essays on the role of unobservables in corporate strategy

ESSAYS ON THE ROLE OF UNOBSERVABLES IN CORPORATE STRATEGY DISSERTATION Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Philosophy in the Graduate School of The Ohio State University By Anup M. Nandialath, M.S. Graduate Program in Business Administration The Ohio State University 2009 Dissertation Committee: Jaideep Anand, Advisor Jay B. Barney Douglas A. Schroeder c  Copyright by Anup M. Nandialath 2009 ABSTRACT The Resource Based View suggests that firms that are most successful possess certain unique resources. This logic has been applied to a wide variety of strategic choices such as market entry and mergers & acquisitions among others. An implicit assumption is that such resources or the value from such resources are perfectly observed by all concerned. However, in reality resources are imperfectly observed. Through three essays, this dissertation develops models to study the role of imperfect observability on strategic choices. Theoretically it is shown that unobservability can lead to a counter intuitive position where firms that may indeed possess valuable resources fail to capture sustainable advantages. Similarly, it is shown that firms can consider using noisy signals to reduce the unobservability problem and thereby induce an outcome favorable to them. We demonstrate this in two settings. First, where potential target firms may use signals such as open market repurchases to attract more bidders and thus gain superior valuations. Second, we also examine the case where firms use market entry as a signal of their inherent strengths and thus may deter other potential entrants. The propositions from the theoretical models are also tested empirically. The structure imposed in the theoretical models present a difficult challenge from an empirical setting. This dissertation also develops an apt empirical model which takes into account the richness of the information structure embedded in the theoretical models. ii In memory of my grandparents Mrs. Sathyabhama G. Menon and Mr. K. Gangadhara Menon iii ACKNOWLEDGMENTS This dissertation is a culmination of a long and fruitful journey. The journey would not have been possible if not for the considerable amount of support I received from several individuals. First, I am deeply indebted to my advisor Jaideep (Jay) Anand for investing considerable time and effort in helping me develop my ideas. Jay has taught me to be a complete scholar and has been a constant source of support and inspiration throughout my stay in the program. I’m ever so grateful that despite being an extremely busy scholar himself, he always found time for me. He also taught me the value of hard work and staying focused on the task on hand. Thank you Jay! Special thanks to my committee members Jay Barney and Douglas Schroeder for their contributions to my research and also guiding me through the rigors of the graduate program. I’m thankful to Jay (Barney) for always being there for me to bounce ideas and focus on the big picture questions. His clarity in thought and expression has helped me vastly improve my work. Doug has been instrumental in developing my interests in connecting theory and empirical work and has been a source of inspiration. His PhD seminar on methodology remains one of my favorite classes in the doctoral program. His focus on precision and rigor in analysis has helped me think more clearly about my ideas. iv I’m also grateful to several other faculty at the Fisher College of Business - Greg Allenby, Jay Dial, Sharon Alvarez, Michael Leiblein, Sharon James, Anil Arya, David Greenberger, Mona Makhija, Anil Makhija, Ben Campbell, Michael Weisbach, Geof- frey Kistruck, Lawrence Inks, Robert Lount, Steffanie Wilk, Andrew Karolyi, Anne Beatty, Mikelle Calhoun, Richard Dietrich, John Fellingham and Shail Pandit for their insightful comments, feedback and support. Over the past four years, I have benefited greatly from associations with past and present students in the Fisher College of Business. In particular I am grateful for the friendship and associations with my colleagues in the strategy area Naga Damaraju, Nilesh Khare, Christopher Welter, Suresh Singh, Sungho Kim, Susan Young, Bi-Juan Zhong, Beth Polin, Brian Saxton, Alison McConnell, Jieun Park, Yeolan Lee, Charles Stevens, Erin Coyne, Chad Brinsfield and Joe Cooper. I have also benefited greatly from conversations and interactions with Benjamin Blunck, Taylor Nadauld, Jeffrey Dotson, Jerome Taillard, Mathias Enz, Reining Chen, Rudi Leuschner, Anthony Meder, Alan Lacko and Robert Woolman. I would also like to express my gratitude to Kathleen Zwanziger, Heidi Dugger, Joan Evans and Mamata Lehmann for helping with numerous administrative issues. Finally, I would not have been able to complete this journey if not for the support, love and affection of my family, especially my mother Mrs. Latha Menon. v VITA July 11, 1977 . . . . . . . . . . . . . . . . . . . . . . . . . . . . Born – Trichur, Kerala, India 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .B.B.A. Business Administration, Uni- versity of Madras 1999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .P.G.D.M., Institute for Financial Man- agement & Research 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .M.S. Agricultural Economics, Kansas State University 2004-Present . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Graduate Teaching and Research Asso- ciate, The Ohio State University FIELDS OF STUDY Major Field: Business Administration vi TABLE OF CONTENTS Page Abstract . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ii Dedication . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iii Acknowledgments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iv Vita . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . vi List of Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . x List of Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xi Chapters: 1. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2. ESTIMATING ENTRY MODELS WHEN RESOURCES ARE IMPER- FECTLY OBSERVED . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 2.2 Previous Studies on Entry Decisions . . . . . . . . . . . . . . . . . 9 2.2.1 Entry without Strategic Interaction: The Resource-Based Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 2.2.2 Entry with Strategic Interaction . . . . . . . . . . . . . . . 12 2.2.3 Resource heterogeneity, observability and strategic interaction 14 2.3 Conceptual Development . . . . . . . . . . . . . . . . . . . . . . . . 14 2.3.1 Resources and Capabilities are completely observed . . . . . 16 2.3.2 Resources and capabilities are imperfectly observed . . . . . 18 2.4 Empirical Methodology . . . . . . . . . . . . . . . . . . . . . . . . 21 2.4.1 Aggregation and loss of information . . . . . . . . . . . . . 22 vii 2.4.2 Translating theory to empirics . . . . . . . . . . . . . . . . 23 2.4.3 Structural empirical model . . . . . . . . . . . . . . . . . . 25 2.5 Testing the Proposed Model with Simulated Data . . . . . . . . . . 28 2.5.1 Empirical strategies . . . . . . . . . . . . . . . . . . . . . . 29 2.5.2 Traditional estimation when data have no strategic interaction 30 2.5.3 Traditional estimation when data display strategic interaction 31 2.5.4 Structural estimation when data display strategic interaction 32 2.5.5 Structural estimation when data do not display strategic in- teraction . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 2.6 Discussion and Conclusions . . . . . . . . . . . . . . . . . . . . . . 35 2.6.1 Understanding the causal link between RBV and Hypercom- petition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 2.6.2 Limitations and Future Research . . . . . . . . . . . . . . . 39 2.6.3 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . 41 3. IMPERFECT OBSERVABILITY OF RESOURCES AND STRATEGIC INTERACTIONS BETWEEN TARGET AND BIDDER FIRMS . . . . 47 3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 3.2 Resource heterogeneity, Stock repurchases and the Market for cor- porate control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 3.3 Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 3.3.1 Payoffs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 3.3.2 Timing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 3.3.3 Information . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 3.3.4 Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . 57 3.3.5 Comparative Statics . . . . . . . . . . . . . . . . . . . . . . 60 3.4 Data and Methods . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 3.4.1 Data and Sample . . . . . . . . . . . . . . . . . . . . . . . . 62 3.4.2 Empirical Methodology . . . . . . . . . . . . . . . . . . . . 65 3.4.3 Deterrence/Attraction Effect . . . . . . . . . . . . . . . . . 71 3.5 Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 3.5.1 Interpreting Coefficients . . . . . . . . . . . . . . . . . . . . 73 3.5.2 Deterrence/Attraction Effect . . . . . . . . . . . . . . . . . 75 3.6 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 4. IMPERFECT OBSERVABILITY OF RESOURCES AND STRATEGIC INTERACTIONS BETWEEN POTENTIAL ENTRANTS . . . . . . . . 81 4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 4.2 Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86 4.2.1 Payoffs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86 viii 4.2.2 Timing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 4.2.3 Information . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 4.3 Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 4.3.1 Comparative Statics . . . . . . . . . . . . . . . . . . . . . . 92 4.4 Data and Methods . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 4.4.1 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 4.4.2 Empirical Methodology . . . . . . . . . . . . . . . . . . . . 95 4.4.3 Dependent Variable . . . . . . . . . . . . . . . . . . . . . . 100 4.4.4 Independent Variables . . . . . . . . . . . . . . . . . . . . . 101 4.4.5 Control Variables . . . . . . . . . . . . . . . . . . . . . . . . 104 4.5 Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105 4.5.1 Is market entry a good signal to deter potential entrants? . 107 4.6 Discussion and Conclusions . . . . . . . . . . . . . . . . . . . . . . 108 Appendices: A. DERIVATIONS AND PROOFS . . . . . . . . . . . . . . . . . . . . . . . 114 A.1 Derivations and Proofs for Chapters 3 and 4 . . . . . . . . . . . . . 114 A.1.1 Derivation of the equilibrium solution . . . . . . . . . . . . 114 A.1.2 Proof of Uniqueness . . . . . . . . . . . . . . . . . . . . . . 116 A.1.3 Comparative Static Analysis . . . . . . . . . . . . . . . . . 118 B. ESTIMATION ALGORITHMS . . . . . . . . . . . . . . . . . . . . . . . 120 B.1 Estimation algorithms for chapter 2,3 and 4 . . . . . . . . . . . . . 120 B.1.1 Informational assumptions . . . . . . . . . . . . . . . . . . . 120 B.1.2 Equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 BIBLIOGRAPHY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128 ix [...]... 1992) The primary goal of the stimulus response framework is to understand strategic interaction by empirically extracting the effect of action/reaction characteristics on the likelihood that a particular action/reaction will be adopted A common theme running across both streams of work is the exogenous treatment of strategic interactions and does not invoke any form of ex-ante rationality Therefore, these... firms know their true competitive position On the other hand, the presence of unobservable resources could lead to a situation where strategic interactions become critical, which would generate predictions that are counter-intuitive Though extant literature, particularly within the domain of economics and industrial organization, has examined strategic interaction in the context of entry decisions, it... been a source of inspiration for empirical work (e.g Lieberman, 1987) Early empirical work, primarily descriptive in nature, 12 examines the predictions generated from theoretical models using traditional econometric methods One stream of literature, primarily grounded within the domain of economics and industrial organization, focused on investigating performance outcomes conditional upon observed market... Strategic Interaction Beyond the RBV-based studies reviewed above, entry studies have also been the focus of extensive investigation by scholars interested in understanding strategic interactions between competing firms However, such studies have primarily ignored the critical role of resources and their impact on strategic interactions Much of the work in this stream of literature relies on sophisticated... examine the impact of imperfectly observed resources on strategic choice behavior In Essay 1 (Chapter 2) the role of unobservabilitiy of resources is explored in depth in the context of market entry decisions Studies of competitive entry into new businesses, technological arenas, or international domains are common in strategic management research This research has provided important results on the. .. ignored the role of firm resources Even though these streams of research complement each other, there is still a gap in terms of an approach that integrates resources heterogeneity and strategic interactions while also presenting an empirical solution consistent with both sets of theories In the following section, we build a simple model that attempts to fill the void between these streams of work 2.3 Conceptual... compete As the ratio of unobservable resources increases, we clearly see that the likelihood of competition between the incumbent and the entrant also increases 19 Where the unobservable component is very high, for instance above 80 percent of the contribution from resources, the likelihood of competition starts declining again (although it is still not zero) At such high levels of unobservability, there... by Airbus, Boeing subsequently announced that it was backing out from this 1 Strategic interaction is defined as the state that prevails when multiple firms take into consideration not only their own resources, but also the other firms’ potential responses when making a decision (Bettis and Weeks, 1987) 7 segment These interactions between Airbus and Boeing raise interesting questions For instance, Ghemawat... “Specifically, one particular line of game-theoretic modeling offers the non-obvious insight that although the incumbent, Boeing, would earn higher operating profits if it could somehow deter the entrant, Airbus, from developing a superjumbo, entrydeterrence through new product introductions may be incredible even if the incumbent enjoys large cost advantages in new product development (e.g because of lineextension... possibly conceive of strategies to capture pure information rents, for instance through bluffing In this situation, the implications of resource heterogeneity on sustainable competitive advantage are no longer clear cut To illustrate this point, we use a graphical approach Figure 2.3 graphs the probability of observing competition between the incumbent A and potential entrant B (the outcome where the incumbent . ESSAYS ON THE ROLE OF UNOBSERVABLES IN CORPORATE STRATEGY DISSERTATION Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Philosophy in the Graduate School of The. and expression has helped me vastly improve my work. Doug has been instrumental in developing my interests in connecting theory and empirical work and has been a source of inspiration. His PhD seminar on. resources on strategic choice behavior. In Essay 1 (Chapter 2) the role of unobservabilitiy of resources is explored in depth in the context of market entry decisions. Studies of competitive entry into