Organizational Failure in the Aftermath of Radical Institutional Change

Abstract

This paper focuses on the question of the extent to which the institutional founding environment affects organizational success after a radical institutional change. We analyse firms founded in the German Democratic Republic (GDR) that experienced the fall of the Iron Curtain in 1990 and focus on how the institutional environment of their founding period influences their failure rates. Results show that organizational failure rates vary after institutional change due to differences in institutional founding conditions. This variation is influenced by the degree of (dis)similarity between the imprinted past and the present institutional context. Discussing the time-varying effect of institutional founding conditions, we contribute to a more comprehensive understanding of imprinting and organizational failure in situations of institutional change.

Keywords

event history analysis imprinting organizational failure qualitative analysis radical institutional change transition economies

Introduction

Institutional change and the question of how firms successfully overcome situations in which institutional logics shift have received considerable attention in organization and management research during the last decades (Dobrev, 1999; Kogut & Zander, 2000; Krause & Wyrwich, 2010; Kriauciunas & Kale, 2006; Newman, 2000; Newman & Nollen, 1998; Shinkle & Kriauciunas, 2012). Research on institutional logics, for example, aims to explain how new logics emerge and how they affect firms (Greenwood et al., 2011; Thornton et al., 2012). Literature on organizational learning (March, 1991) and dynamic capabilities (Dixon et al., 2010) explains how firms adapt to changing institutional requirements. However, the impact of institutional founding conditions on organizational success in situations of institutional change has received only scant attention so far.

Only recently, a stream of imprinting research has started to address this research gap by analysing transition countries in Central and Eastern Europe (CEE) in which institutional change affected economies in their entirety (Krause & Wyrwich, 2010; Kriauciunas & Kale, 2006; Shinkle & Kriauciunas, 2012). Here, the socialist institutional logic was replaced with the fall of the Iron Curtain in 1990 by a market logic, and firms in these countries experienced a situation in which the founding institutions fundamentally differed from the institutions in place after the transition (Kornai, 1992). Existing studies have shown that organizations founded in socialist institutional environments often have difficulties adapting to new institutional requirements (Dixon et al., 2010; Kriauciunas & Kale, 2006; Marquis & Qian, 2014; Shinkle & Kriauciunas, 2010, 2012). However, not all organizations fail after radical institutional change. In our study, we propose that differences in survival chances might be due to differences in imprinting during the founding of the organizations and different perceptions of the severity of the institutional change.

This supposition, however, has not yet been tested, as past research has been restricted by a lack of suitable data. Firstly, institutional conditions have in general been classified only in a binary way, while in reality even institutional environments that appear to be stable change over time (Shinkle & Kriauciunas, 2012). Therefore, past research was unable to answer the question of whether different degrees of misfit between founding conditions and contemporary institutional environment play out equally. Secondly, due to the available datasets, researchers were only able to observe the short-term success (Dobrev, 1999) or the success at a particular point in time (Kriauciunas & Kale, 2006) of organizations after radical institutional change. Thus, it is not surprising that most studies assume a uniform influence of imprinting. However, the longitudinal effects of a mismatch between founding conditions and the conditions after a radical institutional change might not be monotone, i.e. not all organizations stemming from the foregone institutional environment are doomed to fail.

Therefore, the time-varying effect of imprinting needs to be considered in more detail in order to better understand the consequences of different degrees of institutional imprinting. This seems especially important as institutional change is a frequently observed phenomenon not only in times of political change, but also when industries are deregulated or when cross-border transactions—like direct foreign investments—are facilitated by removing trade barriers (Suarez & Oliva, 2005; Zhou & van Witteloostuijn, 2010). A more detailed analysis of imprinting effects would also have managerial implications with regard to the question of how to overcome situations of institutional change successfully.

In our study, we analyse the effect of imprinting on organizational vitality and how this effect varies depending on the degree of (dis)similarity between the imprinted past and present institutional context (Marquis & Tilcsik, 2013). Based on qualitative and quantitative analyses, our results show that organizational failure rates vary with time after radical institutional change. We propose that this variation is influenced by the degree of (dis)similarity between the institutional logic imprinted and the institutional logic after institutional change.

Based on our finding, the study advances the understanding of (socialist) imprinting and the persistency of its effects. Moreover, results allow us to contribute to conceptual work on the question of how the extent of institutional change influences firm success (Greenwood & Hinings, 1996; Newman, 2000). Greenwood and Hinings (1996) argue that with an increasing embeddedness of organizations in their institutional context, the likelihood of revolutionary organizational change increases if the institutional environment changes dramatically. Following the argument that adaptation to the institutional environment increases the survival chances of organizations (DiMaggio & Powell, 1991; Meyer & Rowan, 1977), Newman (2000) adds to this argument by proposing that the degree of institutional change influences the likelihood of organizational transformation. We challenge these conceptual arguments by suggesting that it is not the extent of institutional change that influences adaptation and, subsequently, organizational survival chances, but the institutional conditions imprinted at the founding that determine whether or not the extent of institutional change is experienced by the organization as extreme. The initial success of organizations in the aftermath of institutional change may thereby be misleading, as it might prevent organizations from adapting to radically new environments adequately.

In the next section, we introduce our theory and hypotheses. We continue by describing our research context in greater detail. The empirical part of our study is twofold: The first part is based on eight expert interviews. With these interviews we aimed to get a better understanding of the differences of institutional founding conditions in the GDR and how imprinting affected firms after 1990. The second part of our study is based on the quantitative analysis of the survival chances of 1596 private firms founded in the GDR in the aftermath of the reunification. Finally, we discuss the results of our study and how they contribute to the literature.

Theory and Hypotheses

Research on the phenomenon of imprinting and institutional change

Many theories address the question of how organizations and their failure rates are affected by institutional change. One of the most notable theories in this context is the concept of imprinting (Stinchcombe, 1965). According to Stinchcombe, organizations are imprinted by their institutional founding conditions and exhibit the specific technological, economic, political, and cultural frameworks of the time at which they were founded (Marquis & Tilcsik, 2013; Stinchcombe, 1965).

As studies on imprinting show, founding conditions have a long-lasting effect on managerial structures (Baron et al., 1999), inter-organizational networks (Marquis, 2003), intra-organizational capabilities (Marquis & Huang, 2010), and strategy (Boeker, 1988). Moreover, imprinting affects organizational outcomes such as survival chances (Dobrev & Gotsopoulos, 2010; Swaminathan, 1996), and success (Johnson, 2007). Because of inertia forces such as tradition, institutionalization, vested interests, or ideology, organizations may survive far into the future with their founding structures largely intact (Stinchcombe, 1965).

The general argument of imprinting is frequently tested and incorporated in different theoretical frames. Organizational ecologists, for example, stress the structural inertia of organizations (Carroll & Hannan, 2000), which is also a precondition for the persistence of imprints. Hannan and Freeman (1984) propose that an organization’s ability to adapt to environmental changes is limited because of inertia and that adaptation is subsequently time-consuming and costly. When environmental conditions change, both the time needed to adapt and the costs of adaptation rise (Péli et al., 2000; Péli, 2009). This especially holds true in times of radical institutional change, i.e. in times of a “rapid and pervasive change in the norms and values that underlie and legitimate economic activity” (Newman, 2000, p. 603). Subsequently, organizational failure rates increase when institutional settings change radically.

In a similar vein, the literature on the resource-based view argues that capabilities acquired by an organization at its founding, i.e. their imprinting, can become a strategic barrier as they cannot be easily changed and might prevent the organization from adapting to new environments (Schreyögg & Kliesch-Eberl, 2007). This non-adapting behaviour may lead to lower performance, particularly in situations of radical institutional change. Moreover, Heirman and Clarysse (2005) show that resources available at the time of founding can impact long-term business success (Chittoor et al., 2009). This finding is also supported by Yiu et al. (2005), who highlight the role of early stage resources for organizational prosperity in situations of institutional change.

Another branch of research that relies on the general argument of imprinting focuses on the cognitive frames of managers in situations of institutional change and on the persistence of their frames (Iederan et al., 2011; McCarthy et al., 2008; Tilcsik, 2010; Tripsas & Gavetti, 2000). Studies in this area show that decision-makers apply pre-existing cognitive schemes to make sense of institutional change and the pressure they experience resulting from the change (Bacharach et al., 1996). Moreover, studies focussing on a post-socialist context show that organizations which were founded during socialism are often run by managers who were also educated during the socialist era (Tilcsik, 2010). This indicates that the imprinting argument may also be applied to formerly state-owned and partly state-owned enterprises, as has been argued by Zhou and van Witteloostuijn (2010). The orientation of managers may limit the ability to adjust cognitive frames. It may lead to inertia and reduce the adaptability of the organization (see for an overview Kaplan, 2011).

The theoretical claims presented so far serve as preconditions and background for our study: First, organizations experience radical institutional change as a challenging situation (Bacharach et al., 1996; Greenwood & Hinings, 1996; Iederan et al., 2011; Newman, 2000; Schreyögg & Kliesch-Eberl, 2007), with which they have difficulties coping and which subsequently may result in increasing failure rates (Hannan & Freeman, 1984). Second, due to the experienced level of similarity between the organization’s imprint and the setting after institutional change, the degree of change might be perceived differently.

Imprinting and its persistence

While the general imprinting argument has become an influential approach in organization and management theory, more recent studies challenge the persistence of imprinted features. Marquis and Tilcsik (2013, p. 223), for example, propose that “in some situations, as the environment changes, significant countervailing pressures may push organizations to diverge from the imprints they carry.” This argument of deviations from organizational imprints over time, particularly in situations of institutional change, is in line with recent empirical findings. Kriauciunas and Kale (2006), for example, focus on a sample of the largest firms in Lithuania and analyse how a socialist environment at the time of founding influences organizations’ attempts to successfully alter their knowledge base after institutional change. They show that, overall, the socialist imprint negatively affects the ability of organizations to modify their operating knowledge. However, they also show that those organizations that sought new knowledge from sources located in non-socialist countries were better able to adapt to the new institutional requirements. This finding is in line with the result of Iederan et al. (2011), who show that Eastern European firms faced with the threat of institutional change aimed to modify their internal structures and to copy successful business models of Western European organizations. In another study conducted by Marquis and Huang (2010), the authors introduce the notion of “exaptation” to describe the process through which the current usefulness of a capability departs from its historical origin. Focusing on the US banking industry between 1978 and 2001, they show that founding conditions affect the propensity of banks to engage in acquisitions. Moreover, taking into consideration institutional change caused by deregulation, Marquis and Huang (2010, p. 1467) stress that “the extent to which historical changes result in selective pressure has more to do with the degree of alignment, or match, between origin and current use, and less with external changes per se.”

Such adjustments of imprints are characterized as key developmental stages (Carroll & Hannan, 2000) or sensitive periods of organizations (Marquis & Tilcsik, 2013), which can be triggered by transition and change (Greenwood & Hinings, 1996; Tushman & Romanelli, 1985). If institutional change occurs, organizations experience a subsequent sensitive period, which may lead to a new or a broader orientation (Marquis & Tilcsik, 2013). Taking a long-term perspective into account, it seems reasonable to argue that organizations founded in institutional environments that more closely resemble the environment after institutional change may—not least because of their routines and the cognitive frames of their managers, the functionality of which appears to be confirmed—be lulled into a false sense of security, which might in turn affect their willingness to change.

This actual maladaptive specialization of routines is labelled as a “competency trap” by learning theorists (e.g. Levitt & March, 1988). Learning theorists highlight that such traps can occur if favourable outcomes—such as organizational survival—are reached with unfavourable routines and procedures. Stinchcombe (1986) stresses that the magnitude of differences between inferior routines and potentially superior procedures influences the odds for organizations to fall into a competency trap.

Imprinting research suggests that organizations are not always equally sensitive to questioning their own routines (Marquis & Tilcsik, 2013). In times of institutional change, organizations go through a sensitive period. If the magnitude of difference between inferior routines and potentially superior alternatives is perceived to be great, competency traps can be avoided through realignment and internal change. To the contrary, if organizations experience success in a sensitive period with old routines, they are likely to fall into competency traps as routines which have become inferior in the meantime are reproduced (Ferriani et al., 2012). “In this way, organizations’ experience contributes to the inertia that binds them to routines of the past, leading them to employ routines well beyond their point of usefulness and ultimately resulting in their failure” (Baum & Shipilov, 2006, p. 80).

If organizations survive the initial phase after institutional change without altering their structures and procedures, decision-makers might misinterpret the organization’s survival as confirmation of their fit. Old cognitive patterns of managers may be enforced instead of being adapted to new environmental requirements (Tilcsik, 2010). Managerial attention is focused on business as usual, obscuring the need for organizational change (Fox-Wolfgramm et al., 1998). Put differently, success after institutional change might lead to the paradoxical situation that these firms are at a high risk to fail in the long run because managerial beliefs are not reflected and managers become reluctant to acknowledge the need for change (Lewin & Volberda, 1999; Schreyögg & Kliesch-Eberl, 2007). Overall, these organizations are likely to have lower incentives to change radically.

High degrees of dissimilarity between the founding institutional environment and institutional conditions after change, on the other hand, are more difficult to ignore. Organizations confronted with this situation are more likely to be sensitive to implementing new structures and a new orientation (for a similar argument, see Suarez & Oliva, 2005). This argument is also in line with the work of Fox-Wolfgramm et al. (1998), who studied organizational adaptation after institutional change (see also Starbuck et al., 1978; Miller, 1991). The authors argue that resistance to change and to meeting new institutional demands is to some extent caused by an organization’s perception that it already meets current institutional demands, while performance failures are likely to motivate change and adaptation (Fox-Wolfgramm et al., 1998).

Based on these conceptual considerations and empirical findings, we propose that the more radically the institutional founding conditions differ from those after institutional change, the higher the initial failure risks will be. However, we also propose that those organizations that experience a higher degree of institutional dissimilarity are more likely to radically alter their structures and practices and to improve their survival chances in the long run, provided that they survive the change process (Suarez & Oliva 2005; Swaminathan, 1996). Therefore, we propose that failure risks after radical institutional change do not evolve monotonically, but are dependent on the degree of congruence of the imprint at the time of founding and the institutional requirements after radical institutional change. We hypothesize:

Hypothesis 1. The degree of similarity between the institutional founding conditions of an organization and the institutional conditions after radical institutional change is negatively associated with failure risk in the short run.

Hypothesis 2. The degree of similarity between the institutional founding conditions of an organization and the institutional conditions after radical institutional change is positively associated with failure risk in the long run.

Research Context

We analyse the failure risks of firms founded in the former GDR after radical institutional change. As in other transition economies in the CEE countries, the socialist environment in the former GDR placed demands on firms that substantially differed from those of firms in market economies. The centrally planned economy of the GDR affected all major sectors of economic life. The government decided what should be produced and instructed firms to produce exactly these goods, in a determined quantity and quality, and to sell them at a fixed price. A firm’s revenues and expenditures were planned prior to production by the Central Planning Commission and were closely monitored (Nuti et al., 1988). This led to a situation in which most firms were driven mainly by the ideology of full employment and the fulfilment of production goals (Kornai, 1992). In socialism, profit maximization, increasing market shares, and bankruptcy were regarded as impossible for firms (Collier, 1990; Makhija, 2003; Shinkle & Kriauciunas, 2012).

Compared to most other countries in CEE as well as the Soviet Union, East Germany had specific characteristics (Pickel, 1992): Before the Second World War, the GDR was part of one of the strongest economies in the world, usually defined as a market economy. After 1990 it became part of the reunited Germany, i.e. part of a strong and mature institutional environment and a market economy considered to be highly competitive. Consequently, after the fall of the Iron Curtain, firms in the former GDR immediately faced the problem of incongruence between their imprinted institutional settings and the new institutional environment, as Western German institutions immediately expanded and Eastern German firms were instantly faced with competition by Western firms (Newman, 2000; Pickel, 1992, Steiner, 2010).

However, the founding conditions were not uniform during the existence of the former GDR (Pickel, 1992; Steiner, 2010).Three distinct phases of economic policies can be distinguished that differ in terms of the degree of central decision-making (i.e. the extent to which an important element of the ideology of the socialist economy was put into practice). Thus, start-ups in the GDR did not experience identical institutional founding conditions, as the extent of socialist policy and control differed depending on the founding phase of a firm (Elliott & Scaperlanda, 1966; Krause & Wyrwich, 2010; Leptin & Melzer, 1978; Vogt, 1976).

Phase 1 (1949–1962): After the Second World War, a centralized planning economy was introduced to the former market economy of the eastern part of Germany. This phase was characterized by the attempt to strengthen the state-owned sector of the economy in order to implement the principles of a uniform socialist planning system and to systematically apply the economic rules of socialism. One key principle of the economic policy was collectivization. The state set production targets and prices and allocated resources. These decisions made at the state level were codified in a comprehensive plan (Five-Year Plan) or a set of plans and individual contracts with firms. Firms were not able to negotiate the terms of the contracts; they were valid even without a firm’s agreement and signature. Thus, entrepreneurial decisions, managerial freedom, and strategic choices vanished for private firm owners, as well as for managers of state-owned firms. If firms were nonetheless able to yield a profit, the entire surplus was claimed by the Central Planning Commission. If a firm did not fulfil its plan, its production was monitored more closely on a day-to-day basis, and the quantity assigned to the firm was sometimes reduced in the following years (Parsons, 1986). As a result of this central planning policy, the efficiency of the performance of the GDR’s industrial sector decreased over time. In fact, the GDR’s rate of industrial growth was the lowest among Eastern European nations in 1961 (Elliott & Scaperlanda, 1966). Because of a lack of resources, firms had high incentives to hoard materials. The lack of resources on the one hand and the waste of raw materials on the other continued to worsen as a result. Subsequently, the government decided to replace the ineffective system of Five-Year Plans.

Phase 2 (1963–1970): Due to declining industrial growth rates and the social and economic crisis of East Germany from 1960 to 1962 (Vogt, 1976), the economic policy was changed in 1963 by Walter Ulbricht. Ulbricht, head of the Council of the GDR, adapted Liberman’s theories and introduced the New Economic System (NES), an economic reform program that included some decentralization in decision-making and the consideration of market and performance criteria (Elliott & Scaperlanda, 1966; Hanhardt, 1968). Although firm behaviour in the economy of the GDR had always been guided both directly and indirectly toward the implementation of state objectives, the NES phase was characterized to a greater extent by indirect steering (Jeffries & Melzer, 1987). The NES aimed to create an efficient economic system and to transform the GDR into a leading industrial nation. Decentralization involved the partial transfer of decision-making authority from the Central State Planning Commission and National Economic Council to firms. Again, the Central State Planning Commission set overall production goals, but each firm determined its own internal financing, utilization of technology, and allocation of manpower and resources (Vogt, 1976). “To wean plant managers away from the temptations of fulfilling plan objectives at any cost, the notions of price, profit, investment, and cost accounting were introduced by the New Economic System” (Hanhardt, 1968, p. 94). Moreover, a firm’s revenues were divided between the firm’s owner and managers and the Central Planning Commission. An incentive scheme was introduced by linking the salaries of top and middle managers to the efficiency of their firm’s operations. The NES stipulated that production decisions be made on the basis of productivity, that salaries reflect performance, and that prices respond to supply and demand. The increased scope of entrepreneurial decision-making included investments, product and input mix, and composition and organization of the labour force, as well as the terms of contracts (Jeffries & Melzer, 1987). To stimulate growth rates in the high-technology sectors, increase the number of exportable products, and enhance the profitability of plants (for example, by further increasing the freedom of decision-making for plant managers), Ulbricht replaced the NES in 1968 with the Economic System of Socialism (ESS) as a continuation of the NES. Failure to meet ESS goals, however, resulted in the ultimate termination of previous reform efforts in 1970 and a reversion to a very rigorous form of socialism.

Phase 3 (1971–1989): After 1970, the centralized, administrative direction of the economy and firms (similar to phase 1) and the collectivization of firms were reintroduced (Baylis, 1986). Moreover, the system of Five-Year Plans was reinstated. From 1971 on, one could observe an increasing number of interventions by central bodies in firms’ affairs (Vogt, 1976). The Central Planning Commission coordinated the allocation of resources. Additionally, the number of central planning norms and specifications containing quantitative and qualitative production goals increased as well. Profit rates were set for all firms. If firms exceeded their specified profit rates, half of the excess profits had to be channelled into the state budget (Vogt, 1976). However, private ownership was not abandoned. In 1976, the GDR gave new support to its single remaining stronghold of private ownership (even if the vast majority of the economy was already state owned), permitting the creation of new firms and providing an ideological justification for their existence under socialism (Baylis, 1986). The private sector was officially recognized as a significant economic factor for the realization of the party’s social policy (Neues Deutschland, 1987) and held up as a model of the work ethic and achievement orientation for a socialist society as a whole (Pickel, 1992). This policy, together with a more liberal licensing practice for founders, led to an increase in the number of newly founded firms in the GDR in the 1980s (Pickel, 1992).

Overall, the GDR’s economic policies always differed from those of Western market economies, but the degree of dissimilarity differed in the above-mentioned phases. As Table 1 illustrates, the environmental demands in the more market-oriented phases of the GDR (1963–1970) were more similar to those of a market economy than the demands in the two more socialist-oriented phases of the GDR.

Table 1.

Characteristics of economic policy practices.

Characteristics of Economic Policy Practices
Characteristics	Centralized planning economy in the GDR (1949–1962, 1971–1988)	New Economic System (NES) and Economic System of Socialism (ESS) in the GDR (1963–1970)	Western German market economy
Price setting	Set by State Planning Commission	According to supply and demand, but controlled by State Planning Commission and National Economic Council to the Associations of People’s Firms	According to supply and demand
Centralized decision about production goals	For every firm	For the entire economy	—
Financing	State Planning Commission	Single firm	Single firm
Technology	State Planning Commission	Single firm	Single firm
Allocation of input resources (incl. manpower)	State Planning Commission	Single firm	Single firm
Incentives for entrepreneurs	Fixed salary	Incentive scheme for top and middle managers	High-powered market incentives

Qualitative Study

Data and Method

We started our research by conducting interviews with eight experts who either held important functions in government and economy after the transition or who were founders themselves in the GDR. We spoke, for example, to two former ministers in Thuringia who were in office immediately after the reunification of Germany and who had in-depth knowledge of the economic changes and their consequences. Table 2 provides an overview of the interviewed experts and their positions before and after the transformation. The interviews were based on a semi-structured interview guideline. They took between one and two hours and were recorded and fully transcribed.

Table 2.

Overview of the experts’ background.

Expert	Position before 1990	Position after 1990
E1	Engineer of a large machine manufacturer	Leading position in the department for economic development in the Ministry of Economic Affairs in Thuringia
E2	For reasons of anonymity, we may not name the position	Minister in Thuringia
E3	Professor of economic history	Banker (specialized in East German companies)
E4	Veterinarian	Governing Major of a big city in Thuringia
E5	Engineer in a large machine manufacturer	Minister in Thuringia
E6	Co-owner of a family firm	Head of the formerly co-owned firm, later a politician
E7	Engineer at different large machine manufacturers	Leading position in the Department of Economic Development in a big Thuringian town.
E8	Engineer in the building and construction industry	Leading position in the city management of a big Thuringian town

We coded the interviews by separating factual and value statements (Miles & Huberman, 1994) on: (1) the different imprinting effects on firms and their initial structures in the different phases of economic policy in the GDR and (2) the survival chances that experts expected organizations founded in the different phases of the GDR to have after reunification and the explanations the experts provided for the differences in the expected survival chances.

Findings

Our interviews confirmed our literature review, which revealed that the economic policy of the GDR was characterized by three phases that can be distinguished by different degrees of centralized decision-making and that these phases affected the imprinting of firms founded in the different phases. While the first and third phase were characterized by a high socialization rate and very tight control by the state, the second phase was characterized by a higher degree of decentral decision-making. This change in the economic policy in the different phases was very much emphasized by our interviewees:

In my opinion, Ulbricht’s economic policy [NES phase] was much closer to economic reality [compared to West Germany] than what Honecker did afterwards [in the third phase]. (…) In the early days [i.e, in the first phase], the GDR was oriented towards the Soviet Union, including its planning system. But there was one substantial difference: we had private firms in the GDR which were non-existent in the Soviet Union. (…) And the process from the beginning to the end of the 1960s [i.e. the NES phase] was one of distancing – a theoretical and practical distancing from the Soviet Union. [E3, 154]

There was the [NES] phase, when ordinary people like craftsmen were provided with a certain amount of [economic] freedom. [E8, 178]

Entrepreneurial thinking [was] suppressed [in the third phase]. (…) Performance was not rewarded! (…) That’s how you have to imagine it! In other words, you were actually punished for being intrinsically motivated. [E5, 167]

Further, our interview partners described the second phase of the GDR’s economic policy as more optimistic, especially in terms of entrepreneurial hopes and expectations. For example, three of our interviewees, one of whom was involved in the conceptualization of the NES, stated:

The NES was also an emotional jolt. Amongst my colleagues, at least here, was a jolt: “Man! Now we are finally able to do something!” [E7, 258]

Some people felt a spirit of optimism (…) I know that it was a very special situation back then. [E8, 126]

The core idea of this phase was to increase the economic freedom of firms, to give more leeway with regards to decision-making, and to increase the degree of independence from targets set by the state. In other words, the intention was to set back the influence of a central political power. [E3, 251]

Our interviewees’ perceptions of the institutional changes that came with the end of the GDR were fully in line with our analysis of the literature. With the fall of the Berlin Wall on November 9, 1989, the institutional environment of the firms instantaneously changed from a socialistic to a market economy. Overall, our interview partners perceived the transition from socialism to a market-based system as “fundamental” and “revolutionary”:

We were faced with a revolution, not only a political one but also an industrial revolution. Suddenly, there was no longer someone who told us to do something in a certain way and within a certain time; instead, we were confronted with international, even global, competition. (…) Life changed completely. [E5, 434]

Further, the interviewees related the different phases of socialism with the degree of required change that organizations were confronted with after the reunification. The experts clearly distinguished between organizations founded in the first and third phases and those founded in the second phase:

They [firms of the more socialist phases] had to reorganize from scratch and reconsider everything. [E7, 637]

Moreover, our interviewees mentioned that organizations founded in the second phase were able to rely on imprinted knowledge after the reunification that helped them to survive. In the long run, however, these imprints were regarded as a reason for closure rather than a reason for successes, as they did not perfectly fit the new environmental demands.

Yes, they adapted to the market (firm of the more socialist phases). Right, they adapted to the market and needed some time for this purpose. The NES-firms were better prepared, but they were not up to date anymore. A lot of documents and concepts still existed from the starting phase of the NES, but they were outdated. [E7, 632]

[Some] firms didn’t change after the reunification and continued their business in their old structures. They may have survived for some years. However, many of them closed down. [Other] firms started all over again, so that every employee recognized continually that the firm is no longer the same. These firms had better survival chances. (…) Thus, by moving to new buildings, structures and hierarchies changed too and, therefore, these firms were able to get rid of the socialistic bacillus. [E3, 415]

In summary, our interviews indicated that the adaptation pressures of the firms differed depending on the conditions of the institutional environment at the founding of the firm. While our interview partners clearly distinguished between the three phases of economic policy in the GDR, they particularly highlighted the differences between the second (more market-oriented) and the first and third (more socialist) phases. This finding supports the design of our hypotheses, which distinguish between more market-oriented and more socialistic-oriented founding institutional environments. Therefore, the collapse of the first and third phases will serve as background for the quantitative part of our study.

Quantitative Study

Data and method

The quantitative part of our study is based on the life history of 1596 private firms that were founded in the GDR from 1 January 1949 until 9 November 1989 and had to register at the Chambers of Industry and Commerce in Thuringia (a state in Germany) after the reunification. Our observation period ends at 31 December 2005. As the political regime in the GDR generally did not want firms to go bankrupt, reliable information about firm closure during the existence of the GDR does not exist. Data from Chambers of Industry and Commerce from 1990 onwards, however, are highly reliable (as all firms in the districts that operate in the industry and trade sector must register) and are frequently applied in longitudinal studies on organizational failure (see among others Brüderl & Schüssler, 1990; Preisendörfer & Voss, 1990; Oertel & Walgenbach, 2012; Oertel, 2014; Günther et al., 2015). Consequently, our data equate to a census of all private firms founded in Thuringia during the GDR phase that still existed at the time of German reunification. Firms that were formerly fully state owned are not included in the dataset because their re-privatization occurred in a different manner, i.e. they were taken over by the Treuhand agency, disintegrated, and privatized or closed down.

The exact date of registration (founding date) is included for all firms in our sample, as is the date of deregistration (closing date) for firms which were closed in the observation period. This longitudinal structure of our data allows us to apply event history analysis in which firm failure was modelled using a hazard rate model in which the probability of an event at time t is estimated, given that the event has not yet occurred. To estimate the hazard rate, we applied a piecewise constant model (PCE) (Blossfeld et al., 2007; Cleves et al., 2010).

We applied this type of regression model for two main reasons: First, the PCE model allows us to account for unobserved heterogeneity of time-dependent covariates (Blossfeld et al., 2007; Powers & Yun, 2009). This is highly important to us, as we assume that the effect of founding institutional environment varies with time and that the variation differs by sub-groups (i.e. firms founded in the first, second, and third phase of the GDR). This model specificity is based on the division of the observation period into several time-episodes. In these episodes an exponential distribution is assumed—i.e. the parametric assumption is that the hazard risk does not change over time. However, the base rate of the hazard risk may vary freely across these episodes (Blossfeld et al., 2007; Cleves et al., 2010). Second, in contrast to other parametric models that assume a particular distribution of the failure rate, the PCE model is very flexible and is particularly appropriate for research in which the distribution of the hazard rate is unknown (Blossfeld et al., 2007).¹ However, the disadvantage of the PCE model is that the episode splits need to be sufficiently long, as hazard rates can be calculated only if a sufficient number of firms failed in every episode (Phillips, 2002; Blossfeld et al., 2007). Therefore, we cannot estimate intervals of less than three years. As our observation period captures 16 years, four episodes encompass three years; the last episode is based on four years.

Our dependent variable organizational failure was coded “1” for firms that failed and “0” for firms that continued to exist at the end of every three-year episode. Our independent variable (founding institutional environment) was a dummy variable based on the founding date of firms. In line with the structure of our hypotheses and the findings of the qualitative part of our study, firms founded in the more market-oriented NES phase (1963 to 1970) were coded “1,” and firms founded in the first socialist phase (1949 to 1962) or the second socialist phase (1971 to 1989) were coded “0.” However, in later robustness checks we also introduced separate dummies for each of the three economic policy phases of the GDR.

Past studies show that there are several variables that affect firm failure. Our control variables were based on time-constant (firm size, industry, age at reunification) and time-varying variables (location, legal form, density): The first control variable was firm size (Ranger-Moore, 1997; Haveman, 1995; Sharma & Kesner, 1996), which was used as a proxy to assess a firm’s resources. Following Geroski et al. (2010), we applied firm size at the time of institutional change on the number of employees. This information was included in our data set as a categorical variable based on ten categories: 0, 1–3, 4–6, 7–9, 10–19, 20–49, 50–99, 100–199, 200–499, and more than 500 employees. Besides size, firms’ legal form (Brüderl & Schüssler, 1990), location (Baum & Mezias, 1992; Schutjens & Stam, 2003) and industry may affect firm survival in our setting. Controlling for the legal form after reunification, we followed a basic differentiation between corporations, private companies, and tradesmen. Location was included as dummy distinguishing between firms that were located in a town (more than 20,000 citizens) and in a rural area. Finally, industry effects were controlled by four dummies based on the WZ-2008 Code (a code similar to the US SIC code classification). Thereby we distinguished between: (a) business services sector, including consulting; (b) energy and communication, including logistics, mining, and water and electricity suppliers; (c) manufacturing, which refers to the production of intermediate and/or end products; and (d) trading and services as the reference category, including wholesale, retail, catering, and the hotel industry. Moreover, we also included organizational age at the time of reunification as a control variable in order to account for age-dependent effects on firm failure in situations of institutional change (Freeman et al., 1983; Marquis & Tilcsik, 2013; Stinchcombe, 1965). Finally, we controlled for density rates after the reunification, as density has been shown to affect firm failure rates (Carroll & Hannan, 2000; Dobrev & Gotsopoulos 2010). Density was calculated on the basis of the industry of the firms.

Before running the models, we checked whether we faced any problems of collinearity: As founding institutional environment and age at reunification are theoretically collinear, we calculated the VIF and used coldiag2 (Belsley et al., 1980). The VIF was not higher than 2.45 in models in which we distinguished between firms founded in the NES and those founded in the more socialistic phases (see Models 1–3 in Table 4) and not higher than 8.86 in Models 4–5 (in which we distinguished between the three institutional founding phases separately), which was below the threshold of 10 (Kennedy, 1992). Moreover, we also applied the STATA program coldiag2 (Belsley et al., 1980) and models passed this test, with the highest value reached being 19.44 (a value higher than 30 might indicate collinearity).

Results

Descriptive statistics are presented in Table 3. The relatively high founding rate in the third phase is due to the history of the GDR. Starting in 1976, the GDR regime gave greater support to private ownership and permitted the creation of new firms (Baylis, 1986) in order to eliminate bottlenecks in production and to remedy inefficiencies in coordination. Official statistics used in a study by Brezinski (1987) show that the share of private firms increased from 1.8% in 1975 to 7.3% in 1980.

Table 3.

Descriptive statistics.

	Mean	(sd.)	Min	Max
Organizational failure	0.777	0.416	0	1
Years experienced after reunification	7.667	5.622	1	16
Founded in NES	0.068	0.252	0	1
Founded in phase 1	0.091	0.287	0	1
Founded in phase 2	0.068	0.252	0	1
Founded in phase 3	0.841	0.366	0	1
Size	0.587	1.253	0	10
Legal form	0.167	0.574	0	2
Region	0.229	0.420	0	1
Industry, construction, and logistics	0.196	0.397	0	1
Trade	0.350	0.477	0	1
Hotels and restaurants	0.370	0.483	0	1
Other business services	0.084	0.277	0	1
Density	20,810.12	14,258.28	704	36,770
Age at reunification	9.357	10.157	1	41

Besides correlations between founding phases and age at reunification, we do not observe correlation coefficients larger than 0.65.

Table 4 shows our regression models in which our dependent variable is defined as organizational closure. Therefore, a positive coefficient indicates an increase in the hazard risk, while a negative effect indicates a decrease in the hazard risk.

Table 4.

Effects of institutional founding conditions on organizational failure risk.

	(1)		(2)		(3)
0-3 years after reunification	−3.092***	(0.680)	−3.086***	(0.680)	−3.073***	(0.681)
4-6 years after reunification	−2.802***	(0.806)	−2.797***	(0.806)	−2.827***	(0.807)
7-9 years after reunification	−3.222***	(0.837)	−3.217***	(0.837)	−3.284***	(0.838)
10-12 years after reunification	−3.572***	(0.859)	−3.568***	(0.859)	−3.681***	(0.861)
13-16 years after reunification	−3.661***	(0.884)	−3.656***	(0.884)	−3.773***	(0.885)
Founded in NES			0.067	(0.126)
Founded in NES*0-3 years after reunification					−0.596**	(0.262)
Founded in NES*4-6 years after reunification					−0.036	(0.202)
Founded in NES*7-9 years after reunification					0.350	(0.250)
Founded in NES*10-12 years after reunification					0.766***	(0.295)
Founded in NES*13-16 years after reunification					0.905***	(0.316)
Size	−0.318***	(0.034)	−0.318***	(0.034)	−0.317***	(0.034)
Legal form	−0.004	(0.009)	−0.005	(0.009)	−0.007	(0.009)
Region	−0.200***	(0.071)	−0.200***	(0.071)	−0.204***	(0.071)
Industry, construction, and logistics	0.891*	(0.527)	0.892*	(0.527)	0.917*	(0.528)
Trade	0.687	(0.487)	0.687	(0.487)	0.711	(0.487)
Hotels and restaurants	0.054	(0.262)	0.051	(0.262)	0.007	(0.263)
Density/1000	0.100*	(0.058)	0.100*	(0.058)	0.102*	(0.058)
Density²/1000	−0.002**	(0.001)	−0.002**	(0.001)	−0.002**	(0.001)
Age at reunification	−0.031***	(0.009)	−0.033***	(0.010)	−0.033***	(0.010)
Age² at reunification	0.001***	(0.000)	0.001***	(0.000)	0.001***	(0.000)
Log Likelihood	−2,266.17		−2,266.04		−2,255.65
Subjects	1,596		1,596		1,596
Observations	4,487		4,487		4,487

Standard errors in parentheses.

***

p<0.01, ** p<0.05, * p<0.1.

Model 1 is our baseline model. In Model 2, we test whether the general imprinting assumption holds true, i.e. whether being founded in the more market-economic phase of the GDR (in contrast to the reference category “founded in the more Socialist phases”) affects the failure risks of firms after reunification. Interestingly, this static test reveals that the imprinting effect is not significant. The lack of significant results, however, is likely due to the dynamic effects that become apparent in Figure 1.

Figure 1.

Failure rates of organizations (smoothed hazard rates).

Figure 1 shows the smoothed hazard rates of firms founded in the three phases of socialist policy. The results show that firms founded during the more market-oriented phase of the GDR (1963–1970) had lower hazard rates during the early years after German reunification. However, their hazard rates greatly increased from 1992 to 2003 and exceeded the hazard rates of firms founded in the more socialist phases of the GDR in the mid-1990s. Firms founded during the more socialist phases of the GDR reached the peak of their hazard rates between 1992 and 1995. After this period, their hazard rates significantly decreased. Figure 1 indicates that there is not a general and time-independent effect of institutional founding conditions after reunification. A test of the time-dependent effect of imprinting in Model 3 supports our Hypotheses 1 and 2. The results of the regression show that firms founded in the more market-oriented phase of the GDR initially display lower hazard risks compared to firms founded in the more socialist phases (Hypothesis 1), while they increase with time (Hypothesis 2).

While our hypotheses are based on differences between firms founded in the more market-oriented phase of the GDR and those founded in the more socialistic phases, one could ask whether there are also differences between the effects of the founding conditions in the different more socialistic phases. Therefore, we ran robustness checks, which are presented in Table 5. These additional tests support our findings.

Table 5.

Robustness checks.

	(4)		(5)
0-3 years after reunification	−2.981***	(0.702)	−3.527***	(0.740)
4-6 years after reunification	−2.691***	(0.825)	−2.697***	(0.837)
7-9 years after reunification	−3.111***	(0.854)	−2.762***	(0.878)
10-12 years after reunification	−3.462***	(0.877)	−2.739***	(0.907)
13-16 years after reunification	−3.551***	(0.900)	−2.690***	(0.936)
Founded in phase 1	0.008	(0.243)
Founded in phase 3	−0.105	(0.164)
Founded in phase 1 * 0-3 years after reunification			0.730**	(0.350)
Founded in phase 1 * 4-6 years after reunification			−0.193	(0.329)
Founded in phase 1 * 7-9 years after reunification			−0.104	(0.375)
Founded in phase 1 * 10-12 years after reunification			−1.712***	(0.663)
Founded in phase 1 * 13-16 years after reunification			−0.168	(0.438)
Founded in phase 3 * 0-3 years after reunification			0.554*	(0.284)
Founded in phase 3 * 4-6 years after reunification			0.039	(0.228)
Founded in phase 3 * 7-9 years after reunification			−0.403	(0.273)
Founded in phase 3 * 10-12 years after reunification			−0.732**	(0.313)
Founded in phase 3 * 13-16 years after reunification			−1.023***	(0.335)
Size	−0.317***	(0.034)	−0.318***	(0.034)
Legal form	−0.005	(0.009)	−0.007	(0.009)
Region	−0.200***	(0.071)	−0.207***	(0.071)
Industry, construction, and logistics	0.891*	(0.527)	0.828	(0.528)
Trade	0.686	(0.487)	0.627	(0.488)
Hotels and restaurants	0.053	(0.262)	0.057	(0.266)
Density/1000	0.100*	(0.058)	0.092	(0.059)
Density²/1000	−0.002**	(0.001)	−0.002**	(0.001)
Age at reunification	−0.032***	(0.011)	−0.033***	(0.011)
Age² at reunification	0.001**	(0.000)	0.001**	(0.000)
Log likelihood	−2,265.97		−2,248.26
Subjects	1,596		1,596
Observations	4,487		4,487

Standard errors in parentheses.

***

p<0.01, ** p<0.05, * p<0.1.

Model 4 in Table 5 shows the main effects of the founding institutional environment for firms founded in the first and third phase of the GDR. As with the main effects for founding institutional environment observed in Model 2 (Table 4), effects are not significant. In Model 5, we split the effect of the founding institutional environment to show how it varies with time after the reunification. We find that firms founded in the first and the third phase of the GDR initially had higher failure rates than firms founded in the NES phase. Ten years after reunification, however, the effect switched and failure rates were lower for those firms than for firms founded in the more market-oriented phase.

Discussion

That institutional founding conditions imprinted in organizations affect their longevity is a hypothesis in organization and management theory that has frequently found support (Marquis & Tilcsik, 2013; Simsek et al., 2015). This finding is often explained by a misfit between imprinted features and the institutional requirements of the organization’s environment that is particularly high in the context of institutional change (Kriauciunas & Kale, 2006; Newman, 2000). However, failure rates in the aftermath of institutional change are likely not to be static but to vary as organizations may alter their imprint (Marquis & Huang, 2010) and adapt to new conditions (Greenwood & Hinings, 1996; Newman, 2000), which implicates dynamic variations in failure rates.

This variation, however, remained a theoretical argument and has received only scant attention in empirical research so far. We addressed this research gap by focusing on the question of how survival chances of firms founded in the former socialist part of Germany (GDR) varied over time after the reunification, and how this variation is related to their founding period.

Our findings lead to several theoretical conclusions that are in line with the qualitative part of our study. We propose that the variation in failure rates is due to different degrees of perceived adaptation pressure, which forced organizations to conform to the market institutional logic relevant after 1990. The institutional founding conditions of firms founded in the more market-oriented phase of the GDR met the new environmental requirements after reunification at least to some degree (Krause & Wyrwich, 2010). Consequently, they did not realize the need for adaptation (Newman, 2000) and showed lower failure rates right after the reunification.

Our interview data indicate that while firms founded in the more socialistic phases had to reorganize from scratch and reconsider everything, firms founded in the NES may have misinterpreted the (seemingly positive and confirmative) signals they received immediately after the transition and subsequently perceived less pressure to alter their structures and practices (Fox-Wolfgramm et al., 1998; Starbuck et al., 1978). This misinterpretation of the new institutional environment may be due to the cognitive frames of decision-makers in the organization, which hindered them from fully realizing the magnitude of the recent institutional change (Iederan et al., 2011).² In contrast, firms founded in the more socialist phases of GDR policy experienced a more extreme sensitive period (Marquis & Tilcsik, 2013) that forced them to fundamentally adapt to the new institutional conditions. As change is costly and time intensive because counteracting forces of inertia need to be overcome (Hannan & Freeman, 1984), radical adaptation initially led to higher failure rates for those firms. In the long run, however, the failure risk of organizations with institutional founding conditions that were the least congruous at the time of radical institutional change decreased compared to that of organizations that were founded in conditions that resembled at least some of the institutional requirements after radical institutional change. We propose that this time-varying effect is due to a competency trap and the misinterpretation of signals of the institutional environment by organisations which perceived an initial fit after radical institutional change. The notion of (mis-)fit as a relative rather than an absolute concept is also found in the emerging field of individual-level imprinting research in which a very similar concept of “imprint-environment fit” has been introduced recently (Tilcsik, 2013).

Our findings and conclusions supplement and challenge earlier studies in the field of imprinting and institutional change. Swaminathan (1996), for example, analysed the effect of density at founding and observed initially high failure rates for newly founded firms that decrease over time. He argued that this variation in failure rates is due to a trial by fire effect, i.e. high density at founding leads to a shake out of weak competitors and the remaining (strong) firms show lower failure rates in the long run. While firms founded in the more socialist phases surely experienced a shake out after the reunification, and those firms that survived changed routines and procedures, the trial by fire hypothesis does not explain our finding regarding firms founded in the NES. In contrast to the trial by fire hypothesis, it seems to be not only the effect of density at founding that leads to the observed shake out in our study regarding firms founded in the first and third phase of the GDR. Instead, it seems to be the overall similarity between founding institutional settings and institutional requirements that determines failure rates after institutional change. Moreover, firms founded in the NES phase experienced a later shake out, which is likely to be based on the misinterpretation of the new institutional environment and not on unfavourable founding conditions per se. With this finding, we also add to literature on institutional change (Greenwood & Hinings, 1996; Newman, 2000) which argues that the extent of institutional-level change influences the likelihood of an organization to adapt and subsequently influences its survival chances. Our findings indicate that it is not the level of institutional change per se that matters, but the similarity between the founding institutional environment and the institutional settings after change that influence survival.

We also contribute to research on (socialist) imprinting (Dobrev, 1999; Kriauciunas & Kale, 2006) from a methodological side, as we show that the interpretation of (socialist) imprinting effects has to be treated with caution when focusing on rather short observation periods or on observations at a particular point in time. In our setting, observing only the first years after reunification, failure rates would show a different picture than observing failure rates after 15 years. This challenges future methodology of imprinting research and illustrates the relevance of long observation periods.

Finally, our findings imply that a combination of imprinting and strategic decision-making approaches may be a promising avenue for a better and in-depth understanding of organizational evolution in the aftermath of institutional change (see Boone & van Witteloostuijn, 1995; Tripsas & Gavetti, 2000). Ocasio (1997) argues that individuals within a firm are bound by their past experiences, leading them to pay attention only to selected developments in the environment. Such a link to strategic decision-making approaches would allow the development of more detailed managerial implications about how managers and decision-makers in organizations should behave in situations of institutional change. As our findings indicate, radical change may not immediately be needed to adjust to new settings in the aftermath of radical institutional change. However, not recognizing the need for further adaptation may increase failure rates in the long run. Consequently, managers should pay attention to the need for adaptation, i.e. the level to which their firm meets new institutional requirements and the extent to which adaptations are needed.

Further, understanding the dynamic effects of misfits has managerial implications as well, such as that in times of massive institutional change, early success should raise managers’ and owners’ awareness. It seems that competencies that appear appropriate at the moment of institutional change constitute rigidity and thus negatively impact a firm’s long-term performance (Lewin & Volberda, 1999). Both the cognition-based theory of organization (e.g. Iederan et al., 2011) and the resource-based view (e.g. Schreyögg & Kliesch-Eberl, 2007) argue that success in the short run might lead to inertia in the sense that decision-makers will not be aware of the need to change or will be unable to change their organization due to sunk costs. Thus, time seems to play a crucial role in the process of readjusting an imprint.

When focusing on long observation periods, data limitations are often an issue of concern. We were faced with such concerns as well in our study. For example, it could be argued that our findings may be affected by cross-population interactions as observed by Zhou and Van Witteloostuijn (2010) in their study based on different types of ownership-defined organizations in China. While we controlled for density effects in our study, data on other ownership types (e.g. information on state combines in the GDR) that would allow controlling for density effects of competing forms were not available to us.

Moreover, it could be argued that organizational change is an omitted variable, i.e. controlling for change would decrease the observed variation in survival chances in our study. While our qualitative data support our interpretation of our regression models, and we are able to control for changes in the legal form and location of firms, we think that observing organizational adaptation after institutional change in more detail would enrich our understanding of imprinting and how imprinted features are altered over time. In our setting, detailed information on adaptation was not available to us, as most firms in our sample do not exist anymore and former owners are very difficult to identify. Moreover, we focus only on very small firms, which are generally not required to publish financial statements. Information on time-varying variables such as sales and growth rates was therefore not available to us.

Footnotes

Acknowledgements

The authors would like to thank Nikolaus Beck, Suleika Bort, Markus Höllerer, Reinhart Lang, Renate Meyer, Katja Rost, Thomas Steger and Jörg Sydow for helpful comments on previous versions of this paper. We would also like to thank the editor Frank den Hond and three anonymous reviewers for their helpful comments. Moreover, we are grateful to the Chambers of Commerce in Thuringia for providing us with the statistical data.

Funding

This research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors.

Notes

Author biographies

Simon Oertel is a postdoctoral researcher at the Chair of Organization, Leadership, and Human Resource, Management, School of Economics and Business Administration, Friedrich Schiller University of Jena, Jena, Germany.

Kirsten Thommes is a postdoctoral researcher at the Chair of Human Resource Management and Personnel Economics, School of Business and Economics, RWTH Aachen University, Aachen, Germany.

Peter Walgenbach is professor of Organization, Leadership, and Human Resource Management, School of Economics and Business Administration, Friedrich Schiller University of Jena, Jena, Germany.

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