Abstract
In the 20 years since the last review on organizational decline and turnaround, the scope of turnaround research has expanded dramatically; however, research on this phenomenon remains empirically and theoretically fragmented. Recent research has incorporated managerial cognition, strategic leadership, and stakeholder management and has identified simultaneous and complex resource-based actions beyond the two-stage model developed in the last review by Pearce and Robbins two decades ago. Thus, herein we build from Pearce and Robbins’ review by cataloguing the past 20 years of empirical evidence related to turnaround, developing a descriptive model of organizational decline and turnaround, and concluding with a theory-based research agenda for organizational decline and turnaround. In doing so, this article summarizes what we know about organizational decline and turnaround, and proposes what we need to study, while providing a theoretical road map to guide this future research.
Organizational decline occurs when a firm’s performance or resource base deteriorates over a sustained period of time (Bruton, Oviatt, & White, 1994; Weitzel & Jonsson, 1989). Causes of organizational decline originate from external factors, such as gradual changes in the competitive landscape or sudden environmental jolts (Park & Mezias, 2005; Short, Ketchen, Palmer, & Hult, 2007), as well as internal factors, such as operational deficiencies and ineffective resource management (Morrow, Sirmon, Hitt, & Holcomb, 2007). Evidence also suggests that most, if not all, firms experience organizational decline. Schendel and Patton (1976) found that nearly one third of the firms in the S&P 500 in 1976 were experiencing 4 years of declining profitability; while more recently, about half (49.8%) of firms in the S&P 500 index for the year 2010 had experienced more than 3 years of decline within the prior 5 years. In fact, firms in fast-growth industries also experience decline. Ndofor, Vanevenhoven, and Barker (in press) found that over 15% of firms in the software industry during the boom period of 1990 to 1996 experienced organizational decline.
In light of the continued weakness in the global economy, the persistent threat of organizational decline—along with the turnaround processes it often necessitates—is likely to remain a highly relevant concern to managers worldwide. However, the concerns and challenges managers face when executing an organizational turnaround are unique and distinct from those of improving performance in a nondecline situation. First, managers must improve performance in a situation of scarce and dwindling organizational and environmental resources. Next, they do so within a context of increasing stakeholder conflict as different constituents jostle to protect their interests. Finally, despite the imperative for decisive action to turn around performance, managers of declining firms make decisions with diminished managerial discretion as greater supervision by boards and increased restrictions by creditors, bondholders, banks, and suppliers all limit their power.
To hasten the development of our theoretical knowledge of organizational decline and turnaround, this article reviews the related research that has occurred since Pearce and Robbins’ (1993) instrumental review nearly 20 years ago. On the basis of their review of nine articles, Pearce and Robbins proposed a two-stage turnaround model that highlighted the contingencies related to retrenchment and strategic actions in promoting turnaround. However, congruent with several critiques of the two-stage model (e.g., Arogyaswamy, Barker, & Yasai-Ardekani, 1995; Barker & Mone, 1994), our review of the fragmented evidence presented in 40 articles suggests a more complex and dynamic process of turnaround.
In light of this literature’s increasing theoretical and empirical fragmentation over the past two decades, our primary objectives for this review are twofold: (a) to catalogue the empirical work in the decline and turnaround stream since 1993 and (b) to offer a revised descriptive model of turnaround that consolidates these new insights and helps propel a theory-based research agenda. In total, this review shows that although Pearce and Robbins’ (1993) core ideas remain central to the process of turnaround, recent research highlights the role that managerial cognition, strategic leadership, stakeholder management, and more-complex resource-based actions play in turnaround. In light of these extensions, we discuss theories relevant to decline and turnaround, thereby assuaging a key criticism of turnaround research: that this stream is largely phenomenon driven. Specifically, we explore resource orchestration, strategic leadership, and stakeholder theory within the decline and turnaround literature to provide a theory-based program for future decline and turnaround research.
Our review begins with a brief review of Pearce and Robbins’ (1993) model and its critiques, then moves to the review of current research and the expanded model this research supports. We then close with a discussion of how resource orchestration, strategic leadership, and stakeholder theory can help direct future research.
A Brief Review of Pearce and Robbins’ Two-Stage Model
Pearce and Robbins (1993) reviewed nine key articles upon which they developed a two-stage turnaround response model. This model pointed to the importance of retrenchment and strategic actions to promote turnaround. More specifically, they suggested that the nature of the cause of decline—that is, whether it is external or internal (Cameron, Sutton, & Whetten, 1988)—should influence the retrenchment and strategic actions in which the organization engages. Retrenchment actions, used synonymously with operating actions, are defined as a set of organizational activities undertaken to achieve cost and asset reductions (Michael & Robbins, 1998: 35). Conversely, strategic actions are those actions undertaken to change or adjust a firm’s domains and how it competes within those domains (Barker & Duhaime, 1997). With a logic of congruence, it was argued that decline resulting from operating issues (i.e., inefficiencies) requires operating actions (such as downsizing) for recovery, whereas recovery from strategic problems (i.e., misalignment of firms with their environments) requires strategic actions (such as new product introductions). Second, the severity of decline should influence whether cost retrenchment (i.e., increased efficiency) or asset retrenchment (i.e., divestment) is needed; severe decline generally necessitates asset retrenchment. Third, according to this model, turnaround is a two-stage process in which cost or asset retrenchment is followed by strategic actions. Finally, the outcome of the turnaround is not guaranteed but instead could range from failure to significant performance gains.
While very influential, Pearce and Robbins’ (1993) turnaround review has been criticized for its narrow scope and the deterministic nature of its two-stage model. For example, Barker and Mone (1994) argued that retrenchment is not always indispensable to the turnaround process, while Arogyaswamy et al. (1995) suggested that turnaround is not always sequential, beginning with retrenchment and followed by strategic recovery actions. Additionally, empirical work outside the scope but within the time period of their review suggested additional complexities. For example, D’Aveni (1989) found that the structure of the top management team was closely associated with response actions. Moreover, D’Aveni found that asset retrenchment is challenging, in that although declining firms often divest businesses, they frequently fail to divest their weakest units. Thus, both critiques and early work alluded to complexities of turnaround, including the challenges of synchronizing resource-based actions, as well as the role that governance structures play in turnaround. As such, a more comprehensive model will include factors beyond the contingencies of two types of actions.
Organizational Decline and Turnaround: An Extended Model
We now turn attention toward research in the decline and turnaround literature that has occurred since 1993. We utilize 40 empirical articles, which are summarized in Table 1, to drive our efforts. These articles were found by examining eight respected journals for articles dealing with decline or turnaround. These journals included Administrative Science Quarterly, Academy of Management Journal, Journal of Management, Journal of Management Studies, Leadership Quarterly, Management Science, Organization Science, and Strategic Management Journal. These journals were selected either because they are premier journals in the general management field or because they have demonstrated a specific aptitude for decline and turnaround studies. For example, Leadership Quarterly and Journal of Management Studies have published several key articles in this area that a decline and turnaround review would be remiss to exclude. This table of empirical findings is organized by research area and serves as a basis for the model of organizational decline and turnaround presented in this review. The table highlights the empirical findings as well as sample and operationalization issues of interest to researchers.
Empirical Decline and Turnaround Articles, 1993-2012
Note: This table reflects the order in which the research areas are presented in the extended model of turnaround. TMT = top management team; ROA = return on assets; ROE = return on equity; ROS = return on sales; ROI = return on investment; BoD = board of directors.
Foreshadowing our discussion, Figure 1 presents a graphic representation of our extended turnaround model based on the aforementioned articles. As seen in the model, the literature has mirrored early forerunners to explore managerial cognition, strategic leadership, and stakeholder management as well as richer and more complex resource-based actions. We utilized lighter font and italics to identify elements in the model that are found in Pearce and Robbins’ (1993) two-stage model, while the nonitalicized, dark fonts indicate new additions based on the review of the literature. This helps illustrate the contributions that the recent empirical research has made to our understanding of turnaround. It is worth noting that although our discussion flows from left to right across the model, organizational turnaround is an iterative process that can have many feedback loops.
Model of Organizational Decline and Turnaround
Causes of Decline
The conceptualized sources of decline remain rooted in the stream’s foundational work. Cameron et al. (1988) proposed a two-part definition of decline: Decline occurs when an organization’s adaptation or alignment with its niche or domain deteriorates (external causes) or when the firm’s resources constrict, resulting in the deterioration of performance (internal causes). While the sources of decline are well accepted, research on the causes of decline continues.
External factors
Research examining external causes of organizational decline focused on changes in industry and general environment factors (Short et al., 2007). Such changes included environmental jolts (Park & Mezias, 2005), technological changes (Dowell & Swarminathan, 2006), industry decline, and competitive dynamics (van Witteloostuijn, 1998). The concept of “environmental jolt” differentiates difficult-to-foresee external events that result in potentially detrimental disruption of the organization from more subtle or incremental changes in the environment (Billings, Milburn, & Schaalman, 1980; Park & Mezias, 2005). Sudden and discontinuous change in an environment may render existing firm strategies ineffective and therefore result in organizational decline (Meyer, 1982; Wan & Yiu, 2009). New, disruptive technologies (Christensen, 1997) fundamentally alter the value chain and key success factors for an industry (Tushman & Anderson, 1986). Demographic changes, changes in product technologies, and the creation of new substitutes can lead to decline in a firm’s industry and subsequently to organizational decline (Grinyer & McKiernan, 1990). Finally, competitive pressures from other firms in the industry that result in more intense rivalry (Grinyer & McKiernan, 1990) can also send a firm into organizational decline (van Witteloostuijn, 1998).
Internal factors
The strategic-fit literature (Porter, 1980) and work related to contingency theory (Lawrence & Lorsch, 1968; Pennings, 1992) argued that organizational performance results from the alignment between a firm, its resources, and the environment. If a firm were poorly aligned with the environment, even if this environment were munificent, the firm would face performance losses, thereby leading to decline (Zajac, Kraatz, & Bresser, 2000).
Structural characteristics of an organization, such as size and operating procedures, influence the success of the firm in the long term. Organizational theory has noted that the mortality rates of firms decline with increased size (Hannan & Freeman, 1989; Sutton 1997). However, large firms can suffer from routinization that limits flexibility and fosters inertia, leading to environmental maladaptation (Cyert & March, 1963). Additionally, ineffective top management team interactions or policies can lead to organizational decline. For example, inaction or actions that use resources ineffectively (Schendel, Patton, & Riggs, 1976), such as reducing R&D investments (Johnson, 1996) or targeting acquisitions that lack complementarities (Hitt, Harrison, & Ireland, 2001), can lead to decline.
Response Factors
The next section of the model introduces the response factors to decline. Although these factors of managerial cognition, strategic leadership, stakeholders, and actions were alluded to in research at the time of the last review, their empirical examination has started in earnest over the past two decades. They therefore expand Pearce and Robbins’ (1993) model to illustrate a more detailed turnaround process.
Managerial cognition
The first aspect of a firm’s response to decline, managerial cognition, accounts for how the top management team (TMT) perceives and interprets the factors that cause decline; as such, it forms the interface between causes of organizational decline and the actions organizations take to reverse it. High-quality, value-added decision making by top management depends on accurate perceptions of the environment (Morrow et al., 2007). Three cognitive factors have been examined and found to affect subsequent turnaround actions: awareness of decline, attribution of decline, and perceptions of the decline’s severity.
Awareness of decline refers to managers’ formal recognition that the firm is in decline. The timing of decline awareness has been found to be central to triggering actions that can eventually reverse decline (Furrer, Pandian, & Thomas, 2007; Pajunen, 2006). However, Winn (1997) demonstrated that such awareness is not always readily apparent. Specifically, Winn found that declining asset productivity, in the absence of declining sales or profitability, inhibits decline awareness.
Next, attribution of decline refers to the causal factors management identifies as responsible for the decline. While leaders of declining firms are often blamed and serve as scapegoats for organizational decline (Cameron, Kim, & Whetten, 1987), they themselves tend to affix blame elsewhere. Barker and Patterson (1996), for example, found that shorter-tenured TMTs were more likely to attribute decline to internal, controllable, and stable factors, and less likely to blame external factors, than were longer-tenured teams.
An accurate perception of the decline’s severity is also essential because poor assessment results in ineffective restructuring strategies that fail to engineer a performance turnaround (Sudarsanam & Lai, 2001). Musteen, Liang, and Barker (2011) found that managerial characteristics influence such perceptions. Specifically, they found that executive age and experience, external locus of control, and throughput functional background increase the perception of decline severity, which subsequently increases the extent of retrenchment.
Although research to date has illustrated the importance of managerial cognition on turnaround, there remain many theory-driven opportunities to better understand the effect cognition has on the whole turnaround process. For example, resource orchestration could aid in understanding the interplay between awareness, attribution, and perception of severity of decline, on the one hand, and turnaround actions and outcomes, on the other. Additionally, agency theory and behavioral agency theory allow for further investigation into how characteristics of the board of directors (BoD) and the TMT affect managerial cognition.
Strategic leadership
In this section, we focus on research that has examined the effects of the CEO, TMT, and the BoD on the turnaround process. Broadly speaking, the strategic leadership of the firm can act as an impediment or facilitator of turnaround. Specifically, firm turnaround can be affected by the TMT’s compensation and ability, the CEO’s “fit” or suitability for the current context (Chen & Hambrick, 2012), and the composition and vigilance of the BoD.
The turnaround actions of a firm in decline are significantly influenced by the compensation of the TMT. The career risk associated with firm decline and bankruptcy is not attractive to high-quality managers unless they are compensated for taking a risk to their reputation and future employment (D’Aveni, 1990). Thus, executives who are effectively compensated are motivated to take turnaround actions that best meet the goals of the shareholders. However, equity-based compensation (stock options), which results in a stronger alignment between the managers and shareholders in times of organizational growth (Daily, Dalton, & Cannella, 2003), may result in an “all-or-nothing” risk-taking approach for TMTs that see the cash value of their options falling dramatically. Latham and Braun (2009) found that higher equity holdings motivated managers to decrease R&D investment to respond to decline at a greater rate than managers with no equity position, while higher levels of organizational slack strengthened the decrease in investment in R&D by equity-holding managers. Tangentially related research on executive wealth suggests that an executive’s compensation and personal wealth outside the firm may strongly affect strategies such as investment in R&D during decline (Campbell, 2012).
In comparison with what we know about TMT ability and behavior during periods of firm growth (Finkelstein, Hambrick, & Cannella, 2009), we know relatively less about the TMT during decline and turnaround. Indeed, to the extent that managerial deficiencies (e.g., dysfunctional decision-making processes, deteriorating communications across levels, and increased conflict) have caused or precipitated organizational decline (Arogyaswamy et al., 1995), addressing these issues should be fundamental to turning around performance. Carmeli and Schaubroeck (2006), for example, found that TMT behavioral integration affects not only the perception of quality of strategic actions but also organizational survival.
More recent research also indicates that the ability of the CEO to meet firm needs within a turnaround context is important to the outcome. Conflicting evidence remains regarding the need for CEO replacement, and specifically for an outside successor, to facilitate a successful turnaround. Ndofor et al. (in press) found a strong effect of CEO succession on turnaround performance for declining firms in a growth industry. In contrast, Winn (1997) found that firms that successfully turned around from asset productivity decline did not replace their top management, whereas firms that failed to turn around from asset productivity decline did replace management 21.5% of the time. Davidson, Worrell, and Dutia (1993) found that although shareholders react negatively to bankruptcy, they react positively to succession both before and after bankruptcy. Additionally, they found that outside successions, which are more likely to occur in bankrupt or nearly bankrupt firms, are more positively received than insider successions. However, Boyne and Meier (2009) found that the appointment of a superintendent from within a school district was more strongly associated with successful turnaround than an outside successor. Chen and Hambrick (2012) found that installing a new CEO with experience outside the firm and industry to succeed a longer-tenured CEO with no throughput experience improves firm performance. Additionally, longer-tenured CEOs may be less effective in turnaround contexts. These results support the logic that decline among younger firms may be due to deficient managerial knowledge, whereas decline in older firms may be due to ineffective adaptability on the part of management (Thornhill & Amit, 2003).
The evidence above suggests that certain organizational characteristics may themselves be important mitigating factors in turnaround. For example, firm size has been found to influence risk taking during decline, with smaller firms reducing risk and larger firms increasing risk (Audia & Greve, 2006). Furthermore, independent and subsidiary organizations cope differently with decline, especially environmentally dependent decline. Bradley, Aldrich, Shepherd, and Wiklund (2011) found that independent organizations are more resourceful in coping with sudden environmental changes, particularly in the use of financial slack and assets, than subsidiary organizations, despite the subsidiary’s greater access to resources from the parent company.
The composition of the BoD has also been found to be important to the success of the turnaround process. Research has shown that boards composed of fewer independent directors are strongly associated with bankruptcy (Daily & Dalton, 1994a, 1994b). Moreover, the composition of the board affects the results of attempted turnaround actions. Daily (1995) found that boards of successfully reorganized firms were composed of approximately 65% outside directors, while firms that ended in failure had boards composed mostly of insiders. Of those firms filing for Chapter 11 bankruptcy reorganization, firms with a greater proportion of outsider directors spent less time in reorganization (Daily, 1996). Sheppard (1994) found firms that failed to turn around were more likely to have fewer director interlocks and financial resources than firms with successful turnarounds. Additionally, successful turnarounds are characterized by high levels of board and organizational diversity (Filatotchev & Toms, 2003). Finally, there is greater churn of directors in the 5-year period preceding bankruptcy for declining firms than for nondeclining firms (Daily & Dalton, 1995). However, evidence is mixed in terms of directors’ willingness to see a firm through a crisis (Withers, Corley, & Hillman, 2012).
Research on the relationships between the board and the TMT and within the TMT in the turnaround context is sparse. However, Barker, Patterson, and Mueller (2001) found that the greater the outsider composition of the board, the greater the turnover in the TMT during turnaround. They also found that longer elapsed time since a change in strategy and larger firm size were associated with lower turnover of TMT during turnaround. And as TMT turnover occurs, changes in the firm’s competitive strategy, organizational structure, and controls increase. However, organizational inertia was found to inhibit TMT replacement.
The monitoring role of the board may be crucially important in a crisis situation, such as decline. A vigilant board with a fiduciary responsibility to shareholders may affect how managers negotiate and take action with other stakeholders (Zahra & Pearce, 1989). In fact, greater structural independence of boards (i.e., an outsider-dominated, separate board leadership structure) is likely to play an important role in managers’ turnaround choices because these boards are more willing to remove ineffective executives (including both the CEO and other executives) before a crisis reaches the point of corporate bankruptcy (Daily et al., 2003). However, Tuggle, Sirmon, Reutzel, and Bierman (2010) found that the attention of the BoD to managerial actions is not as focused before decline as after a decline has been identified.
In summary, decline and turnaround research has begun to investigate the effect of some elements of strategic leadership on organizational turnaround. Much ground, however, remains to be covered. Although this is an important and challenging time for TMTs and BoDs, which are responsible for steering the firm through the turnaround process, we know less about how they interact with one another and within themselves and how those processes influence turnaround actions and outcomes. By directing future research to more theory-driven investigations of strategic leadership in decline and turnaround situations, researchers may better understand this response factor and how agency conditions and mechanisms aid or hinder the attempts at organizational turnaround. Thus, the research agenda for strategic leadership for firms in decline still leaves significant opportunity for further research.
Stakeholder management
Stakeholders play a critical role for all firms, and the limited evidence suggests that the importance of their role increases for firms experiencing decline and attempting turnaround. Stakeholders who have the needed resources and are able to control the interaction and resource flows in the network will most likely have a strong influence on the firm’s survival (Pajunen, 2006) and thus the actions the firm takes. Existing stakeholders may provide resources that normally would not be available to a firm that is experiencing decline (Arogyaswamy et al., 1995); or, conversely, they may exacerbate management’s struggle with decline and turnaround. For example, Schick and Ponemon (1993) found that when auditors perceive a firm to be in rapid decline, the probability of an audit is increased. Understanding stakeholders of a declining firm is challenging because evidence suggests that the objectives of stakeholders can change as the firm enters decline and begins turnaround (Pajunen, 2006); however, identifying and influencing the perceptions of the critical stakeholders is essential for firm turnaround (D’Aveni & MacMillan, 1990). Specifically, we focus on the owners, creditors, suppliers, customers, employees, and government of the firm in decline.
The majority of research has focused on ownership, and while ownership could also be categorized under governance, we discuss it here to highlight concerns related to the changing and potentially conflicting objectives of different stakeholders during decline and turnaround. Early work related to ownership in declining firms examined bankruptcy. Daily and Dalton (1994a) found that institutional ownership decreases the incidence of bankruptcy for firms that enter decline because these owners cannot easily liquidate their positions and thus become active participants in the turnaround process. Furthermore, firms that experience successful turnaround tend to have more institutional ownership than those that fail (Filatotchev & Toms, 2003).
Research has identified family and management ownership as particularly relevant to turnaround situations. While firms with higher management ownership reduce R&D expenditures and the availability of slack resources during decline (Latham & Braun, 2009), family ownership has a mixed effect on turnaround strategies. Cater and Schwab (2008), in a case study, noted that traditional family characteristics, such as strong ties to the family firm, internal orientation, altruistic motives, and long-term goal orientation (Sirmon & Hitt, 2003), may in fact influence the implementation of turnaround strategies. Research into family businesses underscores how the objectives of different owners may diverge for stakeholders during decline. Gomez-Mejia, Haynes, Nunez-Nickel, Jacobson, and Moyano-Fuentes (2007) provided evidence that family-owned firms adopt strategies that have significant downside risk and little upside gain (e.g., staying independent rather than joining a co-op) in an attempt to preserve the family’s ownership and firm viability.
Next, creditors wield considerable power over the decision making of firms in distress. Bruton, Ahlstrom, and Wan (2003) found that major creditors to a firm in decline, such as banks and financial institutions, often apply considerable pressure for decisive action, such as the removal of a CEO. Furthermore, firms that have access to organizational slack through banking relationships have better survival rates, as do firms that have more leniency on accounts payable to suppliers (Pajunen, 2006). Financial capital (organizational slack) from suppliers and creditors enables firms to continue day-to-day operations while enacting retrenchment activities and to fund strategic initiatives essential for some turnaround situations.
Managing the perceptions of customers is important for keeping the basic functions of the business running while attempting a turnaround. Firms that maintain present customers during the turnaround may find the time frame in which they can enact turnaround lengthened, because maintaining customers may stem further declines in profitability (Bruton et al., 2003). Equally important is maintaining the idiosyncratic human capital essential to competitive advantage and the high morale needed in a workforce faced with layoffs and downsizing (S. Freeman & Cameron, 1993). Also worthy of note is potential government intervention for those firms deemed “too big to fail.” In such cases, the government renegotiates the contractual disputes between the firm (most recently, in the automobile and financial industries) and several stakeholders, including employees, suppliers, and creditors; and low-interest loans are granted in order to prevent firm failure.
In total, this preliminary evidence suggests that stakeholders play a key role in decline and turnaround scenarios. Indeed, the stakeholder response factor in the model recognizes the importance of management’s acknowledgement of the stakeholders’ interest and influence during the turnaround process. However, given the fragmented empirical examination of the stakeholders within the turnaround setting, this area of research could benefit from the application of stakeholder theory to present a more robust understanding of how the divergent interests and claims of stakeholders are manifested and sorted during decline and how this process affects turnaround outcome.
Firm Actions
Operational actions
Empirical evidence of the effect of operational actions on turnaround performance has been fragmented, inconsistent, and without much cumulative theory building. Love and Nohria (2005) found that declining industrial firms that proactively downsized, and did so across the board, had better turnaround performance. Similarly, Bruton et al. (2003) found asset retrenchment resulted in improved performance for declining firms. In producing evidence to the contrary, Nixon, Hitt, Lee, and Jeong (2004), however, found the level of downsizing to have a negative impact on firm performance.
Barker and Mone (1994) argued that the effect of retrenchment actions would be contingent on the industry condition of the declining firm. Morrow, Johnson, and Busenitz (2004) provided evidence that asset retrenchment leads to performance gains in growth industries; yet, in declining industries, asset retrenchment negatively affects performance, but cost retrenchment positively affects performance. Similarly, Ndofor et al. (in press) found evidence that both cost and asset retrenchment negatively impact turnaround for firms facing decline in growth industries. Importantly, Barker and Mone, however, did not find any evidence that firms engaging in retrenchment actions in a declining industry had better performance than those who did not. Indeed, firms that engage in retrenchment actions experience reductions in industry- and firm-specific human capital as well as industry-specific social capital that increase the probability of firm failure (Pennings, Lee, & van Witteloostuijn, 1998).
There are two possible explanations for the inconsistent findings on the effect of retrenchment actions. First, Barker and Mone (1994) contended that in some circumstances, retrenchment actions were more a response to the depth of decline rather than a cause of turnaround performance. Firms with steeper declines were more likely to engage in retrenchment actions as a form of triage. Ketchen and Palmer (1999), for example, showed that firms experiencing severe decline were more likely than better-performing firms to discontinue existing high technologies. Second, some papers operationalized retrenchment actions using changes in firm ratios, which might not capture actual retrenchment actions (Ndofor et al., in press) or that tend to correlate with performance ratios (e.g., return on assets [ROA]) because of a shared denominator rather than causal effect (Barker & Duhaime, 1997).
Strategic actions
The evidence has underlined the critical role of strategic actions in turnaround. Indeed, it is thought that strategic actions are the true driver of long-term performance gains after decline. For example, Morrow and colleagues (2007) found that recombining the firm’s existing stock of resources to create valuable new products, processes, or technologies, as well as acquiring resources through mergers or acquisitions, has a positive effect on organizational recovery. Both of these actions were more important than allying to gain access to new resources.
Researchers have also investigated how environmental conditions affect strategic actions in turnaround. Interestingly, evidence suggests that more firms fail in growing industries than in declining industries (Moulton, Thomas, & Pruett, 1996), which speaks to the importance of strategic actions’ fit with the environment. In the context of decline driven by environmental jolts, where the environment’s munificence falls precipitously, acquisitions taken during the jolt produce greater returns than acquisitions taken either before or after the jolt (Wan & Yiu, 2009). Also, in declining industries, related acquisitions perform better than unrelated acquisitions for distressed firms (Anand & Singh, 1997). The same results have been found when examining a broader spectrum of strategic actions. Ndofor et al. (in press) found that new product introductions, acquisitions, and strategic alliances are instrumental to turning around decline in growth industries. Similarly, Barker and Duhaime (1997) provided evidence that among firms facing decline, those in growing markets tended to engage in more strategic actions than those in stable or declining industries. Ketchen and Palmer (1999) found that strategic actions related to technology are common for firms facing extensive decline. For example, firms that are early entrants into R&D joint ventures are stimulated to innovate as a response to performance declines (Bolton, 1993). These scholars found that strategic actions increase the firm’s market share and lead to greater survival prospects.
Finally, as is the case for retrenchment, slack plays a role in determining the effect of strategic actions. Specifically, the level of reductions in slack and organization size influences the riskiness of firms’ strategic actions (Greve, 2011; Wiseman & Bromiley, 1991). Additionally, organizational slack affects the resulting performance increases of acquisitions made during environmental jolts (Wan & Yiu, 2009) as well as the decreases in profitability by firms that enact strategic actions, such as asset acquisition with high levels of debt financing (Moulton et al., 1996).
Overall, the past two decades have witnessed an increase in the research examining the effect of retrenchment and strategic actions on turnaround performance. While the findings show a more consistent and positive effect of strategic actions, the effect of retrenchment actions is far from settled. Although Figure 1 lists the potential retrenchment and strategic actions, research indicates that the efficacy of retrenchment and strategic actions may depend on several contingencies, such as industry life cycle and the availability of slack. Additionally, because these actions are not independent of one another, they should be examined for their interactive effects. Furthermore, although researchers have advanced our understanding of firms’ actions in a turnaround situation, little theoretical headway has been made in this area. The addition of resource orchestration to research on firm actions in turnaround provides a theoretical framework by which to examine the contingencies of dynamic actions in the decline and turnaround setting.
Turnaround Outcomes
The final component of the turnaround model is focused on performance outcomes. Two key issues have arisen in the literature on the measure of performance turnaround: (a) how a successful reversal of decline is defined and (b) how to operationalize performance turnaround. The first issue addresses both the magnitude of performance change needed to qualify as a performance turnaround and the duration after commencement of decline within which the organization’s performance is evaluated to determine whether it has successfully reversed the decline. There is general consensus that to constitute a successful recovery, performance measures should at least be positive or above the risk-free rate of return (Barker & Duhaime, 1997). There is less agreement, however, on how long the reversal of decline has to last to be considered a successful turnaround. While some (e.g., Morrow et al., 2007) have argued that 1 year is sufficient to confirm a turnaround, others (e.g., Barker & Duhaime, 1997; Bruton et al., 2003) have argued that at least 3 years of sustained positive performance are necessary to judge a successful turnaround.
The second issue with turnaround outcomes lies with how to operationalize a successful turnaround. Pearce and Robbins’ (1993) review noted only three outcomes of the turnaround process: recovery, moderate recovery, or liquidation. However, more recent research has extended the conceptualization of turnaround outcomes. Moulton and Thomas (1993) not only found that some firms use bankruptcy as a deliberate reorganizational strategy within the turnaround process but also introduced the concept of partial turnaround success, in which a firm divests most of its assets and either is acquired by another firm or maintains its identity. They found that firms that liquidated after a failure to reorganize were smaller in total assets prior to reorganization and experienced more years in decline prior to bankruptcy filing than those firms that were successful or partially successful at reorganization.
The outcome category of our model encompasses a finer-grained operationalization of turnaround. Thus, Figure 1 shows that the iterative process of turnaround is composed of both positive outcomes, which end the turnaround process (sharp-bend recovery, mergers or divestitures where assets are sold at a premium, and recovery), and negative outcomes, which may result in additional turnaround actions (moderate recovery, mergers or divestitures in which assets are sold at a discount, Chapter 7 bankruptcy filing for reorganization, and firm failure or liquidation). Thus, it proposes categories that range from the most positive result of turnaround—a sharp-bend recovery, in which a firm not only recovers but also experiences substantial sustained growth (Grinyer, Mayes, & McKiernan, 1990)—to the most negative outcomes of turnaround—an organizational failure and liquidation, in which a firm has experienced numerous turnaround attempts and is finally forced to close its doors.
Turnaround: Future Research
Decline and turnaround research has clearly made significant progress since Pearce and Robbins’ (1993) review over 20 years ago. While the evidence validates some underlying elements of the two-stage model, at the same time, it suggests a more complex process of turnaround. Indeed, what we do not know or what is currently understudied far outweighs what is known about decline and turnaround. More importantly, this review highlights the fact that most of the decline and turnaround research has been phenomenon based, with less theoretical development within and integration across the components of the decline and turnaround process. Building on this research, we now turn attention toward the theoretical implications of the empirical review.
While turnaround research is perceived as largely phenomenon driven, it is important to note that theory can be a source of new discoveries and provide programmatic direction to the research stream. The empirical review helps identify gaps in the literature as well as theories that may be especially relevant in their application to future turnaround research. For example, although the governance literature covers organizational bankruptcy extensively, it fails to address the turnaround process. Whereas stakeholders are addressed within the literature, stakeholder theory remains underutilized. Additionally, the dynamic management of resources remains central to a successful organizational turnaround; however, little research has utilized the theoretical lens of resource orchestration to discuss the synchronization of resource-based actions. And our knowledge of the role of CEOs, TMTs, and BoDs in the turnaround process can be enhanced by utilizing strategic leadership, resource orchestration, or stakeholder theory. As such, we discuss each of these perspectives in the turnaround context. We specifically delineate a future direction of research within organizational decline and turnaround, through the lenses of resource orchestration, strategic leadership, and stakeholder theory. See Table 2.
Future Research Directions in Organizational Decline and Turnaround
Resource Orchestration
Managing firms in decline necessitates orchestrating resources to synchronize action, such as divestment, rebundling, and deploying resource sets. Resource orchestration suggests that the firm must simultaneously consider retrenchment and recovery actions during a turnaround attempt. Research on resource orchestration has found that a firm’s capability weaknesses often undermine firm performance. Although firms can still achieve a high level of performance by bundling capability weaknesses with strengths, doing so conveys significant risk (Sirmon, Hitt, Arregle, & Campbell, 2010). Thus, effective resource orchestration is vital to turnaround because firms in decline are likely to have capability portfolios replete with weaknesses. For this reason, asset retrenchment activities, such as divestment, need to be accurately focused to avoid losing strengths along with weaknesses. Indeed, Morrow and colleagues (2007) found that turnaround was best accomplished by reconfiguring valuable and rare resources while divesting undifferentiated assets.
Resource orchestration draws upon the conceptual work of resource management (Sirmon, Hitt, & Ireland, 2007) and asset orchestration (Helfat et al., 2007) and is theoretically grounded in the resource-based and dynamic capabilities literatures. Resource orchestration focuses on the actions managers take to effectively utilize the firm’s resources through structuring the firm’s resource portfolio, bundling resources into capabilities, and leveraging the capabilities for value creation (Sirmon, Hitt, Ireland, & Gilbert, 2011). Although each action is important, it is in synchronizing or orchestrating the leadership’s resources management actions that value is added in positive firm outcomes.
Resource orchestration allows for the investigation of simultaneous retrenchment and strategic actions or the configuration of actions that best fits with a decline situation. Indeed, given the centrality of resource-based performance arguments in management research, it is surprising that so little turnaround research has examined how the management of a firm’s resources during decline (i.e., the divesting of nonessential resources and the reconfiguration, bundling, or acquisition of new resources) and their leveraging in new competitive actions influence performance turnaround.
Cognitive theories could also be combined with resource orchestration to shed further light on the turnaround process. Changes in the cognitive framework of TMTs could influence changes in resource acquisition, bundling, and leveraging activities. For example, Ndofor, Priem, Rathburn, and Dhir (2009) found that changes in the cognitive models of an organization’s managers lead to subsequent changes in relative resource allocation across different areas of the organization.
Finally, there may be resources (factors) that detract from a firm’s ability to generate rent, including the liabilities of the firm (Powell, 2001) or its core rigidities. A firm’s resource liabilities may include lawsuits, poor reputation, negative employee morale, defective inventory, or high quantities of debt. Any of these factors can limit the firm’s ability to turn its performance around. For example, highly leveraged firms will have a resulting decline in income to service debt; but in the absence of organizational slack, a firm may also miss opportunities to create future competitive advantage and forestall impending decline. Furthermore, to the extent that some prescribed turnaround actions, such as downsizing, could create resource liabilities (e.g., negative employee morale), the interaction and feedback effects of turnaround actions on eventual performance need further investigation.
Thus, the future research agenda of turnaround research can encompass a number of different research directions through resource orchestration. Resource orchestration can provide a theoretical lens through which numerous unresolved issues in turnaround research can be examined, such as resource mismanagement as a cause of organizational decline, the interplay of timing between resource retrenchment and strategic actions to turn around performance, and the relative importance of resource-generation actions (such as bundling or reconfiguring) and resource exploitation (such as leveraging) in fostering performance turnaround. Furthermore, future turnaround research can also combine resource orchestration with cognition research to examine how changes in the TMT’s cognitive framework, together with changes in resource orchestration activities, affect the probability of turning around declining performance. Finally, future research can also utilize resource orchestration to examine how managers can deal with resource liabilities and core rigidities in decline situations to successfully turn around performance.
Strategic Leadership
As a result of the separation of ownership and control in the modern corporation, there is a divergence of interests between those who run the firm (agents) and the owners. The actions of managers may not always be in the best interests of the owners. These management actions may be motivated by the background and characteristics of the CEO and TMT or by the divergent interests of management. Organizations in decline provide unique situations in which management actions might be accentuated, and the governance mechanisms put in place to align interests may foster (or impede) the turnaround process. Turnaround research has primarily investigated governance mechanisms, either immediately prior to or at the point of bankruptcy (Daily, 1994). For this reason, little evidence is available regarding the effect of strategic leadership on the actions of the firm during the turnaround process itself. Governance mechanisms may have different effects on firms in decline than on firms experiencing growth. This could be a result of restricted management discretion owing to increased board oversight, bankruptcy monitoring, or increasingly divergent goals among shareholders, creditors, boards of directors, and managers.
The BoD plays a role in the hiring and monitoring of the CEO and TMT. Each CEO and TMT has a unique cognitive framework that shapes its attention and interpretation of the environment. The experiences and social interactions unique to individuals or teams shape the differences of cognitive frames (Reger, 1990; Sutcliffe & Huber, 1998). The differences in executives’ cognitive frameworks have been found to influence firm-level strategic behavior (Marcel, Barr, & Duhaime, 2011), specifically, the awareness and speed with which executives respond to organizational challenges (Sharma, 2000; Tripsas & Gavetti, 2000). Thus, either hiring the appropriate CEO and TMT member(s) or deciding to fire a CEO and TMT member(s) may be contingent on the BoD’s responsibility within agency theory. It is essential that the BoD have the aptitude to determine the ability and cognitive frames of the management of a firm in decline and to hire CEOs with the characteristics to successfully manage the turnaround process.
Although research has shown that the unique cognition of the CEO—such as early awareness, attribution of decline, and perceived severity of decline—has a significant influence on the success of turnaround actions, other CEO, TMT, and firm characteristics that affect the timing of management’s awareness of decline and perception of its severity remain unexamined. Furthermore, the accuracy of the CEO’s and TMT’s perceptions may play a key role in the quality of subsequent decision making. Cognition frameworks within strategic leadership research can therefore be used to examine several unresolved areas in turnaround research.
Thus, future research on turnaround in strategic leadership can build on agency theory to examine how TMT and board composition, board monitoring, and TMT compensation during decline influence the actions undertaken and success at turning around performance. Additionally, agency theory can be used to examine the hiring of a new CEO or the poor fit of the present CEO to the firm’s needs within the firm attempting turnaround. Given that cognitive frameworks evolve with the unique experiences of the executives, are executives with prior experience with organizational decline better able to accurately perceive decline and identify its cause and severity? Is a CEO (or management team) with past experience in decline situations better able to deal with decline?
Similarly, behavioral agency theory provides a comprehensive view of managerial risk taking by integrating governance structure, risk, and performance attributes that influence executive behavior (Wiseman & Gomez-Mejia, 1998). This extends agency theory by considering an alternative to the assumption of consistent risk aversion among agents. Executive aspirations, the perceived risk to executive wealth, past and current performance outcomes, and executive incentives all influence the executive’s problem framing (Wiseman & Gomez-Mejia, 1998). These individual influences, in addition to the fiduciary responsibility to shareholders, remain unexamined in the turnaround setting. Is it possible that the some influences encourage a CEO to attempt a turnaround, while other influences encourage the CEO to seek mergers-and-acquisitions solutions to firm decline?
Stakeholder Theory
Stakeholder theory argues that managers must consider the goals of both internal stakeholders (e.g., owners, customers, employees, and suppliers) and external stakeholders (e.g., governments, competitors, special-interest groups, and the media) to successfully manage the firm (R. Freeman, 1984). The balancing of stakeholder objectives is instrumental to maintaining access to or control of the resource flows that strongly influence a firm’s survival (Pajunen, 2006). Research on stakeholder theory has noted that management does not pay equal attention to all stakeholders (Laplume, Sonpar, & Litz, 2008).
When firm resources are being depleted, as often occurs when a firm is experiencing organizational decline, stakeholders become more sensitized to their claims on the firm. Managing stakeholder demands, especially when the firm may need more resources from these stakeholders, becomes even more important. Thus, identifying and influencing the stakeholders critical to firm survival during organizational decline are essential to the success of any turnaround attempt. Stakeholders have the potential to significantly affect turnaround actions and subsequent survival of the firm.
Although turnaround literature has acknowledged the influence of stakeholders (Arogyaswamy et al., 1995; D’Aveni & MacMillan, 1990; Rosenblatt, Rogers, & Nord, 1993), it has not examined it extensively. Indeed, stakeholder theory can be used to shed light on many unresolved questions in turnaround research. For example, the objectives of creditors and owners may differ more strongly for firms in decline or attempting a turnaround. Creditors offer liquidity and sources of investment capital, yet they may be less willing to risk further investment, because their position in a liquidation is far more secure than that of owners. Again, creditors’ upside gain and downside risk for further investment differs from owners’. Thus, the similar objective of creditors and owners during growth times—desire for the firm’s success—can clash during crisis. Finally, while no evidence is readily available in a turnaround context, it is likely that management and employees may be far more willing to encourage all stakeholders to assist the firm to maintain a very moderate recovery rather than allow it to fail and have the assets redeployed because of the reputational and wealth effects such a failure would deliver to employees.
In addition, shareholders may not have unitary interests. The ownership structure of a firm may have significant effects on the actions taken during turnaround (Cater & Schwab, 2008). Family firms desiring to maintain socioemotional wealth (Gomez-Mejia et al., 2007) may take risk-averse actions when their firms experience decline. Firms with higher family ownership may be less likely to implement operational decisions that harm family employees or potentially risky changes to the strategy of the firm. Additionally, family management may block the needed management changes necessary to change the cognitive map of the firm. Future research can examine how actions taken by firms with higher management and family ownership affect the outcome of the turnaround process. In addition, future research can focus on activist shareholders who may advocate certain courses of action in order to extract the most rents possible in a decline situation. Thus, building on agency theory (and other governance theories), future research can shed light on questions such as how ownership concentration and type (institutional, management, or family) affect the type of turnaround actions taken, how stakeholders affect the actions of firms in decline, what motivates a stakeholder to become involved in the turnaround process, and how the power plays between competing stakeholders that invariably take place in decline situations will affect outcomes.
Finally, future research on decline and turnaround viewed through the lens of stakeholder theory may shed significant light on the factors that motivate stakeholder involvement in the turnaround process, the power struggles that occur between stakeholders with divergent interests, and management’s ability to leverage relationships to foster support for the turnaround actions. Additionally, stakeholder theory, in conjunction with governance research, may add significantly to the knowledge of the divergent interests between different owners, such as the family firm with both family and nonfamily ownership, in decline situations that must balance socioemotional wealth and profit maximization.
Operationalization Issues
Organizational decline and turnaround research could also benefit from better measures of turnaround performance. There are currently no set standards for measuring decline or turnaround. (See Table 1 for recent operationalizations of decline and turnaround.) Some studies have used financial measures such as return on investment (e.g., Robbins & Pearce, 1992), return on equity (e.g., Pearce & Michael, 1997), or ROA. Using financial ratios has, however, been criticized because performance can be manipulated simply by reducing the denominator (Barker & Mone, 1994). For example, ROA could be made to increase simply by shrinking the asset base (as with asset retrenchment) without any increase in actual performance. As a result, other research has used market-based measures of performance, such as Jensen’s alpha, because they capture investors’ expectations of the future cash flows of the firm (Morrow et al., 2007). However, because these are all continuous measures that require the organization to continue to exist and report performance, there is a high degree of selection bias. That is, the measures do not account for attrition of the firms that are unsuccessful in reversing organizational decline and experience organizational failure. A solution to this bias is the subjective binary grouping of decline organizations into turnaround and nonturnaround categories based on their performance and, in the case of attrition, the reason and nature of their exit (Barker & Mone, 1994).
While using a binary variable to capture turnaround performance eliminates issues of selection and survival bias, it fails to capture the richness and nuances of organizational performance. A firm that is liquidated in decline, for example, is distinctively different from one that is acquired; yet they could still be grouped together. One possible solution is for future research to use ordered categorical measures based on the status of firms within a set time frame from the commencement of decline. Declining firms, for example, could be classified in increasing order of success with turnaround: from failure (including liquidation or Chapter 11 bankruptcy) through reorganization (Chapter 7 bankruptcy), discounted merger or acquisition, limping along, and recovery to premium merger or acquisition and sharp-bend recovery. Statistical procedures that can analyze ordered categorical variables, such as ordered probit models, can be used to examine turnaround models with this dependent variable. This should provide more richness and nuance to the measure of turnaround performance while at the same time eliminating the selection bias inherent in continuous measures.
Conclusion
The study of organizational decline and turnaround has expanded beyond the scope of Pearce and Robbins’ (1993) two-stage model of turnaround. While the new model of decline and turnaround contributes to our understanding of recent expansions of research on this phenomenon, much of the turnaround domain remains uninvestigated. There remains much to learn about the causes and consequences of firm decline, how strategic leadership differs in decline versus growth settings, how incongruent goals between stakeholders shape organizational turnaround decisions, and the nature of the interdependences between retrenchment and strategic actions. We hope this review and model encourage additional theory-driven research into this valuable and impactful area of research.
Footnotes
Acknowledgements
The authors would like to thank our action editor Annette L. Ranft and two anonymous reviewers for their helpful suggestions and advice. We are also deeply grateful for the feedback provided by Vincent Barker III on earlier versions of this manuscript.