and imply the adoption of a novel product or process (Jiménez-Jiménez Sanz-Valle, 2011). The study at hand follows this approach and applies the definition of Damanpour and Gopalakrishnan (2001) who refer to innovation as “the adoption of an idea or behaviour, pertaining to a product, service, device, system, policy, or programme, that is new to the adopting organization” (p. 47).

As mentioned above, the desirable effects of organizational innovation are an improved adaptation to environment, the development of distinct competencies, and finally superior performance. Accordingly, several empirical studies have found a significant positive relationship between innovative activities and subsequent firm performance (e.g. Bowen et al., 2010; Brown Eisenhardt, 1995; Damanpour Evan, 1984; P. W. Roberts, 1999; Weerawardena, O'Cass, Julian, 2006). Nevertheless, there are also some scholars that reflect innovation or more specifically the investment in innovation rather critically. Correspondingly, Hundley, Jacobson, and Park (1996) note that RD expenditures may cause a decrease in liquidity and Chen (2008) comments that investments in innovation may eventuate in financial burdens. Moreover, Abrahamson (1991) states that the positive outcome associated with innovation is uncertain, wherefore investments in innovation cannot be considered as a guarantee for success. Accordingly, Simpson, Siguaw, and Enz (2006) indicate that the outcomes of innovation are two-sided, with positive effects on performance but also with negative consequences such as increased costs, unreasonable changes in firm structures and processes, and an increased exposure to market risk. Latham and Braun (2010) also emphasize the risks of innovative activities when they point out that RD investments inevitably detract from short-term profitability without guaranteeing any paybacks.

1.3 Problem Statement and Research Questions

In view of the uncertainties and risks associated with innovative activities, it is highly questionable how managers assess the cost-benefit ratio of RD investments and which factors influence their RD spending behaviour. To date, scholars have tried to isolate concrete determinants of innovation, but failed in getting unambiguous results (Bolton, 1993). This applies especially for studies that examined the effect of organizational characteristics such as firm structure (Hoskisson Johnson, 1992), ownership structure (Graves, 1988), or management attributes (Kor, 2006); however, research streams focusing on alternate determinants such as declining firm performance have yielded inconsistent results as well.

Although a few investigations exist concerning the questions whether and how organizational decline affects firms’ innovative behaviour, the small numbers of articles compared to other strategic management topics expose the decline-innovation relationship still as a relative uncharted territory. Indeed, scholars have developed various frameworks that attempt to predict the RD search intensity of firms faced with organizational decline; however, a commonly accepted consensus is still lacking. While the “Necessity is the Mother of Invention” (“NMOI”) -position predicts a positive relation between firm decline and subsequent innovative activities, the “Necessity is the Mother of Rigidity” (“NMOR”) -perspective projects the opposite. Surprisingly, both theoretical approaches have been supported by empirical studies (cf. Greve, 2003; Latham Braun, 2009). As a consequence of the ambiguous results of prior works and the associated call for more research on this topic (McKinley et al., 2014; Mone et al., 1998), the present study aims at shedding more light on the relation between organizational decline and firms’ subsequent RD spending behaviour.

One possible explanation for the inconclusive results concerning the decline-innovation relationship might be that the correlation between organizational decline and RD search intensity is highly dependent on moderating factors. In order to account for this assumption, the study examines how the company-specific factors ‘threat of bankruptcy’ and ‘organizational slack’ influence a management’s decision to accept the risks of RD investments during a period of poor performance. Even though similar studies have investigated the main effect of threat of bankruptcy on RD search intensity (Chen Miller, 2007), they have failed to investigate its moderating effect. This, however, is worth a detailed examination, since D'Aveni (1989) discovered that not all declining firms are under the same pressure of demise. Assuming that the threat of bankruptcy increases the mental pressure on decision makers, those whose firms experience decline while close to collapse may assess the chances and risks associated with innovative activities different than those whose firms are not directly threatened by bankruptcy. Hence, it is conceivable that the threat of bankruptcy directly affects a management’s decision whether or not to invest in RD as a response to organizational decline. The second contextual factor whose moderating effect on the decline-innovation relationship will be examined is organizational slack. In prior works, organizational slack has been identified as a buffer of uncommitted resources that either fosters risky investments such as RD expenditures or inhibits them (Nohria Gulati, 1996). Due to these contrary findings, in particular in studies that examined firms’ innovation behaviour as a reaction to organizational decline (cf. Chen, 2008; Latham Braun, 2009), further research on this relationship is required. Thus, the following research question is investigated:

How does organizational decline affect a firm’s investments in research and development in the subsequent year and how is this relationship moderated by the firm’s level of organizational slack and threat of bankruptcy?

1.4 Analysis Plan and Value Added

With the purpose of answering the stated research question, the analysis provides an integrated view of the relation between organizational decline and RD search intensity. Therefore, it separately examines the overall effect of performance decline on RD search intensity as well as the moderating impacts of firms’ threat of bankruptcy and organizational slack. The statistical evaluation is based on balanced panel data from Japanese manufacturing firms for the years 2008 to 2012. This longitudinal research design has been chosen since it is superior to cross-sectional designs with respect to performing causal analyses (Hsiao, 2007). In addition to that it is important to note that a relative measure of organizational decline is applied, since this approach considers that strategic firm behaviour is guided by discrepancies between organizational aspirations and actual firm performance (Ansoff, 1979; Cyert March, 1963). Thus, an organization is not judged to be in a decline state when it falls short of a fixed threshold, but when its performance is below a variable reference level such as its previous year’s result or the performance of comparable organizations. The time lag between performance decline and the measured change in firms’ RD search intensity is specified to one year. This horizon takes account of the high reaction speed expected from managers when organizational circumstances change and consequently considers that managers make their strategic investment decisions based on prior year’s performance figures (Bromiley Harris, 2014). Thus, the term ‘subsequent’ generally represents a time horizon of one year in this work.

The study adds value to the topic’s current state of research through several substantial contributions. First, while previous studies have either focused on a single industry or U.S. firms only, this study uses a not yet considered sample of Japanese manufacturing firms. Hence, the work broadens the fundament for the relationship under investigation and hopefully sheds more light on the ambiguous findings of prior works. Further, it departs from prior research by offering an integrated view of the decline-RD spending relationship. In contrast to most other studies, the examination not only focuses either on the “NMOI”- or “NMOR”-position when developing hypotheses, but accounts for the theoretical dichotomy between the two perspectives. Thus, each hypothesis results from a discussion of the contradictory theoretical perspectives. In addition to that, it is the first study [according to the author’s knowledge] that introduces a firm’s threat of bankruptcy as a moderator of the decline-innovation relationship. Considering these complements, the study presents an additional step towards a complete picture of the relationship between organizational decline and investments in innovation. Albeit this research study is, due to its objective to improve the understanding of firm procedures, especially interesting for academics, practitioners may benefit from the results by a better anticipation of competitors’ actions. Additionally, the outcomes may help consulting firms advising clients as well as research firms forecasting innovation behaviours in an industry or even economy.

1.5 Structure of the Study

Following this introduction, the theoretical foundations of the decline-innovation relationship are displayed in the next chapter. The “NMOI”- and “NMOR”-perspective as well as their underlying theories are explained and hypotheses developed. Afterwards, the applied research methodology is presented in detail in the third chapter and the results of the empirical analysis are described in the fourth chapter. Finally, in the fifth chapter, the results are discussed with respect to their academic as well as managerial implications and the study is closed with a short conclusion.

2 Theoretical Foundations of the Decline-Innovation Relationship

The following chapter introduces the theoretical foundations of this study. Starting with an introduction to the frameworks predicting organizational behaviour in response to organizational decline, the initial sections present the contradicting perspectives of “Necessity is the Mother of Rigidity” and “Necessity is the Mother of Invention” as well as their underlying theories. Based on arguments inherent in these frameworks, hypotheses concerning firms’ RD spending behaviour in response to organizational decline are developed in the conclusive sections.

2.1 Necessity is the Mother of Rigidity

The “Necessity is the Mother of Rigidity”-perspective represents a school of thought which suggests that organizational decline has an inhibiting effect on firm adaptation and innovation (McKinley, 1993). It is grounded in the “threat-rigidity model” developed by Staw, Sandelands, and Dutton (1981).

In general, the threat-rigidity theory posits that “a threat to the vital interests of an entity, be it an individual, group, or organization, will lead to forms of rigidity” (Staw et al., 1981, p. 502). This means that individuals, groups, and organizations that are faced with threats, such as might be represented by organizational decline (Mone et al., 1998), avoid activities with uncertain outcomes, but rely on well-established routine procedures (Chattopadhyay, Glick, Huber, 2001; George, Chattopadhyay, Sitkin, Barden, 2006; Greve, 2011). Focussing on the organizational level of analysis, Staw et al. (1981) describe three distinct consequences of threat: First, upcoming psychological stress, anxiety, and arousal reduce managers’ and hence firms’ information processing capabilities . Second, decision makers’ quest for enhanced control leads to increased centralization, formalization, and standardization. Finally, efforts for greater efficiency provoke a conservation of resources. Together, these implications restrict a firm’s capacity to consider and implement variations from standard practice and thus hamper organizational adaptation and change. Therefore, to the extent that firm executives perceive organizational decline as a threat, Staw et al.’s (1981) threat-rigidity model predicts a negative relationship between organizational decline and innovation (McKinley et al., 2014).

Theoretical and empirical support for the threat-rigidity theory has been found in a variety of studies. In the literature on organizational decline, for instance, researchers have revealed evidence that performance deterioration may lead to an efficiency orientation (Cameron, 1983; D'Aunno Sutton, 1992; D'Aveni, 1989), a narrowing of domains (Bozeman Slusher, 1979), risk rejection (Audia Greve, 2006), resistance to change (Cameron, Kim, et al., 1987; McDonald Westphal, 2003), and finally to diminished innovative activity (Latham Braun, 2009). Similar support comes from scientists who have focused their research on organizational crisis (e.g. Billings, Milburn, Schaalman, 1980; D'Aveni MacMillan, 1990; Kahn, Barton, Fellows, 2013). Scholars exploring the concept of crisis, which is often modelled as the outcome of long-lasting organizational decline, particularly emphasize the negative cognitive effects of crisis on decision-makers (Mone et al., 1998). They argue that crises reduce decision-makers’ information processing capabilities in a way that initially leads to a restricted consideration of alternatives and finally to a focus on existing instead of innovative activities. Therefore, this research stream also shows evidence for the basic argument of Staw et al.’s (1981) model that threat causes rigidity.

2.2 Necessity is the Mother of Invention

Despite the compelling argumentation and comprehensive evidence for the “Necessity is the Mother of Rigidity”-hypothesis, there is also a large volume of scientific support for the opposite position – that organizational decline acts as an impetus for organizational change and innovation. The two most popular theoretical frameworks supporting this position are the behavioural theory of the firm (BTOF) and the prospect theory (McKinley et al., 2014).

The central statement of the prospect theory (Kahneman Tversky, 1979; Tversky Kahneman, 1981) postulates that decision-makers who expect a future situation of subpar performance become more risk-seeking than those awaiting stable or growing results (Chen, 2008; Wiseman Gomez-Mejia, 1998). The logic behind this assertion is that individuals are loss averse and therefore attempt to prevent such conditions (McKinley et al., 2014). Thus, if future performance development is expected to be insufficiently, decision-makers underweight the risk of additional loss and overweight potential gains that could preserve them from the loss situation (Chattopadhyay et al., 2001; George et al., 2006). Consequently, if risk-taking is conducive to innovation, anticipated organizational decline may stimulate innovative activity.

Prospect theory is based on a strong forward-looking approach which suggests that managerial decision-making depends on subjective performance forecasts rather than the current performance state (Chen, 2008). For that reason, it is an inappropriate framework for the analysis of organizational responses to performance states that have already arisen. Consequently, in this study, the theoretical posture of the “Necessity is the Mother of Invention”-perspective will be dominantly linked to Cyert and Marchs’ (1963) behavioural theory of the firm.

The behavioural theory of the firm conceptualizes how organizations react to aspiration-attainment discrepancies. Thereby, it occupies a backward-looking approach, which means that decision-makers evaluate whether the firm’s current performance corresponds with prior expectations (Lant Shapira, 2008). According to Cyert and March (1963), firms establish aspiration levels as a “weighted function” (p. 115) of the organization’s past aspiration, the organization’s past performance, and the past performance of comparable organizations. The latter two factors are commonly labelled as historical (self) and social aspiration (e.g. Baum, Rowley, Shipilov, Chuang, 2005; Greve, 1998, 2003). In case an organization fails to achieve an aspiration, it is theorized that problemistic search, defined as “search that is stimulated by a problem […] and directed towards finding a solution to that problem” (Cyert March, 1963, p. 121), will be initiated and finally leading to organizational change. This connotes that organizational change occurs more frequently when firm performance is below, rather than above, the aspiration level (Shinkle, 2012). When performance is rated below the aspiration level, organizations are expected to become more receptive to risky variations from established routines in order to improve performance to a satisfactory level (Cyert March, 1963; McKinley et al., 2014). In contrast, when performance surpasses the aspiration level, the BTOF suggests that organizations maintain their status quo (Bromiley, Miller, Rau, 2001) and avoid any actions that might eventuate in performance decline below aspiration levels (March Shapira, 1987). Summarized with regard to organizational innovation, the BTOF states that performance decline to a level lower than expected, leads to intensified innovative activity.

In Cyert and March’s (1963) original remarks, the BTOF refers strictly to organizational phenomena (Bromiley Harris, 2014). Yet, since organizational aspirations have a primary psychological connotation (March Simon, 1958), the literature regularly discusses them as a “managerial-level construct” (Shinkle, 2012, p. 423). It is argued that decision-makers implicitly or explicitly select the aspirations for a firm, since they initially process the respective determinants through their own mental reasoning (Kiesler Sproull, 1982) and finally combine them in a way that represents an organization-level (Crossan, Lane, White, 1999). In this way, the aspirations of firm executives and organizations are inextricably linked.

While the authors of early studies that used the aspiration-attainment discrepancy as a performance indicator argue that managers judge firm performance on a simple dichotomous scale (March Simon, 1958), subsequent academics have replaced this classification by a continuum that is contingent on the magnitude of the deviation (Greve, 1998; Shinkle, 2012). These more recent studies model aspiration levels based on a linear function devised by Cyert and March (1963), as where is the aspiration level, the historical performance of the organization (self-aspiration), the average performance of comparable firms (social aspiration), the year, and a weight for the various components. Despite virtually all scholars refer to this original equation; most of them focus exclusively on the historical and social aspiration components which are typically considered in separate measures (Bromiley Harris, 2014; Greve, 2002).

As already mentioned at the beginning of this section, scientific evidence for the BTOF and “NMOI”-school exists in a variety studies. Chen (2008) as well as Chen and Miller (2007), for example, have found in their studies on U.S. manufacturing firms that performance decline below a firm’s aspiration level results in increased RD intensity. Identical results are presented by Greve (2003) who investigated the innovation behaviour of Japanese shipbuilding industries as response to aspiration-attainment discrepancies. Additionally, other studies supporting the “NMOI”-perspective show evidence for increased innovative activity after decreases in sales figures (McKinley, 1984) and profitability (Hundley et al., 1996).

2.3 Necessity – Mother of Invention or Rigidity?

The debate within the academic decline literature on how organizations respond to decreasing performance has generated contradictory conclusions. As presented in the previous sections, some scholars have argued and found evidence that organizational decline acts as an impetus for firm adaptation and innovation, whereas others have proofed that firm decline leads to rigidity and thus reduced innovative activity. In view of these conflicting results, the following sections will elaborate the relationship between organizational decline and subsequent investments in innovation with due regard to the competing theoretical approaches. It focuses on the general relation between organizational decline and RD investments, but also on the moderating roles of firms’ threat of bankruptcy as well as firms’ slack resources. Based on the argumentations, hypotheses will be developed.

2.3.1 Linking Organizational Decline and Innovative Activities

According to the management literature on firm decline and the consequent understanding in this study (cf. introduction), organizational decision-making and hence the strategic behaviour of firms is dependent on managers’ perceived aspiration-attainment discrepancy (Greve, 2003; Shinkle, 2012). Firm executives compare their organization’s performance with historical as well as social aspiration levels and base their decisions on the level of attainment. On closer consideration of the applied aspiration levels, it becomes clear that organizational expectations have a variable rather than fixed nature (Wiseman Bromiley, 1996). This means that aspirations are based on varying reference levels such as firms’ past performance and/or competitors’ performance, instead of fixed benchmarks such as predetermined sales or return on asset (ROA) rates. The disadvantage of variable aspiration levels is that even if their non-fulfilment signifies a state of organizational decline, it usually does not allow a statement about firms’ health and long-term survival. For example, an organization that experiences a negative aspiration-attainment discrepancy after several years of continuous performance growth can be classified to be in a decline state, but is usually still far away from demise. In contrast, a firm with aspiration-exceeding performance could be close to collapse if it has experienced severe decline in previous years (D'Aveni, 1989). Consequently, since aspiration-attainment comparisons are not reliable in determining firms’ viability, situations of organizational decline in terms of aspiration-attainment discrepancies cannot generally be classified as life-threatening. This, however, is according to Staw et al. (1981) a basic condition for rigid firm behaviour. They note in their fundamental theory that rigidity is a response to “a threat to the vital interests of an […] organization” (p. 502).

Nevertheless, although a negative aspiration-attainment discrepancy cannot be directly linked to a life-threatening firm condition, disregarded organizational decline leads to a downward spiral that ultimately eventuates in a lethal firm state (Hambrick D'Aveni, 1988). For that reason, it is suggested that firms do not neglect performance shortfalls but try to make a stand against it. This is in line with Cyert and Marchs’ behaviour theory of the firm (1963), which states that managers whose firms are faced with performance below aspirations are motivated to make efforts to improve it (Wiseman Bromiley, 1996). They are expected to have an open mind for novel strategies and to engage in problemistic search. In particular problemistic search is considered as a cure for declining organizations (Cyert March, 1963). It is conducted in the part of an organization that is close to the perceived weakness and results in increased RD investments when process or technology upgrades are expected to solve the performance problems. Thereby, the additional RD expenditures are channelled to projects near completion rather than all-new activities. This offers managers a compromise between the need to solve an urgent performance problem and the long lead times common in RD (Greve, 2003). Thus, in due consideration of the preceding argumentation, organizational decision-makers are expected to increase RD search intensity when firms are judged to be in a decline state (in terms of aspiration-attainment discrepancies). Therefore, it is hypothesized:

Hypothesis 1: When firm performance falls below aspirations, RD search intensity will be increased in the subsequent year.

2.3.2 The Moderating Effect of Threat of Bankruptcy

Organizations whose executives ignore or mistreat performance decline are usually exposed to downward spirals that result in crisis situations characterized by a serious threat of bankruptcy (Billings et al., 1980; D'Aveni, 1989; Hambrick D'Aveni, 1988). According to scholars who analysed the impact of perceived threat of bankruptcy on management and firm behaviour (e.g. Chen Miller, 2007; Miller Chen, 2004), decision-makers faced with high financial distress are under exceptional psychological pressure. They conceive intense stress and anxiety which lead to restrictions on information processing as well as a tightening of control (Staw et al., 1981). Moreover, they tend to conserve resources, eliminate redundant expenses, and avoid activities with uncertain outcomes (Ketchen Palmer, 1999; March Shapira, 1987). Therefore, when an organization is perceived to be close to bankruptcy, RD expenditures will be decreased rather than increased (Chen Miller, 2007).

Although this argumentation may hold true for analyses of the “isolated” threat–innovation relation, the construct becomes more complex when the actual performance of threatened firms is below aspiration levels (means that organizational performance continues declining while the firm is already threatened by bankruptcy). In this case, decision-makers face competing pressures (March Shapira, 1992). While, on the one hand, the persistent performance shortfall leads to a preference for problemistic search and more risk-taking (cf. chapter 2.2), the perception of a crisis, on the other hand, triggers the cognitive and organizational processes predicted by the threat-rigidity theory (Greve, 2011). In view of these unclear behaviour patterns, March and Shapira (1987, 1992) have sought to reconcile the contradicting arguments by postulating that firms and thus managers have two alternative targets – an aspiration level and a survival level. Their model suggests that decision-makers shift their focus of attention between these two reference levels. If managers focus their attention on survival they are expected to be risk averse, but also willing to accept greater risk when firm performance improves. In turn, when managers focus on aspiration levels, risk-taking increases with negative aspiration-attainment discrepancies (Miller Chen, 2004).

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