Corporate controls are mechanisms that corporations use to ensure that the processes and/or outcomes of their business units meet corporate expectations. Challenges in measurement of corporate controls have led many researchers to operationalize them as part of the more ambiguous corporate effects construct, instead of addressing them separately. The purpose of this paper is to examine the significance of “fit” between corporate control mechanisms and business unit strategy in performance of business units.
The authors use ordinary least squares regression analysis on data collected between 2010 and 2012 from surveys from managers of 142 Iranian corporations and 1,822 of their subsidiaries. The authors also use financial and market data collected by an IDRO division and accessed through partnership in a joint project.
The authors found that while the fit between business unit strategy and corporate controls has a significant effect on business unit financial performance, it does not have a similar effect on market performance. The findings demonstrate that when business unit managers perceive that they are subject to a balance of strategic and financial controls with a slightly greater emphasis on strategic controls, then business units have higher financial and market performance, although the difference in financial performance is not significant.
The authors find that the misfit between corporate controls and business strategies in such cases could negatively affect the performance of the business unit. However, this research also contributes to a better understanding of the importance of strategic controls to the successful performance of business units. The findings show that while the fit between controls and strategy is most critical for achieving financial performance in business units that pursue product leadership, strategic controls play a more prominent role than financial controls in achieving higher financial or market share performance for all business units.
The findings of the propositions in this research would discourage corporations with tight financial control from engaging in acquisition of businesses considered to be product leaders in their relative product markets.
Past research focusing on the fit between corporate-level factors and business-level factors and their role on business performance are largely limited to conceptual work. The limited empirical studies completed in the past generally reduce control mechanisms to lack or absence of autonomy. This shortcoming has been mainly due to difficulties in measurement of control mechanisms. The empirical study overcomes these barriers and in doing so, reveals surprising findings related to the effectiveness of different control mechanisms.
Seifzadeh, P. and Rowe, W.G. (2019), "The role of corporate controls and business-level strategy in business unit performance", Journal of Strategy and Management, Vol. 12 No. 3, pp. 364-381. https://doi.org/10.1108/JSMA-10-2018-0114Download as .RIS
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The trends in diversification have resulted in significant changes to the traditional ways that businesses are managed. The main question in corporations has become, “How can the corporation ensure that its business units operate in a manner that creates the highest value for the corporation and its shareholders as a whole?” To answer this question, it is imperative to understand how corporate-level influences and business-level factors work together to play a role in performance of business units. Therefore, researchers have conducted extensive conceptual and empirical research, and corporations have designed and employed various mechanisms to realize the economic expectations associated with the logic of pursuing a corporate-level strategy of different levels of diversification (e.g. Ahuja and Novelli, 2017; Lang and Stulz, 1994; Palepu, 1985; Schommer et al., 2019).
Most past research focusing on the corporate parent–business unit relationship has limited itself to the broad influence of corporate effects (e.g. McGahan and Porter, 1997) and business unit effects. A composite concept, corporate effects includes corporate strategy, corporate structure, corporate controls and corporate rewards. What has not been considered in the research on corporate effects is the possibility of countervailing, neutralizing or negating effects among strategy, structure, controls and rewards at the corporate level. The broad definitions that exist for corporate effects often omit that different constituents of corporate effects may counter one another and that their misalignment may have an attenuating influence on the measurement of corporate effects (e.g. Bowman and Helfat, 2001; McGahan and Porter, 1997; Rumelt, 1982).
Understanding the precursors of performance is central to the literature of strategic management. In corporations, this interest has focused on the influence of corporate effects on both business unit performance (e.g. Chen et al., 2013; Rumelt, 1982, 1991; McGahan and Porter, 1997; Hoskisson and Hitt, 1990; Bowman and Helfat, 2001), and corporate-level performance (e.g. Gort, 1962; Arnould, 1969; Rumelt, 1974; Seifzadeh, 2017). Therefore, much of past research applies a multilevel approach when conducting the analysis. The main reason for applying a multilevel approach is often based on considering business effects to be partly nested within the effects at the corporate level, without proper deconstruction of the effects (Hough, 2006; Misangyi et al., 2006). Therefore, to decompose the variance, many studies have adopted multilevel analysis techniques.
In this research, we provide a more clear understanding of the antecedents of business unit performance in diversified corporations. Our review of extant literature has led us to conclude that the role of corporate controls remains largely absent in theoretical and empirical studies that focus on performance of business units. Therefore, we set out to unpack the concept of corporate effects and disentangle the impacts of corporate diversification strategy and corporate controls; to unpack business unit strategy from the concept of business effects; and to re-examine the relationship between corporate controls, business unit strategy and business unit performance. More specifically, we address the constraints on business unit performance that result from the interaction between control mechanisms and business unit strategy, establishing the link between business-level strategy and each business unit’s subsequent performance for subsidiaries of corporations.
While the influences of corporate-level factors or corporate effects on the performance of business units and corporations have generated much interest among researchers during the past several decades, much of past literature, including those employing variance decomposition techniques (Bowman and Helfat, 2001), has fallen short of deconstructing corporate effects and understanding their constituent parts and roles (e.g. Gort, 1962; Arnould, 1969; Rumelt, 1974, 1982; McGahan and Porter, 1997, 1999). Building on a different methodology, this paper has taken steps to directly measure several dimensions of corporate effects and more specifically, to clarify the role of corporate control mechanisms as one such dimension in business unit strategy pursued.
Business-level strategy refers to the competitive actions pursued by business units in order to create differences in their competitive position relative to their direct or indirect competitors (Porter, 1980). To achieve this objective, business unit managers have to make a series of decisions regarding their resource allocation procedures in order to improve the competitive position of their business unit within their relative product market (Porter, 1990; Dundas and Richardson, 1980) and to maximize value creation for the business units and for their customers (Priem et al., 2018). In corporations with multiple business units, these decisions and actions are often made at the level of the business unit, and the main concern at the corporate headquarters is to ensure that the results are aligned with the best interests of the business unit and the corporation (Seifzadeh, 2017).
Past research has introduced several typologies for business-level strategy (e.g. Miles and Snow, 1978; Porter, 1980; Treacy and Wiersema, 1995) with the aim to identify the range of generic strategies available to businesses (Parnell, 2011; Zamani et al., 2013). There have been conflicting findings in empirical research focusing on the link between generic strategies and firm performance; some studies have found total commitment to one of the generic strategies (purity) to be a source of higher performance, and some have found similar results for hybrid strategies (Thornhill and White, 2007). Most theories have argued that due to complexity of hybrid strategies and the difficulty of setting priorities, which results in confusion and loss of direction, strategic purity – i.e., focus on only one specific category of generic strategies – to be associated with higher firm performance (Thornhill and White, 2007; March, 1991; Treacy and Wiersema, 1995). In this paper, we turn our focus to the two most widely accepted business-level strategic orientations: operational excellence and product leadership (Thornhill and White, 2007).
Firms that pursue operational excellence are those that put a heavier emphasis on actions and decisions that exploit the business unit’s existing resources and capabilities in order to achieve a better competitive position relative to their rivals. Such firms emphasize efficiency, reliability, refinement and execution (Thornhill and White, 2007), leading them to develop capabilities that allow business units to produce and market their comparable products at efficiency levels higher than their direct competitors (Porter, 1990). However, an excessive emphasis on exploiting their existing capabilities could result in the obsolescence of a business unit (March, 1991), therefore it should maintain a certain degree of exploration to maintain competitive product quality in order to survive (Porter, 1990; Hill, 1988).
Firms that pursue a product leadership emphasize achieving superior performance through offering products or services to the market that are superior to those of competitors. Also categorized as product differentiators (Porter, 1980) and prospectors (Miles and Snow, 1978), product leaders are those that explore (March, 1991; Menguc and Auh, 2008) new ways to provide superior products or services with more value to their customers (Porter, 1980). However, businesses that pursue exploration often pursue exploitation to some degree in order to extract rents that are generated as the result of their endeavors. Therefore, product leaders are also those that take a more balanced approach when pursuing exploratory and exploitative strategies (Gupta et al., 2006).
Corporate controls mechanisms help corporations to ensure that their performance corporations materialize through alignment between action at the business unit level and corporate objectives. They have often been considered to fall into one of two categories: the more qualitative strategic controls, and the more objective and quantitative financial controls (Hoskisson and Hitt, 1994).
According to agency theory, the principal–agent relationship is formed when one party acts on behalf of the other. Therefore, agency theory has a special interest in understanding the causes and consequences of the incongruence in goals that arises between the goals of agents and those of principal owners (Barney and Hesterly, 1996). Corporations, design and implement control mechanisms to monitor both the behavior of executives, and the outcomes of their actions at the business unit level (Eisenhardt, 1988, 1989; Carpenter and Sanders, 2002) and to transfer potential negative consequences of agency problems from owners (corporate parent) to decision makers and the business unit level (Eisenhardt, 1989; Jensen and Meckling, 1976). In corporations, agents (i.e. CEOs or directors of wholly owned business units) are compensated or punished by existing control mechanisms according to alignment of their performance with the best interest of the corporation. Such mechanisms may target financial benefits or continuation of tenure (Eisenhardt, 1989).
Types of corporate controls
Corporate headquarters might use financial controls, strategic controls or a hybrid of strategic and financial controls for this purpose (Hoskisson and Hitt, 1994). However, while different types of controls are generally employed for the same objective, they employ distinctive processes and have implications that could be quite different.
Financial controls refer to those that rely primarily on financial and accounting evaluations of firm performance, regardless of the processes through which such performance has been achieved. Such performance, which is generally reported through annual and quarterly reports, consists of such indicators as return on assets (ROA), return on investments (ROI) and earnings per share (for holding companies). The generic nature of such controls makes them applicable to a wide array of businesses and they can be employed with or without limited knowledge or expertise regarding the business when they are the sole method of performance evaluation.
When corporations rely mostly on financial controls and take less consideration of the strategic and long-term implications of decisions made at the business unit level, business unit senior executives receive better assessments when their decisions are associated with the least negative short-term financial performance. Consequently, the tendency of such business unit managers is to avoid actions or decisions with prospects that diverge from any of the financial and accounting milestones. Therefore, while financial controls allow more flexibility for the business unit executives in making decisions, they also encourage them to make decisions that satisfy the financial expectations of the corporate headquarters from one quarter to another. Due to their generic nature, financial controls are usually employed as the primary control mechanism when the corporate headquarters is constrained in its ability to put in place strategic controls due to a lack of resources or expertise, or when environmental conditions and industry characteristics represent high levels of stability, where minimal strategic decisions at the business unit level are required.
Strategic controls are those that focus on the quality of the decisions made and their long-term strategic implications (Rowe and Wright, 1997). Strategic controls are qualitative, subjective and evaluative. They also focus on the effect that decisions and actions at the business unit level have on other business units and the fit of strategic decisions of each business unit with the strategies of the corporation as a whole. The relationships between business units and the quality and nature of those relationships are other dimensions of business unit performance that are included in the strategic evaluation of performance for each business unit. In most instances, strategic and financial controls are implemented simultaneously, which enables the corporate headquarters to take the strategic implications of business unit performance in its evaluations into consideration. However, strategic actions do not necessarily lead to short-term returns.
However, implementing strategic controls, unlike financial controls, requires the corporate headquarters to possess considerable knowledge and expertise in the field in which the business unit is operating (Hoskisson and Hitt, 1994). Such expertise is required for conducting in-depth analysis of the actions and strategic decisions made by executives at the business unit level and to understand the implications that such actions and decisions might carry. Unless such expertise exists, the qualitative monitoring of processes and the actions of businesses are unlikely to yield valuable results, and therefore strategic controls will not be put in place properly and the corporate headquarters will be forced to rely on the immediate financial implications of business unit actions.
In corporations, an important function of strategic controls is to monitor the interrelationships of different business units and to ensure that the economies of scope expected from synergies between business units are realized (Vancil, 1979; White, 1986). However, such interrelationships can often affect business units’ short-term financial performance. Putting in place strategic controls enables corporations to integrate the strategic implications of business unit actions into their performance evaluation and ensure business unit executives that the potential lower subsequent financial performance may be justifiable by their strategic outcome of taking risky actions such as R&D spending. The distinctive embodiment of strategic controls in organizations can often involve frequent meetings between the business unit manager and the corporate staff to facilitate the corporate headquarters’ understanding of the decisions made at the business unit level.
Business unit performance
Past research has identified three conceptually distinct types of performance dimensions as financial and other accounting reports, market valuations and key informant descriptions (Hoskisson, Hitt, Johnson and Moesel, 1993). Furthermore, Rowe and Morrow (1999) have identified the firm performance dimensions as reputation, market dimension and financial dimension. However, despite the recognition of performance as a multidimensional construct and the identification of several corresponding dimensions, most strategy researchers take firm financial performance as the core of the domain of possible dimensions (Venkatraman and Ramanujam, 1986).
In most literature on the construct of performance to date, the emphasis has been on the financial and accounting performance of firms. Accounting reports dominated early research on firm performance, with market-based performance becoming more popular by the mid-1980s (Glick et al., 2005; Hawawini et al., 2005; Hoskisson, Hill and Kim, 1993; Hoskisson, Hitt, Johnson and Moesel, 1993; Lubatkin and Shrieves, 1986).
Performance has typically been operationalized in terms of existing accounting ratios (e.g. ROA, ROS, ROE, ROI) or market-based measures such as Sharpe’s measure, Treynor’s measure, Jensen’s α and Tobin’s q (Rowe and Morrow, 1999; Venkatraman and Ramanujam, 1986). To estimate the level of financial performance of a firm, both types of performance measures – financial and market – have been used in past research (Rowe and Morrow, 1999). This has led some researchers to suggest an “implicit consensus” between researchers on market performance and accounting performance for the two dimensions of a firm’s financial performance (Rowe and Morrow, 1999).
Although widely accepted as one of the dimensions of firm financial performance, market value has not been as popular as accounting-based measures. This has been the case particularly with market analysts, who have taken issue with market value as a measure of performance that has roots in both the present and the future (Glick et al., 2005), making identification of its sources and the significance of those sources very difficult.
Since the 1980s there has been an increasing tendency toward using market-based dimensions as a more appropriate dimension of a firm’s performance. This is more evident in the work of many strategy researchers in later years, as strategy researchers have begun to rely on market-based measures of performance, either alone or in conjunction with accounting-based measures, when assessing a firm’s financial performance (Rowe and Morrow, 1999; Hoskisson, Hitt, Johnson and Moesel, 1993; Hoskisson et al., 1994). Rowe and Morrow (1999), based on the research done by Benston (1985), Fisher and McGowan (1983) and Watts and Zimmerman (1978, 1990), concluded that the increase in the use of market-based measures of firm performance was partly in response to micro-computers becoming more available, making calculations of market-based measures easier and partly because of the criticisms that have been voiced toward the excessive use of accounting-based measures.
While information such as sales and growth in sales draw on accounting measures for performance, they do not represent the profitability of a firm. Firms with higher costs of production and lower price offerings are able to extract less value from the market (Peteraf and Barney, 2003). However, growth in sales, under certain conditions, can also represent a relative gain in market share, which has been considered as a dimension of market performance. Therefore, past research has focused on growth in sales as an indication of firm market performance (White, 1986).
Business strategy and business performance
The relationship between business strategy and business performance is one of the best-established relationships in the strategic management literature (Anwar and Hasnu, 2016). Past empirical research has often made attempts to measure the business-related effects compared to other existing effects that influence business-level performance (Bowman and Helfat, 2001). Most studies have shown business-level effects, industry effects and corporate effects to be the most influential in defining the success or failure of a single business unit (Rumelt, 1991; Carroll, 1993; Ghemawat and Ricart Costa, 1993; Hoskisson, Hill and Kim, 1993; McGahan and Porter, 1997). While the literature on the link between business-level strategy and business-level performance is substantial, the role that corporate controls play in defining the relationship remains understudied. This shortcoming partly relates to the negligence of controls in defining business-level strategy and the consideration of business unit strategy as an exogenous factor. Therefore, the significance of a “fit” between the controls implemented by the corporation on business units and business unit strategy remains largely unexplored.
Fit between business strategy and corporate controls
Performance of a business unit not only depends on the strategic orientation of the business unit, but also on the “fit” between different organizational factors that can influence that business unit’s performance. The concept of “fit,” which was initially developed in behavioral organizational research (Venkatraman, 1989), has also been used to explain the relationship between corporate controls and the practices that are exercised at the micro level of business units (Rowe and Wright, 1997; White, 1986). Such arguments suggest that in order to maintain efficiency in business units and achieve superior performance, micro-level practices must conform to the requirements of controls at the macro level. Past research has found a fit between business unit strategy and the internal organization of the corporation to influence business unit performance, where higher business unit autonomy leads to greater market performance (i.e. growth in sales) and less autonomy, and tighter controls leads to higher short-term financial performance (White, 1986).
When a business unit is subject to financial controls, divergence from practices that have a fit with an operational excellence strategy can result in “misfit” between corporate controls and practices at the business level (Baysinger and Hoskisson, 1989; Rowe and Wright, 1997; White, 1986) that can result in conflict between the business unit and its corporate parent. The resulting conflict can in turn influence a business unit’s financial performance during a shorter time period due to lack of mutual communication of decision justification between the business unit and the corporate headquarters. This lack of communication could subsequently affect the willingness of the corporate headquarters to allocate additional resources or to leverage its corporate resources to the advantage of the business unit.
As discussed earlier, when a business unit is part of a related diversified corporation, there is a greater likelihood for it to be subject to stronger emphasis on strategic controls in order to achieve expected synergies across multiple business units of the corporation. This allows business units be in a better position to justify strategic decisions with little or no immediate financial outcomes. Hence:
Business units pursuing operational excellence strategies will exhibit higher financial performance when subject to a stronger emphasis on financial controls, and business units pursuing product leadership strategies will exhibit higher financial performance when subject to a stronger emphasis on strategic controls.
For business units that pursue a product leadership, this puts business unit executives in a more confident position when making long-term and exploratory decisions that are crucial to success of a product leadership strategy. Additionally, such business units can also individually benefit from lower cost structures resulting from economies of scope within the corporation exist. On the other hand, in unrelated diversified corporations where synergies are dismal or absent, financial controls are the primary means of monitoring business units (Baysinger and Hoskisson, 1989; Goold et al., 1994). Business units that pursue product leadership and are part of such corporations can be challenged due to misfit between micro-level practices necessary for success of a product leadership strategy and macro-level controls imposed by the corporate headquarters (Baysinger and Hoskisson, 1989). Such a misfit can result in less competitiveness at the business unit level and subsequent lower business unit performance. In contrast, business units that pursue operational excellence will benefit from the greater fit that exists between corporate-level controls and prerequisites of their success. Therefore, business unit performance subsequent to the choice of strategy will likely be influenced by controls associated with different corporate strategies. Hence:
Business units pursuing operational excellence strategies will exhibit higher market share performance when subject to a stronger emphasis on financial controls, and business units pursuing product leadership strategies will exhibit higher market share performance when subject to a stronger emphasis on strategic controls.
Figure 1 represents the theoretical model for the hypothesize relationships.
Sample, methodology and measurements
The proprietary data set we used includes data from 1,822 business units or divisions that operated under 142 Iranian corporations with operations focused primarily within Iran, but also in the Middle East and North Africa (MENA) region. The unique data set was developed as part of large-scale collaborative projects aimed at documenting the conduct and performance of national and regional private and public corporations in order to allocate state-controlled resources for the purpose of each corporation’s improvement. The participation of all business units and their corporate parents in the study was sanctioned and pursued by formal government agencies that monitored their conduct and provided financial and non-financial support to them when deemed necessary. Existing domestic regulations required all participating business units and their corporate parents to provide accurate and complete responses to survey questions and to disclose requested information. To ensure that the effect of exogenous influences on observed variables was minimal, data from the years 2010 to 2012 were used in our sample. The selected period is characterized by more regional stability that led to higher economic growth throughout the MENA region, and particularly in Iran. The decision to limit the data to 2012 was required to avoid possible influences resulting from consequences of imposed economic sanctions going into effect subsequently, on the observed performance variables.
We used retrospective data collected from subsidiary managers through an instrument using a seven-point Likert scale. The surveys contained items such as “level of interaction between divisions,” “level of interaction between business units and the corporate headquarters,” “degree of resource sharing between business units and divisions,” “degree of capability sharing and transfer among divisions,” “level of information sharing,” “level of knowledge by corporate managers regarding processes of business units,” “willingness to accept risk in favour of long-term performance,” “spending on R&D, employee training, capital and equipment, and market research,” “level of emphasis on monitoring market/operational/financial data,” “degree of openness in communication between corporate and division managers,” “method of performance evaluation for employees,” “level of emphasis on cost reduction,” “use of financial data as the criterion for performance,” “degree of competition among divisions” and “degree of focus on short-term ROI, cash flow, revenue growth, and market share as the criteria for evaluating performance” (Hitt et al., 2006). These data capture appropriate aspects of corporate controls: i.e., autonomy, diagnostics and ongoing processes within a corporation. This is consistent with dimensions identified and proposed in past literature (Govindarajan and Fisher, 1990; Hoskisson and Hitt, 1988; White, 1986; Vancil, 1979).
To validate the measure for corporate controls, the data from business units are split in half and exploratory factor analysis is conducted on one half of the data to identify emerging factors. As expected, survey items emphasizing approaches such as “interaction among business units,” “interaction with corporate headquarters” and “resource sharing with other business units” load highly on the strategic controls factor. Those with emphasis on approaches such as “risk avoidance” and “financial evaluation of performance” load higher on the financial controls factor. Then, the items for emerging factors were checked against existing definitions for each type of control such as strategic controls and financial controls. The α value for strategic controls is 0.71 and for financial controls is 0.76. Confirmatory factor analysis (CFA) is then performed to test for distinctiveness and uni-dimensionality of the factors. This analysis revealed a GFI=0.941 and a χ2 value of 925.51. We checked for convergent validity to ensure CV>0.5. We found that convergent validity for strategic and financial controls were greater than 0.5 (CV (ξStrategic Controls)=0.502 and CV (ξFinancial Controls)=0.56). We also checked for discriminant validity. With covariance set at 1, the analysis reveals a worsening in fit, which demonstrates that the unconstrained model has a better fit. This suggests appropriate discriminant validity.
To develop a variable that captures both types of controls, the standardized and centered ratio of the developed measures was used; the measure for strategic controls is divided by the measure for financial controls. Higher values indicate a stronger emphasis on strategic controls and lower values signal a stronger emphasis on financial controls. This variable was measured for every business unit, and varies for each of the business units within a corporation.
Business unit strategy
We used retrospective data collected from subsidiary managers through an instrument using a seven-point Likert scale. The surveys contained items such as “undertaking research and development,” “developing new products/services,” “developing new production/operating techniques,” “expanding into new geographic markets,” “total quality management,” “improving product/service quality,” “reducing labor costs,” “using more part-time, temporary, or contract workers,” “reducing other operating costs,” “reorganizing the work process,” “enhancing labor management cooperation,” “increasing employees’ skills,” “increasing employees’ involvement/participation,” “improving coordination with customers and suppliers” and “improving measures of performance” (Hitt et al., 2006). These data capture appropriate aspects of corporate controls: i.e., autonomy, diagnostics and ongoing processes within a corporation. This is consistent with dimensions identified and proposed in past literature (Govindarajan and Fisher, 1990; Hoskisson and Hitt, 1988; White, 1986; Vancil, 1979).
The α values for the two constructed factors – product leadership and operational excellence – are 0.79 and 0.70, respectively. As expected, items focusing on dimensions such as “R&D investment” and “development of new products or services” load highly on the product leadership factor, while items emphasizing “reducing operating costs,” “reducing labour costs” or “improving production techniques” load highly on operational excellence. CFA revealed that both operation excellence and product leadership met the requirements for convergent validity (CV>0.5), with CV (ξOperational Excellence)=0.51 and CV (ξ Product Leadership)=0.69. With covariance set at 1, the analysis revealed a worsening in fit, which demonstrates the unconstrained model to have a better fit, fulfilling the criterion for discriminant validity.
In line with past research, we use ROI as the measure for financial performance of the firm. The reason to choose ROI over ROA and ROE is based on availability of data. The calculation of ROI, expressed as a percentage, was done for business units in the sample based on the following ratio:
To account for the temporal element in the relationship between business strategy and firm financial performance, the accounting measures from the subsequent year to the measurement of business strategy were employed.
Due to limitations on obtaining data on market indicators that relate to wholly owned business units, it is difficult to estimate their market performance through any of the market performance measures that are available. Therefore, in line with past research (White, 1986), growth in sales is used to measure the market performance of each business unit. To obtain this measure, the revenue of each business unit was compared to the total revenues generated in the subsequent year, and the ratio from t−1 to t (the subsequent year to measuring business strategy) is used to measure the market performance of the firm.
We controlled for influences of the following variables: business unit effects, industry effects, family structure, government ownership, geographic dispersion and corporate effects.
To test the hypotheses, two different methods are used. First, we conduct the statistical analysis using ordinary least squares regression in SPSS. While the data consist of two levels, limitations within group sample size (i.e. number of business units corresponding to each corporation) inhibit the use of hierarchical linear modeling, which requires a minimum of 25 subjects at each level, as the statistical method for data analysis. Therefore, all corporate-level factors were disaggregated to the business unit level. Subsequently, all corporate effects were (through inclusion of corporate parent information) regressed onto all dependent variables in the model. Prior to conducting the statistical analysis, a series of statistical tests are conducted in order to determine the factors that are to be used in the analysis. These factors are particularly important to the measurement of controls, since the survey used in the study contains various items that are related to each type of control mechanisms.
Results and discussion
The results included in Tables I and II indicate a significant moderating role for controls in the relationship between business strategy and financial performance (p<0.05, B=0.09, R2=0.12) and a marginally significant moderating role for controls in the relationship between business unit strategy and market performance (p<0.1, B=0.02, R2=0.12) (Table III).
Figure 1 demonstrates the importance of the fit between business unit strategy and controls implemented over business units to the subsequent financial performance of business units; business units pursuing product leadership achieve higher financial performance when they are subject to a stronger emphasis on strategic controls. However, the plot does not show a significant difference in financial performance for business units that pursue operational excellence strategies. Interestingly, further examination of the plot in Figure 1 shows that subject to a stronger emphasis on strategic controls, business units that pursue operational excellence exhibit marginally higher financial performance compared to those that are subject to stronger emphasis on financial controls, which counters the prediction of the hypothesis. Therefore, we only find partial support for H1.
Moderation plots are used to further examine the findings of the test for H2. While statistical analysis shows marginal support for the H2, an examination of Figure 2 shows that the difference between market share performance is larger for business units pursuing operational excellence compared to those that pursue product leadership. The results show that, counter to H2, being subject to strategic controls is associated with marginally higher performance for business units that pursue operational excellence. Therefore, and based on an examination of Figure 2, it can be concluded that although interesting findings are revealed, no support can be given to H2.
Although business unit strategy to be influenced by corporate strategy through controls, business unit managers can still exercise their judgment of appropriate action and pursue strategies that are not in line with the controls to which they are subject. However, out hypotheses suggest that it is more likely for business units that ensure the existence of a fit between controls and business unit strategy to achieve higher performance. The results of this study lend partial support to one of these hypotheses and while do not support the other, provide interesting findings.
Our findings reveal that while the fit between business unit strategy and corporate controls has a significant effect on business unit financial performance, it does not have a similar effect on market performance. To further examine the effect of fit on market performance, we allowed for a lagged measurement of market performance twice, each time for one year. While the results were not significant, they demonstrated improvement. Therefore, the observed results could be attributed to the limited time frame (five years) of the data.
An interesting point in our findings for the importance of fit reveals the superior role of strategic controls compared to financial controls in subsequent business unit performance. While the hypothesized relationship predicted a better fit for operational excellence strategies with financial controls, further examination of our findings demonstrates that when business unit managers perceive that they are subject to a balance of strategic and financial controls with a slightly greater emphasis on strategic controls, the business units achieve higher financial and market performance, although the difference in financial performance is not significant (see Figures 2 and 3). This means that unlike what previously understood, financial controls and strategic controls are not two equals at different extremes of a continuum.
The findings of the propositions in this research would discourage corporations with tight financial control from engaging in acquisition of businesses considered to be product leaders in their relative product markets. There is an extensive body of past literature that has aimed at understanding the role that different dimensions of diversification strategy play in performance of business units and the corporation as a whole. Our theory and findings provide a more theoretical rigorous alternative to studies that have simplified control mechanisms to “autonomy” (e.g. White, 1986), and a more refined and fine-grained perspective on the influence of corporate effects in some others (e.g. Bowman and Helfat, 2001; McGahan and Porter, 1997; Rumelt, 1982). Confirming several past theoretical and empirical studies (Hoskisson and Hitt, 1994; White, 1986) we find that the misfit between corporate controls and business strategies in such cases could negatively affect the performance of the business unit. However, in contrast, this study contributes to a better understanding of the importance of strategic controls to the successful performance of business units. Our findings show that while the fit between controls and strategy is most critical for achieving financial performance in business units that pursue product leadership, strategic controls play a more prominent role than financial controls in achieving higher financial or market share performance for all business units. Many limitations in past research resulted from the nature of the data available which limited measurement of control mechanisms at the business unit level. For instance, the PIMS database used in some studies (e.g. White, 1986) only captured limited dimensions of attributes associated with different control mechanisms (e.g. autonomy) and restricted information pertaining to membership of multiple subsidiaries under the umbrella of the same corporate parent. This study has overcome this substantial impediment through utilizing data collected at the business unit level and with inclusion of data regarding corporate membership. Subsequently, this study benefits from a more theory-driven measurement of control mechanisms for business units.
While not included in the scope of this study, to compare our findings with previous findings in past literature, we did additional analysis of results with a greater span in years of observation. Interestingly, in the analysis, when ownership remained as a control variable, no surprising results compared to observations from developed nations were observed. However, when controls were removed, we recognized different behavioral patterns. Most importantly, we observed that while misfit between strategy and control mechanisms existed, lower performance persisted overtime without being addressed. This observation can most likely be explained by existing subsidies or channeling of public resources not accessible to typical non-government-owned corporations.
Results from our theoretical and methodological contributions also have a major practical implication. By demonstrating the superiority of strategic controls in achieving higher levels of business unit performance, we rule out the suitability of tendency that some corporate-level managers demonstrate to ignore implementation of strategic control mechanism, which require greater tenacity, in favor of less complex and easier to implement financial controls. While we do acknowledge that the ability to effectively implement strategic controls may become restricted due to size or complexity of corporate operations, when resources permit, they remain the more effective mechanisms to ensure the highest profitability at both corporate and business unit levels.
Limitations and future research
One limitation of this research is that the data set used for testing the hypotheses was limited to corporations with wholly owned business units and therefore did not include holding companies. While there is little business unit-level research on the differences between holding companies and corporations, it seems logical to assume that the ownership stakes in business units would be the source of various differences at the level of business units, particularly in the area of corporate controls, as perceived by business unit managers. This paper, therefore, does not capture the differences when the business unit is not a wholly owned business unit.
The other limitation of this paper is its reliance on data that entirely belongs to companies within the MENA region. Due to the private nature of wholly owned business units, access to their financial and other data is very difficult in most parts of the world. There are very limited sources that grant researchers access to data on the business units of corporations. However, when access is possible, it is often impossible to trace business units back to their corporate parents. The data used in this study, although belonging to industries from a specific region, provided one major advantage over other available databases: it allowed access to very detailed and comprehensive data at the corporate and business unit levels. In addition, it provided proprietary access to survey data that evaluated the relationship between each business unit and its corporate parent.
Another limitation of this research, which is rooted in the limitation just addressed above, is the use of cross-sectional analysis instead of a longitudinal study. While we agree that a longitudinal study would normally provide more valid conclusions for research such as this, as mentioned before, the constraints posed by the structure of the regional economies would lend little value, if any, to the validity of the findings in this paper. To minimize the limitation of the cross-sectional approach, we used data from different years and lagged performance outcomes to account for strategic decisions taking effect.
The limitations of this research also open up opportunities for future research. As mentioned earlier, a main limitation of this research is its reliance on regionally specific data. While the limitation of region-specific data has existed in much past research, the specification and characteristics of MENA’s economic structure may raise questions of external validity. Therefore, one avenue proposed for future research is the replication of this study in countries with economic structures that are more compatible with market economy conditions. However, such a task may prove to be very challenging, as access to data similar to what has been used in this research will be extremely difficult in the less centralized economies of North America, Europe and Southeast Asia.
When completing this research, we encountered many instances of unique institutional pressures that defined economic dynamics within the region. While our intention has been to develop and test a more generalizable theory on how corporate strategy influences business unit strategy, there are many opportunities to investigate the MENA setting on the basis of its unique institutional arrangements. For institutional theorists, this provides a unique opportunity to build on data that has been collected for this research and to provide a better look into the differences in institutional logics and their precursors. This approach will also allow for a better understanding of the nature of the corporate parent–business unit relationship and the logic through which the corporation and its business units operate. Consequently, this approach could allow one to redefine outcome variables such as performance to better fit with the objectives of managers in other contexts.
The surveys, which were completed by managers of business units, could be subject to limitations that can be addressed in future research. First, although we tried to validate surveys through triangulation methods (e.g. comparing with meeting notes, content analysis of correspondence), they still lack the richness that can be achieved through face-to-face interviews. The surveys include many aspects of financial controls and strategic controls that have already been discussed in past literature, but because of the more subjective nature of strategic controls it is possible that they may not encompass the notion of strategic controls completely. Therefore, a study that builds on qualitative data from face-to-face interviews may prove to be more suitable for this purpose. Second, while the pressure of corporate controls is felt mostly by business unit managers, their development and implementation are done through corporate headquarters. In this research, we managed to include only one side of the story – that of the business unit managers. Therefore, this study could benefit from improvements in research designs that also capture the perspective of the corporate headquarters. Another area for future research is the interactive effect of corporate controls and business unit strategy on business unit performance.
Results of regression analysis of the relationship between business unit strategy and financial performance and the moderation of the relationship by controlsa
|Independent variables||Model 1||Model 2||Model 3||Model 4|
|Size of business unit||0.02||0.02||0.02||0.02|
|Effect of business unit strategy on financial performance|
|Business unit strategy||0.11*||0.14*||0.16*|
|Controls×Business unit strategy||0.09*|
Notes: n=1,822 (corporate strategy, span, HQ size, corporate effects, family structure, IDRO ownership, geographic dispersion and CEO experience are measured for a total of 142 corporations. Controls are measured for each individual subsidiary for a total of 1,822). aStandardized coefficients are reported. *p<0.05; **p<0.01; ***p<0.001
Results of regression analysis of the relationship between business unit strategy and market performance and the moderation of the relationship by controls
|Independent variables||Model 1||Model 2||Model 3||Model 4|
|Size of business unit||0.07*||0.06*||0.04*||0.04*|
|Effect of business unit strategy on market share performance|
|Business unit strategy||0.36*||0.36*||0.30*|
|Controls×Business unit strategy||0.02****|
Notes: n=1,822 (corporate strategy, span, HQ size, corporate effects, family structure, IDRO ownership, geographic dispersion and CEO experience are measured for a total of 142 corporations. Controls are measured for each individual subsidiary for a total of 1,822). aStandardized coefficients are reported. *p<0.05; **p<0.01; ***p<0.001; ****p<0.1
Correlations among all subsidiary-level variablesa
|2. Business unit strategy||0.033**||1|
|3. Financial performance||−0.024||0.033**||1|
|4. Market performance||0.113**||−0.024||0.318**||1|
Notes: n=1,822 subsidiaries (business units). aStandardized coefficients are reported. *p<0.05; **p<0.01; ***p<0.001
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