Nonmarket Effects on Strategic Fit and Performance: an Economic Institutional Change Perspective Sean Lux

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COLLEGE OF BUSINESS

NONMARKET EFFECTS ON STRATEGIC FIT AND PERFORMANCE: AN ECONOMIC

INSTITUTIONAL CHANGE PERSPECTIVE

SEAN LUX

A Dissertation submitted to the Department of Management in partial fulfillment of the requirements for the degree of Doctor of Philosophy

Date Awarded: Spring Semester, 2008

The members of the Committee approve the dissertation of Sean Lux defended on February 8, 2008.

Dr. Bruce T. Lamont Professor Directing Dissertation

Dr. Michael D. Hartline Outside Committee Member

Dr. Annette L. Ranft Committee Member

Dr. Gerald R. Ferris Committee Member

Approved:

. Dr. Caryn Beck-Dudley, Dean, College of Business

The Office of Graduate Studies has verified and approved the above named committee members.

To my wife Jennifer. Without her love and support, my pursuit of a doctorate simply would not have been possible.

iii TABLE OF CONTENTS

List of Tables…………………………………………………………………………….. v List of Figures…………………………………………………………………………..... vii Abstract…………………………………………………………………………………... viii

1. INTRODUCTION……………………………………………………………………. 1

2. THEORETICAL DEVELOPMENT………………………………………………….. 7

3. STATISTICAL ANALYSIS…………………………………………………………. 32

4. RESULTS…………………………………………………………………………….. 43

5. DISCUSSION AND CONCLUSIONS………………………………………………. 48

TABLES………………………………………………………………………………… 54

FIGURES……………………………………………………………………………….. 103

REFERENCES………………………………………………………………………….. 107

BIOGRAPHICAL SKETCH……………………………………………………………. 115

iv TABLES

Table 1 Antecedents of Political Activity

Table 2a Descriptive Statistics and Correlations: Market Factors in the U.S. Semiconductor Industry (1986-2000)

Table 2b Descriptive Statistics and Correlations: Nonmarket Factors in the U.S. Semiconductor Industry (1986-2000)

Table 2c Descriptive Statistics and Correlations: Market Factors in the U.S. Pharmaceutical Industry (1986-2000)

Table 2d Descriptive Statistics and Correlations: Nonmarket Factors in the U.S. Pharmaceutical Industry (1986-2000)

Table 2e Descriptive Statistics and Correlations: Market Factors in the U.S. Coal Mining Industry (1986-2000)

Table 2f Descriptive Statistics and Correlations: Nonmarket Factors in the U.S. Coal Mining Industry (1986-2000)

Table 3a Generalized Least Squares Estimates: Effects of Economic Contingencies on U.S. Semiconductor Research & Development Investment Activity (1986-2000)

Table 3b Generalized Least Squares Estimates: Effects of Political Contingencies on U.S. Semiconductor Total Political Activity (1986-2000)

Table 4 Generalized Least Squares Estimates of Deviation from Economic Contingency Prediction on Economic Performance: U.S. Semiconductor Industry (1986-2000)

Table 5a Generalized Least Squares Regression: Effects of Economic Contingencies on U.S. Pharmaceutical Advertising and Research and Development Investment Activity (1986-2000)

Table 5b Generalized Least Squares Regression: Effects of Political Contingencies on U.S. Pharmaceutical Total Political Activity (1986-2000)

Table 6a Generalized Least Squares Estimates of Deviation from Economic Contingency Prediction on Economic Performance: U.S. Pharmaceutical Industry (1986-2000)

Table 6b Generalized Least Squares Estimates of Deviation from Political Contingency Prediction on Economic Performance: U.S. Pharmaceutical Industry (1986-2000)

Table 7a Generalized Least Squares Regression: Effects of Economic Contingencies on U.S. Mining Capital Investment Activity in Plant, Property, and Equipment (1986-2000)

v Table 7b Generalized Least Squares Regression: Effects of Political Contingencies on U.S. Mining Total Political Activity (1986-2000)

Table 8a Generalized Least Squares Estimates of Effects of Deviation from Economic Contingency Prediction: U.S. Mining Industry (1986-2000)

Table 8b Generalized Least Squares Estimates of Effects of Deviation from Political Contingency Prediction: U.S. Mining Industry (1986-2000)

vi FIGURES

Figure 1 Market and Institutional Opportunity Sets

Figure 2 Nonmarket Affects on Dynamic Strategic Fit

Figure 3 The Co-Evolution of Economic Institutions and Markets

Figure 4 Co-evolution of Market and Political Opportunities

vii

ABSTRACT

How do market and nonmarket environmental factors affect firm investment decisions and subsequent performance? Economic Institutional Change Theory is extended to the product market-firm level of analysis to develop a model of dynamic strategic fit to nonmarket and market factors. The co-evolution of market and institutional factors creates four basic opportunity sets comprised of low to high market opportunities and low to high political opportunities. Contingency models are estimated using generalized least squares regression for three of the four opportunity sets. Deviation from the contingency models is used to measure strategic fit and used to test the relationship between fit and economic performance. Empirical evidence did not support the assertion that fit is related to performance in the first two opportunity contexts. Empirical support was found in the third study for strategic fit to political factors.

viii

CHAPTER 1

INTRODUCTION

Strategic management scholars have often focused solely on market factors in economic competition and performance, and have assumed nonmarket factors are exogenous to economic competition (Boddewyn, 2003; Boddewyn & Brewer, 1994). Baron (1995) defined nonmarkets as the “social, political, and legal arrangements that structure the firm’s interactions outside of, and in conjunction with, markets” (p.48). Contrary to the view that economic competition is affected only by economic factors, some scholars have asserted nonmarket factors affect firm performance (Baron, 1995, 1997; Baysinger, 1984; Mahon & McGowan, 1996). Empirical evidence has suggested that firms do engage in political activities (e.g. Hart, 2001; Schuler, Rehbein, & Cramer, 2002) and that these activities improve firm economic performance (Bonardi, Holburn, & Vanden Bergh, 2006; Hillman, Zardkoohi, & Bierman, 1999; Shaffer, Quasney, & Grimm, 2000). The extent effective economic institutions exist and are enforced in a given institutional environment largely determines the opportunities available to market actors (Eggertson, 1990; North, 1990, 1994). The institutional environment is comprised of the informal and formal institutions that govern economic exchange, and the social groups and political organizations that create, maintain, enforce, and change these institutions (North, 1990). Informal institutions are social and behavioral norms (Biggart & Delbridge, 2004; Blau, 1964; Ouchi, 1980), and constitutions, laws, and treaties are formal institutions that govern economic exchange (North, 1981, 1990). Effective and well enforced institutions encourage market actors to engage in economic activities beneficial to society, whereas ineffective and/or poorly enforced institutions dissuade economic activity and encourage market actors to pursue political activities (North, 1990). Baron (1995; 1997) observed that both market and nonmarket opportunities exist to varying degrees in most institutional settings. Market actors will engage in market and/or political activities to the extent those activities generate economic returns in a given institutional environment (Baron, 1995; Mitchell, Hansen, & Jepsen, 1997; North, 1990). A market actor generates economic returns through political activities when the institutional environment is altered or maintained to benefit an actor’s economic activities (Baysinger, 1984; North, 1990). Changes in the institutional environment include policy and policy enforcement changes as well as changes in government investment and contracts (North, 1990). Political opportunities are considered attractive when the economic returns from changing the institutional environment are greater than costs associated with lobbying nonmarket actors to enact those changes. The Walt Disney Corporation’s effort to extend United States copyright protection through influencing political actors is illustrative. The $6.3 million dollars Disney’s political action committee (PAC) contributed to members of the U.S. Congress influenced the creation of the Sonny Bono Copyright Term Extension Act. The Act extended U.S. copyright protection from life of the creator plus fifty years to life plus seventy years for all works copyrighted after January 1, 1923. The change in U.S. copyright law allowed Disney to protect their primary intellectual property, the Mickey Mouse character, for an additional twenty years. The resources invested in changing the institutional environment (U.S. copyright law) to Disney’s advantage were far less than the resources required to replace the loss of Disney’s intellectual property within the existing institutional environment.

Figure 1 illustrates how market actors face four predominant opportunity sets based on the market and nonmarket opportunities available in a given institutional environment. Market actors are likely to perceive that market activities will deliver the greatest returns on investment in the top right quadrant of Figure 1. Political, or nonmarket opportunities are unattractive or nonexistent, and the opportunity to generate economic returns through market-based activity are extensive. Within this context, obtaining and sustaining economic competitive advantage has largely been the strategic management field’s primary focus (Rumelt, Schendel, & Teece, 1994; Schendel & Hofer, 1979). High growth product markets where high levels of government regulation and/or sales create both market and nonmarket opportunities are characteristic of conditions in the bottom right quadrant of Figure 1. Baron (1995; 1997) described firm actions to identify and exploit market and nonmarket opportunities concurrently as integrated strategy. “An integrated strategy captures the synergies between competitive strategies that seek superior performance in the marketplace and nonmarket strategies that shape the competitive environment” (Baron, 1997). Similarly, Aggarwal (2001) suggested that a positional analysis of market, nonmarket, and internal firm factors determines overall firm strategy when market and nonmarket factors both influence firm actions. Market actors are likely to perceive nonmarket rather than market opportunities to be attractive in both effective and ineffective institutional environments. Market actors will likely engage in political activities when economic institutions are ineffective (North, 1990). High uncertainty discourages economic exchange and investment making political opportunities potentially less risky and more rewarding. Bribing government officials to obtain preferential access to resources, government contracts, and foreign markets exemplifies nonmarket activity in ineffective institutional contexts. Nonmarket opportunities exist in effective institutional environments as well. Market opportunities can decrease over time through competition and market maturity. When market opportunities are decreasing and nonmarket opportunities exist, firms are likely to pursue nonmarket activities rather than market activities. Lobbying for regulatory barriers to entry, obtaining government subsidies, and seeking tariffs to protect against foreign competition all exemplify viable nonmarket activities in the bottom left quadrant of Figure 1. Nonmarket and market opportunities do not always exist for market actors. Innovation and competition diminish market opportunities, and the government does not always take an interest in some economic activities (Epstein, 1969; North, 1990; Stigler, 1971). When neither market nor nonmarket opportunities are present, firms will either exit the market or enter decline as illustrated in the top left quadrant of Figure 1. These conditions often exist in maturing product markets made obsolete by innovation. Alignment or fit of firm activities to external factors has been a traditional determinant of economic performance in strategic management scholarship (Andrews, 1971; Ginsberg & Venkatraman, 1985; Schendel & Hofer, 1979). Because a market actor’s set of opportunities may include, or be primarily comprised of nonmarket opportunities (Aggarwal, 2001; Baron, 1995; North, 1990), scholarship that examines nonmarket factors as part of the strategy process is essential. Two primary limitations exist in our current understanding of how nonmarket factors affect firm activities and performance. First, scholarship that examines the role of nonmarket factors on firm actions and subsequent performance is limited. Nonmarket scholarship has been largely focused on the nonmarket and market factor relationship with firm nonmarket activities. Scholars in several

academic fields have developed antecedents that predict firm political activity level and type (Keim, 2001a; Schuler et al., 2002), however this scholarship is largely ad hoc in nature and not based on strategy theories (Hillman, Keim, & Schuler, 2004). Recent empirical evidence has suggested a positive relationship between political activity and firm economic performance (Hillman et al., 1999; Shaffer et al., 2000), however scholarship examining the relationship between nonmarket activity and economic performance is lacking (Getz, 1997; Hillman et al., 2004) Bonardi et al. (2006) and di Figueiredo & Silverman (2006) are two studies that have examined the entire nonmarket strategy process. Bonardi et al. (2006) found that U.S. utility firms with more attractive political opportunities engaged in more lobbying activities and received higher rate increases than utilities with less favorable opportunities. di Figueiredo & Silverman (2006) found universities in districts represented by members of the U.S. House and Senate Appropriations Committees (a nonmarket opportunity) engaged in more lobbying and respectively obtained 2.8% and 3.5% increases in Federal earmarks for every 10% increase in lobbying. Second, scholarship examining market and nonmarket strategies has occurred largely independent of each other. Nonmarket factors are typically assumed to be exogenous or irrelevant to market competition by strategy scholars and are not considered in examining firm performance (Boddewyn, 2003; Keim, 2001b; Mahon & McGowan, 1996). Nonmarket strategy scholars have often assumed that firms engage in nonmarket activities when such activities are required to generate economic returns, and thus do not consider alternative economic investments. Because both market and nonmarket opportunities affect firm strategic choices, scholarship that concurrently examines these effects is required. In my review of existing scholarship, only Taylor’s (1997) study of how firms make investments in political and research and development activities concurrently examined market and nonmarket factors and firm actions, however subsequent performance was not considered. His findings suggested political and innovation investments are complimentary rather than exclusive, especially in regulated industries (Taylor, 1997). Nonmarket and market dynamics requires examining how market and nonmarket factors affect firm strategy over time. Figure 1 implied a fairly stable range of opportunities for market actors, however markets and institutions continually co-evolve over time (North, 1981, 1990). As markets and institutions change, the opportunity sets available to market actors also change encouraging and rewarding different activities. The pace of change increases as markets increase in size and complexity (North, 1990). Although strategy scholars have considered the effects of changing market conditions on firm strategy (Venkatraman, 1989; Zajac, Kraatz, & Bresser, 2000), little is known about how nonmarket dynamics affect firm strategy. Scholars have asserted that nonmarket and market factors affect firm strategy from a static contingency approach. Fit or alignment amongst nonmarket, market, and firm factors at a point in time prescribes firm actions and subsequent performance (Aggarwal, 2001; Baron, 1995). Economic institutional change theory (North, 1990) explains how nonmarket and market opportunities co-evolve and change at the market/institution level of analysis, however this perspective has not been extended to the market/firm level of analysis. A model based on economic institutional change theory that integrates how market and nonmarket factors concurrently affect firm strategy and subsequent performance is developed in this paper. Based on Zajac et al.’s (2000) Generic Model of Dynamic Strategic Fit, Figure 2

illustrates how changing nonmarket and market factors suggest a set of desired strategic actions. The extent a firm engages in these actions determines the degree of strategic fit or misfit. Strategic fit should be positively related to firm performance, whereas strategic misfit is negatively related to firm performance. Political and economic activities in the present (episode 1) subsequently shape external and internal factors in the future (episode n+1).

Dissertation Overview The paper proceeds as follows. Chapter 2 begins with a review of economic institutional change theory (North, 1990) and the role nonmarkets play in shaping economic activity over time. The basic premise of economic institutional change theory is that effective and well enforced economic institutions reduce transaction costs and thus foster economic exchange (North, 1990). Societies and governments can encourage socially beneficial economic activities and dissuade less desirable ones through decreasing and raising the transaction costs associated with those economic activities. Innovation developed through economic activity subsequently shapes economic institutions as governments create, modify, and remove institutions to foster the economic exchange of new goods and services. Market actors also shape institutions through political activities. Because economic institutional change theory is typically utilized to explain how institutions evolve over time and explain performance differences amongst nations (e.g. Hill, 1995; Wan & Hoskisson, 2003), little scholarship exists that explains how institutions encourage and discourage the political and economic activities of individual market actors. Two issues must be resolved to extend economic institutional change theory to the inter-firm level of analysis. First, the co-evolution of institutions and markets must be extended to the market/firm level of analysis to explain how firm nonmarket and market opportunities vary overtime. Second, what constitutes these opportunities needs to be operationalized. Chapter 2 continues with theoretical development addressing these two issues. First, how the co-evolution of institutions and markets can create the four potential opportunity sets in Figure 1 over a market life cycle is explained. Next, political opportunities from multiple theoretical perspectives are utilized to provide a basis for operationalizing political opportunities. This is accomplished through a review and synthesis of corporate political activity antecedents developed in several academic disciplines. Chapter 2 concludes with developing hypotheses that predict how political and market opportunities suggest desirable political and/or market activities. The extent firm activities fit this desired set of activities affects firm performance. The empirical analysis for testing the hypotheses in Chapter 2 comprises Chapter 3. Two research strategies exist for studying the co-evolution of institutions and markets. The first is to examine a single industry or product market over an entire life cycle, which would require data collected over an extensive time frame, however observable firm political activity data is limited prior to amendments in 1979 to the 1971 Federal Election Commission (FEC) Act. The 1971 FEC Act required the reporting of political contributions, however the 1979 amendment increased the campaign contribution limit, which increased market and social actors’ ability to influence political actors. The 1979 amendments allowed firms and individuals to donate unlimited amounts of hard money to voter registration and turnout efforts, and unlimited soft money to political party building activities. Hard money is political donations that fall under FEC regulation, whereas soft money is political donations not regulated by the FEC. Market actors did not begin to fully exploit this new political opportunity until the 1988 election cycle. The 1980 election occurred before market and social actors fully understood the

political opportunities the amendment provided, and the 1984 election featured a pro-business incumbent president versus a candidate viewed as pro-labor and less desirable to business interests. Because incumbents are typically reelected, market actors had little incentive to engage in extensive political activities. The lack of recorded political activity prior to 1988 reduces the viability of this first research strategy. The second research strategy is to examine firms in different product markets that approximate the four nonmarket/market opportunity sets conditions over a condensed period of time. Due to the limited timeframe in which corporate political activity has been both extensively utilized and reported, this research design strategy is adopted. Hypotheses are tested in three different industries that approximate the opportunity sets in Figure 1. Firms in the semiconductor (high market and low political opportunities), pharmaceutical (high market and political opportunities), and coal mining (low market and high political opportunities) industries are studied. Because the presence of firms in low market, low political, opportunity environments is likely to be short lived, this opportunity set is not empirically examined. The United States from 1987 to 2000 provides an excellent context for examining how market actors pursue market and nonmarket opportunities. New political opportunities for U.S. market and social actors created in 1979 began to be exploited in the 1987-‘88 election cycle. The U.S. economy also saw significant changes during the 1987 to 2000 timeframe. Rapid innovation and globalization occurred though the information technology revolution and the fall of the Soviet Union. This introduced new and rapidly growing market opportunities in high technology, whereas the attractiveness of economic opportunities in the materials and manufacturing markets decreased due to new international competition. Chapter 3 concludes with an empirical analysis strategy of the organizing model in Figure 2. Longitudinal regression analysis is utilized to test the model in the semiconductor, pharmaceutical, and coal mining industries from 1987 to 2000. Economic and nonmarket factors are utilized to specify a model predicting firm performance in three industry specific studies. Deviations between the specified model and firm actions are utilized to measure strategic fit. Deviation from the specified model is hypothesized to be negatively related to firm performance. Discussion and implications of the results will be presented in Chapter 4 followed by conclusions in Chapter 5.

Contributions Five primary contributions are made by developing and testing the model in Figure 2. First, economic institutional change theory is extended to the market/firm level of analysis to explain how nonmarket and market factors affect firm strategy. This provides scholars with a multi-level theoretical framework to examine how firms respond to and shape their institutional environment in seeking economic returns. Second, extending institutional change theory to the market-firm level of analysis requires operationalizing nonmarket and market opportunities. Although consensus exists amongst scholars that nonmarket and market opportunities exist and encourage different types of activities (Baron, 1995, 1997; Eggertson, 1990; North, 1990), what constitutes these opportunities has received limited attention. The first steps in this process are taken by reviewing and synthesizing existing scholarship and empirically examining their affects on market actor behavior and subsequent performance. Third, theoretical development in this paper suggests nonmarket opportunities change over time. This suggests the decision to invest in political activities is contextually dependent

providing insight into when firms engage in politics. The fourth primary contribution is the empirical examination of this model over time. This is the first longitudinal study that examines the effects of nonmarket and market factors concurrently on firm actions and subsequent performance. Finally, this dissertation provides insights into how firms affect society through their political activities. An area of inquiry that has been neglected by organizational scholars (Hinnings & Greenwood, 2002). The five contributions in this dissertation have several different constituencies. The first two contributions are of interest to institutional and organizational economists. The third and fourth contributions are of primary interest to nonmarket strategy scholars, and the fifth contribution is of interest to organizational scholars in general.

CHAPTER 2

THEORETICAL DEVELOPMENT

Defining Institutions Several definitions of social institutions exist in organizational science. Neoinstitutional theory scholars define institutions as the source of coercive, mimetic, and normative forces that create isomorphic pressures in society (DiMaggio & Powell, 1983). Institutions thus include governments, laws, courts, professions, interest groups, and public opinion (Scott, 1995). Institutions are similarly, broadly conceptualized as the nonmarket aspects of society in integrated strategy (Baron, 1995). Nonmarket factors are described in terms of social, political, and legal institutions (Baron, 1995; Boddewyn, 2003). In both neoinstitutional theory and nonmarket conceptualizations of institutions, institutions are comprised of both informal (e.g. public opinion and special interest groups) and formal (e.g. governments, laws, and courts) factors. Institutions are conceptualized as formal and informal exchange rules in economic institutional change theory (North, 1990). Public opinion and social norms are informal institutions influenced by the public and social groups, whereas laws, treaties, and policies are formal institutions made and enforced by political organizations (North, 1990). The distinction is made between the social groups and political organizations that create, change, modify, enforce, and remove exchange rules and the actual norms and laws that shape economic activity. Institutional change refers to the altering of existing formal institutions, whereas modification refers to either the reinterpretation of an existing formal institution or its application to a new context. Formal institutions can be described as either political or economic. Political rules (e.g. constitutions and common law) typically lead to economic rules (i.e. trade laws and regulations), “although the causality runs both ways” (North, 1990: 48). Informal institutions evolve overtime through repeated interaction and exchange (Blau, 1964), whereas formal institutions are typically created by political actors. Informal institutions exist either in the absence of formal institutions, such as social norms and standards of conduct, or as “extensions, elaborations, and modifications of formal rules” (North, 1990: 40). In this paper, the general public, social groups, and political organizations are referred to as nonmarket actors, and informal and formal exchange rules as institutions. Nonmarket actors and institutions in a society as a whole are referred to as the institutional environment.

Markets and Institutions Markets play an important role in the advancement of any society. The collective actions of market participants are a society’s primary source of technological development and innovation (North, 1990). The more market activity in a society, the greater the level and speed of a society’s technological advancement. Market activities do come at a cost. Resources dedicated to economic activities cannot be used for other social uses. Societies thus have an interest in ensuring the eventual outcomes of economic activity provide greater benefit than use of resources in other endeavors of the state. A society optimizes economic benefits by encouraging the maximum amount of variation in market activities. The benefits of variation are twofold. First, a society increases the chances of developing optimal solutions. As the level of market actor capability heterogeneity rises, the

likelihood for knowledge creation and innovation increases (Nonaka, 1994). Second, capability heterogeneity increases the level of competition amongst competing technologies, products, and services. This maximizes the efficient use of resources in the marketplace. A society optimizes both innovation and efficiency by encouraging and enabling variation in the market place, however public preferences also influence economic activities. Although technological advancement provides the greatest level of social benefit (North, 1990, 1994), societies may place greater value on outcomes such as stability (Stigler, 1971), cultural values (North, 1990) such as homogeneity (Biggart & Delbridge, 2004). France and Italy’s desire to maintain traditional food sources and the U.S.’s desire to avoid stem cell research are both illustrative of public preferences that value other outcomes over innovation. Societies encourage the maximum amount of capability heterogeneity by providing incentives and reducing the risks associated with developing increasingly complex products and services. Property rights, or regimes of appropriability, often define economic incentives by specifying property control and the extent an actor can appropriate rents generated by that property (Alchian, 1965; Alchian & Demsetz, 1972; Demsetz, 1988). Control over property allows actors to develop more complex and specified products and services, and rent appropriability provides the incentive to do so. Risks are primarily due to the uncertainty that surrounds economic exchange. In any given exchange one or more of the exchange parties may engage in opportunistic behavior. Although market actors can mitigate the likelihood of opportunistic behavior (i.e. contracting), the means to do so create costs (Coase, 1937). Because the likelihood for opportunistic behavior increases as the specificity of the asset exchanged increases (Williamson, 1975), societies interested in encouraging the maximum amount of capability heterogeneity have an interest in reducing opportunism and subsequent transaction costs (Coase, 1960).

Co-Evolution of Markets and Economic Institutions North (1990) observed that three types of institutional governance have evolved to reduce exchange uncertainty. The first is the personalized exchange that has characterized most economic activity throughout human history until the industrial revolution. This form of exchange does not require institutional governance because exchange is repeated amongst a small group of actors, effective informal institutions (social norms) exist, and the products and services exchanged are not highly specialized. However, this personal exchange is no longer effective when production requires higher levels of specialization and exchange partners grow in number and diversity (Williamson, 1975). The second form of institutional governance, impersonal exchange, exists when social, religious, and/or professional norms enable exchange within groups with increasing market and production complexity (North, 1990). Ouchi’s (1980) clan form of economic organization, Boisot and Child’s (1996) network capitalism, and Biggart and Delbridge’s (2004) systems of exchange typology are all illustrative of different impersonal exchange governance systems. Impersonal exchange has two main limitations: first, the number of exchange partners is limited; and second, the individual property rights institutions adopted in most Western countries undermine this form of governance (North, 1990). The third institutional governance form is third party enforcement (North, 1990). Institutions reduce the uncertainty of market exchange and the subsequent costs of transacting by providing informal and formal exchange rules and third party enforcement of those rules. Only in countries where third party enforcement of contracts exists do we see modern economies evolve.

Third party contract enforcement is not ideal, but is necessary in modern societies as opportunistic opportunities and rewards increase with market size and complexity (North, 1990). Without effective third party contract enforcement, complex production and exchange cannot take place. The level of uncertainty in an institutional environment is determined by the extent institutions exist, and the degree to which those institutions are enforced (North, 1990). In institutional environments where institutions are undeveloped and/or loosely enforced, market uncertainty is high discouraging investment, whereas economic investment flourishes in countries with strong, well-enforced institutions. Given the role institutions have in determining the level of uncertainty in markets, the amount and type of market opportunities available in a given institutional context is largely determined by the institutional environment (North, 1990). “Institutions provide the structure for exchange that (together with the technology employed) determines the cost of transacting and the cost of transformation” (North, 1990: 34).

The Institutional Environment and Opportunity North (1990) asserted that opportunities created by the institutional environment provide incentive for different entrepreneurial activities. Firms and other market actors will engage in market entrepreneurial activities (e.g. marketing, research and development, etc.) when investment in such opportunities is perceived to generate the best returns. However, firms will engage in political entrepreneurial activities (e.g. lobbying political organizations, bribery, litigation, etc.) when investment in those activities presents better returns than market entrepreneurial activities. In countries with underdeveloped institutions, corruption is typically present because high uncertainty in market entrepreneurial activities makes investment in bribing government officials a better use of capital (North, 1990). While corruption is not wide spread, if not rare in the United States, opportunities for other political entrepreneurial activities exist. Once institutions evolve that enable complex economic activities, institutions change continuously and incrementally as market and political activities shape the institutional environment (North, 1990). Figure 3 illustrates how the opportunity set in a given institutional environment influences entrepreneurial activities and how these activities subsequently affect the institutional environment. The maximizing effort of market entrepreneurs leads to new technologies and shifts in economic demand. This results in technological development and affects the type and nature of market opportunities in the future. Political entrepreneurial activity influence changes in the institutional environment and subsequently in future market opportunities. As new innovations create new product markets, new institutions are created and old ones modified or removed to improve measurement and enforcement of transactions and accommodate new types of transactions (North, 1990). Market and political activities both shape institutions overtime, however, the two activities differ in how institutional change is affected. Market activities shape economic institutions as nonmarket actors create and modify institutions to remove exchange uncertainty surrounding new forms of economic activity. The introduction of e-commerce business in the 1990s required the creation of new institutions to reduce the uncertainty of exchange over the Internet, and modification of existing institutions to account for changes in taxation and regulation. Political activities shape institutions through actively seeking to modify the institutional environment to the firm’s favor. Unlike market activities that change institutions through creating new ways of doing business, political activities often protect existing firms from competition and technological change.

Political activities are primarily influence attempts targeted at social and political actors that can create, modify, or remove formal institutions or enforcement of those institutions. Market actors roughly valuate the influence cost, the perceived benefits of altering the institutional environment, and the likelihood that such activities will result in desired outcomes. Both costs and benefits associated with shaping the institutional environment vary depending on the institutional level and type.

Nonmarket Opportunities Economic performance in all four opportunity sets is predicated on first recognizing market and nonmarket opportunities (or not pursuing incorrectly perceived opportunities) and then exploiting those opportunities. What comprises market opportunities and subsequent advantage in exploiting market opportunities has been at the heart of the strategic management and entrepreneurship fields. Less is known about what comprises nonmarket opportunities. Nonmarket opportunities exist when a market actor perceives greater returns from nonmarket activities than investment in market activities (Baron, 1995; North, 1990). Like market based opportunities, nonmarket opportunities can be valuated by both the chance of obtaining a desired outcome (i.e. risk-reward) and perceived ability to obtain the outcome.

Rewards of Nonmarket Activities Nonmarket opportunities provide market actors two basic desirable outcomes. First, market actors can encourage nonmarket actors to indirectly and directly invest in activities and resources that benefit the market actor’s economic activities. Second, nonmarket actors can provide policy that alters the competitive context to benefit specific market actors. These two outcomes are not mutually exclusive. Market actors can seek to change policy in order to gain higher levels of nonmarket investment for example. Indirect investment improves the overall economic context for market activities. Investment in education, health care, and military power all indirectly benefit market activities by reducing the uncertainty surrounding market investment (i.e. increased likelihood of finding capable employees and reduced threat from military attack and piracy). Seeking indirect investment from institutions is perhaps as old as the corporate form of organization. The British East India Company lobbied the British government extensively for a larger Royal Navy in order to secure the sea lanes between England and India for example (North, 1990). Direct investment in market activities often occurs when political and social actors want to provide incentive and reduce the risks associated with desirable market activities (North, 1990). Unlike indirect investment forms, direct investment occurs when political actors directly invest in a specific market activity. Subsidies, grants, government subsidized loans, and direct economic exchange with market actors are all forms of direct investment. Direct investment may be directly awarded by political actors or through independent review agencies. Appropriations for computer services and the STTR grant program exemplify the former and later. Although market actors cannot directly lobby political actors for direct investment through independent agency managed programs, market actors can seek to have direct investment programs established and influence program requirement criteria, selection processes, and agency staffing. Nonmarket actors can benefit market actors through creating and changing policy and enforcement. Market actors can seek to have their market space and capabilities protected from competition through policy (Baysinger, 1984) for example. Similarly, Mahon and McGowan (1996) developed a modified version of Porter’s (1980) Five Forces model where policy changes

reduced the threat of new entrants and substitutes by raising barriers to entry, and reduced the bargaining power of suppliers and buyers through mandated quality standards. Nonmarket opportunities offer four primary advantages, or rewards over pursuing market opportunities. First, a finite number of political actors, or policy suppliers exist. Unlike market opportunities were the full number of suppliers and demanders are initially unknown, market actors know the entire field of policy suppliers. Second, market actors can predict whether policy suppliers are sympathetic to their needs based on publicly stated ideology and voting records. Because market actors know the number of policy suppliers and how those suppliers are likely to act, nonmarket opportunities often involve less uncertainty than market opportunities. The third advantage of nonmarket opportunities is the low price of policy. Campaign contributions and bribery limits in most effective institutional environments keep prices in the market for policy artificially low. Market actors can thus obtain/maintain market competitive advantages through nonmarket activities with potentially less investment than in market activities. Although market activities are likely to generate much higher returns than most nonmarket activities, nonmarket activities such as Disney’s influenced extension of U.S. Copyright protection can generate/protect sizable economic returns. Fourth, competitive advantages obtained through nonmarket activities are often more sustainable (Keim, 2001a; North, 1990). Once a policy is created, actors that benefit from the policy form a constituency that must be defeated to remove and/or change the policy. Institutional changes are thus rarely reversed and in effect lock-in advantages obtained through nonmarket activities (Arthur, 1989; Keim, 2001a; North, 1990). Compared to market opportunities, nonmarket opportunities provide market actors an investment alternative that is likely less risky and more sustainable with often comparable reward. A lack of market opportunities can also lead market actors to pursue nonmarket opportunities. Economic organizations often have difficulty in developing new resources and capabilities to pursue new economic opportunities when their current set of economic opportunities diminishes or disappears. Rather than face radical change and increased uncertainty, nonmarket activities provide market actors a means for protecting existing economic activities and resources (Baysinger, 1984; Mahon & McGowan, 1996). Risks of Nonmarket Activities Competition is the first risk in pursuing nonmarket activities. Similar to market competition, market actors must also consider competition in pursuing nonmarket activities. Nonmarket competition comes from both market and nonmarket actors. Market actors compete in nonmarket activities to obtain resources and/or beneficial policy outcomes. Nonmarket actors often compete with market actors to prevent/limit undesirable social and/or economic activities. Although the number of policy suppliers is finite, the number and diversity of policy demanders is often more uncertain than in economic markets (Bonardi & Keim, 2005). Pursuing nonmarket opportunities also has two disadvantages, or risks compared to market based opportunities. The first disadvantage is that nonmarket, and political activities in particular, often violate informal institutions. Informal institutions are often difficult to define and are enforced through social sanction. The lack of institutional specification can cause market actors to misjudge the extent their nonmarket activities violate social norms and the extent of responsive social sanction. This social norm is perhaps strongest in the U.S. were many believe that large economic organizations should not influence the political process. The second disadvantage is the collective action issue (Olsen, 1965). Changes made to the institutional environment are likely to benefit multiple similar market actors. Market actor

investments in nonmarket activities are likely to benefit competitors that is do not contribute to the nonmarket activities. Market actors thus have an incentive to engage in nonmarket activities as part of a collaborative to reduce this free riding problem.

Nonmarket Capabilities Market actors also develop organization, resources, and capabilities to exploit nonmarket opportunities. Engaging in nonmarket activities as part of a collaborative or by proxy reduces both the threat of free riding and social sanction. Society often sanctions market actors through withholding purchases or switching their business to a competitor. Industry or trade groups are more difficult to sanction because consumers must abstain from an entire product market. Engaging in nonmarket activities by proxy further reduces collective action problems and enhances defense against social sanction. Political action committees (PACs) and lobbyists provide market actors a means to disguise their nonmarket activities and a means to enable collective action. Multiple market actors often contribute to a PAC created by a lead market actor or to the same lobbyist firm for a specific nonmarket goal. PAC organization has an added benefit in the U.S. institutional context. Market actors can contribute unlimited resources to issue based PACs according to the 1979 amendments to the 1972 FEC Act, whereas firms are limited in other contribution political forms. Because the law provides broad discretion in how issues are defined, an issue can be defined in a manner to elicit contributions for a specific candidate.

Market and Nonmarket Strategic Fit Market actors are likely to pursue both market and nonmarket activities to varying degrees in a given institutional environment (Baron, 1995; North, 1990). Organizational scholars have examined this phenomenon through enterprise (Ansoff, 1979), external affairs (Miles, 1987), integrated (Baron, 1995), and nonmarket (Boddewyn, 2003), and positional analysis (Aggarwal, 2001) strategies and at the firm level. This phenomenon has also been examined at the functional level through political (Baysinger, 1984; Hillman & Hitt, 1999), philanthropic (Porter & Kramer, 2002; Saiia, Carroll, & Buchholtz, 2003), and public relations (Deephouse, 2000) strategies. The extent market actors pursue market and nonmarket activities is influenced by both the perceived external opportunities in a given institutional environment and the actor’s ability to exploit those opportunities, however, little theoretical development and empirical research exists that integrates these causal factors and their affect on market actor actions and subsequent performance. Because strategic external and internal factors are constantly changing, evaluating strategic fit to nonmarket and market factors requires a dynamic perspective (Miles & Snow, 1994; Venkatraman, 1989; Zajac et al., 2000).

Dynamics of Institutional Opportunities Institutions change over time as innovation and political activities encourage political actors to create, change, and remove formal institutions (North, 1990). In general, innovation creates new product markets and new economic opportunities (Schumpeter, 1934). Political opportunities may or may not subsequently evolve depending on the policy demand created by economic activities. Two factors largely drive policy demand: exchange uncertainty and societal dependence on products and/or services. Product market size and complexity creates exchange uncertainty (North, 1990). The greater the level of uncertainty, the higher the policy demand for formal

institutions that reduce exchange uncertainty (North, 1990). Products and services vary in criticality (Miles, 1987). The more critical a product or service, the higher the level of dependence that market, social, and political actors have on a product market’s outputs. This generates demand for policy that encourages and sustains those economic activities (Miles, 1987; Pfeffer & Salancik, 1978). Figure 4 illustrates the co-evolution of a product market and economic institutions governing product exchange. The impact of innovation is explored at three levels of analysis: the institutional, product market (industry), and firm levels over time. Policy demand determines the level of institutional development governing a product market. Institutional development is the extent product market specific economic rules, regulating agencies, and direct and indirect institutional investment exist (North, 1990). The dashed and dotted lines in Figure 4 represent high and low institutional development levels due to policy demand. Few product specific institutions exist when an innovation leads to a new product market (Baron, 2000). The few existing constituents generally focus their limited resources on economic activities. Exchange uncertainty in new product markets is typically low due to two primary factors. First, the relatively small number of market participants discourages opportunism, and second, the existing institutional structure is typically effective in governing new product exchanges. New institutions are not required when market actors are able to efficiently develop contracts governing new product exchange. This is illustrated by the dotted line in Figure 4. The need for policy only arises when market, social, and political actors are unable to mitigate exchange uncertainty, unable to obtain necessary resources in the marketplace, or seek to increase/reduce certain economic activities. When new product exchanges (and new types of exchange) cannot be effectively governed under the existing institutional structure, exchange uncertainty will rise creating demand for new policy. Exchange uncertainty often becomes more of an issue when the number of exchange participants increases and exchange becomes more complex and diverse (North, 1990). The dashed line in Figure 4 illustrates when demand from a greater number of constituents and increasing exchange uncertainty leads to more market specific policy. Policy demand in the present (or lack of) determines what (if any) future political opportunities exist. Product markets eventually enter into decline due to competition and innovation. A core assumption in economic theory is that rational, optimizing actors then reinvest in more efficient uses of capital, however rational actors are often constrained by previous investments (Teece, Pisano, & Shuen, 1997). The more specific and greater those investments, the more likely economic actors are to remain committed to economic activities with declining returns. The right third of Figure 4 illustrates how differences in policy demand influence the range of nonmarket opportunities available in a declining product market. When specific institutions have developed around a product market, the opportunity to protect economic capabilities and activities from increasing competition and innovation through nonmarket activities likely exists to some degree. This is illustrated in the top right third of Figure 4. The bottom right third illustrates conditions when market specific institutions do not develop due to inadequate policy demand. Market actors in this opportunity set either exit, enter decline, or survive in some remaining market niche. Assuming product markets and institutions evolve roughly in the manner illustrated in Figure 4, firms will likely move from the top right quadrant clockwise through the other quadrants in Figure 1.

The Dynamics of Strategic Fit

Strategic fit with environmental and internal factors has traditionally been examined from a static perspective (Venkatraman, 1989; Zajac et al., 2000). Fit to a set of external and internal factors at a given point in time is utilized to predict firm performance (Venkatraman & Camillus, 1984), however this static perspective only captures strategic fit in snap shots based on cross sectional data (Rajagopalan & Spreitzer, 1997; Zajac & Shortell, 1989). Market actors likely continually adjust strategic fit as the external environment changes and internal resources and capabilities are developed and diminished. Because markets and institutions are continually co- evolving (North, 1990), market actors must adjust to both institutional and market factors in adjusting strategic fit.

Fit to market factors. Considering how market actors dynamically obtain/maintain strategic fit introduces additional considerations. Strategy scholars have traditionally reviewed the fit process as first obtaining fit to a set of factors determined through SWOT (Andrews, 1971) or market (Miles & Snow, 1984) analysis followed by minor strategic changes to maintain fit (Quinn, 1980). Scholars must account for two additional factors in evaluating dynamic strategic fit: whether change is required to obtain fit, and whether strategic change is implemented (Zajac et al., 2000). Adopted from Zajac et al. (2000), four types of fit and misfit are possible when considering dynamic strategic fit. First, a market actor needs to implement strategic change and does so successfully. Dynamic fit is obtained through beneficial strategic change (Zajac et al., 2000). Market actors can implement beneficial strategic change as market changes create and diminish existing opportunities. Whether occurring through significant or incremental change, a firm would likely have to undergo three major strategic changes in order to obtain beneficial strategic change as a product market evolves and matures. Dynamic misfit through failure to implement necessary change is the second type of dynamic strategic fit. This occurs when external and/or internal factors change and a market actor fails to adjust or makes an insufficient strategic change (Zajac et al., 2000). As a firm moves through the evolution and maturity of a product market, the firm may fail to identify the need to adjust strategy and/or develop new capabilities as the opportunity set changes. Firms that fail to develop and implement new products may be in a position of insufficient strategic change as market opportunities develop. The other form of dynamic misfit and third type of dynamic strategic fit occurs when strategic change is not necessary and change is unnecessarily implemented. Zajac et al. (2000) described this as excessive change. Fourth, dynamic fit can also be maintained. Beneficial inertia occurs when change is not necessary and no strategic change is implemented (Zajac et al., 2000). Beneficial inertia is likely to occur under two conditions. First, market actors maintain strategic fit with stable external and internal factors, or when environmental change brings existing firm strategy and capabilities into more of a match or alignment with strategic factors.

Fit to nonmarket factors. Although similar in concept, differences exist between fit to market and nonmarket factors. The primary difference is the lack of market actor concern for over investment in nonmarket activities due to the low cost of policy. The cost of political and other nonmarket activities is often very small compared to the costs associated with firm economic activities, and unlikely to have a sizeable cost driven affect on most firms’ economic performance. Dynamic misfit from under investing in political activities is the primary strategic misfit concern for market actors.

The low cost of policy and co-evolution of markets and institutions mitigates the threat of excessive change. Because institutions often evolve in response to market and political activities, over investment in political activities in the present may lead to beneficial inertia as nonmarket capabilities and resources obtain fit in the future. Firms engaged in political activities are unlikely to significantly reduce their political investments even when political opportunities begin to diminish (e.g. reduced government sales, the election of unsympathetic political actors). This differs from investment in economic activities were market actors should discontinue investment in declining market opportunities and seek other means of obtaining economic returns. The threat of social sanction is the one threat to over investing in political activities. Social backlash against a firm’s economic and political activities can lead to diminished reputation and subsequent loss of revenues. Social sanction against the Starbucks Corporation is illustrative. Starbucks management hired lobbyists on the advice of peers and board members although clear political opportunities did not exist. An opportunity presented itself when the Congress was asked on behalf of the Executive Branch to close a taxation loophole that enabled restaurants to claim tax breaks reserved for manufacturers. Starbucks successfully lobbied that roasting coffee was in fact a manufacturing process. The exemption for coffee roasters was widely called the “Starbucks’ Clause” and widely derided by many social groups (Wall Street Journal, 2005).

Strategic Fit in New Product Markets Economic organizations exist to engage in economic rather than nonmarket activities. Whether formed to reduce transaction costs (Williamson, 1975), create unique value (Barney, 1991), and/or new knowledge (Connor & Prahalad, 1996), economic organizations are formed to obtain economic returns not obtainable through market exchange amongst individual actors. New ventures in new product markets are likely formed to pursue economic opportunity and engage in nonmarket opportunities only later when nonmarket activities are perceived to generate higher economic returns than diminishing economic activities. Market actors are likely to perceive economic opportunities attractive when the potential to obtain economic returns is highest. Economic opportunities are often perceived to be attractive when high demand growth, low levels of competition, barriers to entry, and low bargaining power along the value chain exist (Porter, 1980). These conditions are often found in new product markets. Innovators typically enjoy limited competition with the potential for explosive growth, and first mover advantages and lack of market specific knowledge act as barriers to entry. Limited competition and initially low supply of innovative products and service limit buyer and supplier bargaining power.

H1a: As product market growth increases (decreases), investment in economic activity increases (decreases).

H1b: As product market based revenues increase (decrease), investment in economic activity increases (decreases).

The success of initial product market entrants attracts other market actors seeking economic returns. Increasing competition erodes early margins and forces incumbent firms to become more efficient. Market actors must reinvest economic rents into capabilities and

resources to develop greater value at lower costs (Porter, 1980). If competitive intensity decreases, market actors are able to invest rents to other activities.

H2a: As competition increases (decreases), investment in economic activity increases (decreases).

Increased competition typically leads to increased product market consolidation. Market actors unable to obtain higher operating efficiencies either enter decline or are acquired by more efficient firms. Product market consolidation incentives market actors to invest in economic activities. Moderate levels of consolidation often reduce competitive intensity as market actors obtain market share stability and possibly some level of tacit collusion.

H2b: As product market consolidation increases (decreases), investment in economic activity increases (decreases).

Market actors are likely to invest in market resources for two primary reasons. First, firms invest in market based resources and capabilities when economic activities are perceived to generate the highest returns. High growth economic opportunities provide abnormal returns for many market participants over a period of time. Market actors will invest in resources and capabilities to exploit these early stage opportunities until innovation and competition mitigate the perceived opportunity. Second, market actors will continue to invest in resources and capabilities when they provide sustainable competitive advantage. Rare, valuable, inimitable, and non-substitutable resources provide market actors with a competitive advantage that sustains abnormal returns (Barney, 1991). Market actors that possess these types of resources are likely to obtain abnormal returns in most competitive environments. Market actors ideally invest resources and capabilities for both reasons. Either way, investment in economic based resources and capabilities indicates a market actor is likely to pursue more market activity.

H3: As the value of market based resources and capabilities increase (decrease), investment in economic activity increases (decreases).

Nonmarket opportunities for new product market actors could be described as low reward, low risk. Market actors have little to gain from nonmarket activities unless exchange uncertainty, resources availability, and/or competition are at high levels. Nonmarket opportunities are low risk in the early stages of a new product market because conditions for obtaining policy are nearly ideal (Baron, 2000). The small size relative to the overall economy keeps policy salience low, and political actors possess little knowledge beyond that obtained from market actors when creating new market specific policy. Innovative activities are often perceived to be socially beneficial and likely to gain support from multiple policy suppliers. The decision not to engage in nonmarket opportunities during the early stages of product market development is also affected by capabilities and resources (Baron, 2000; Keim, 2001a). Focused on economic activities, entrepreneurial firms rarely possess the resources and capabilities to engage in nonmarket activities. Political activities undertaken by market actors still possess social risks. Although start up firms typically do not have the public visibility of

larger firms, nonmarket activities that deviate from informal institutions can lead to social sanction and reputation loss. Empirical scholarship does not provide any additional insight into nonmarket activities in new product markets. Most scholarship samples firms in the Fortune 500 or similar large, mature firms. Although empirical evidence has suggested small firms are often the most politically active, these small firms are often in mature product markets with large competitors. Nonmarket activities are unlikely to be undertaken during the introduction or survival phase of product market development. First movers and early entrants are only likely to create or enter a product market were economic opportunities offer potential rents. If conditions conducive to nonmarket activities exist (i.e. exchange uncertainty, lack of resources, high competition) market actors are unlikely to perceive economic opportunity as attractive, nor enter the product market. Nonmarket opportunities can occasionally be attractive in some new product markets, however this is the exception. The emergence of a new product market with a high level of institutional specificity is a rare exception. High levels of institutional specificity were required for the nuclear power industry before the product could be safely brought to market (Miles, 1987). Products and services in new markets can also fall under existing specific institutions. The biotechnology industry developed under the regulatory requirements of the pharmaceutical industry for example. No hypotheses are developed linking nonmarket activities and economic performance in the early stages of product market development. Nonmarket investment during the early stages of product market development is not likely to affect performance. Market actors tend to either not participate or fully participate in political activities. Due to the limited incentive to participate in nonmarket activities in most early stage product markets, many market actors are likely to abstain from nonmarket activity. Over investing in nonmarket activities is unlikely to have negative performance implications due to the low cost of political activities relative to economic activities. Nonmarket activities are likely to only become viable as a product market enters into the high growth and maturity market life span phases.

Strategic Fit in Mature Product Markets The attractiveness of market opportunities declines over time as economic returns attract competition. Increased competition constrains market actors’ ability to generate abnormal returns. Although market actors continue to alter economic activities to perceived changing economic conditions, nonmarket activities can provide market actors a means for generating economic returns as returns from economic activities decrease size and predictability. Fit to environmental factors in mature product markets likely involves fit to nonmarket opportunities. Nonmarket opportunities often increase as a product market matures. Political and social actors develop product market specific institutions as economic exchange volume and complexity increases. As a product market matures, the amount and complexity of economic exchange is likely to increase. Market specific institutions both encourage socially beneficial economic activities and reduce the level of uncertainty surrounding such activities. Scholars generally agree that market actors engage in political activity when opportunities exist to improve economic returns through political activity; however what constitutes political opportunities is less understood. In order to evaluate strategic fit to nonmarket factors, operationalizing nonmarket opportunities is an essential first step. If nonmarket opportunities can be evaluated in a similar manner to economic opportunities

(Buchanan, 1975), organizing previous scholarship into nonmarket reward and risk factors provides an approximate operationalization. Scholars in several academic disciplines have explored how multiple factors affect a firm’s decision to pursue nonmarket opportunities through political activities. A review of the relationship between institutional, market, and firm factors and firm political activities is presented in Table 1. The causal factors are organized into the political and economic rewards, risks, and capabilities that affect the decision to engage in nonmarket activities at each level of analysis.

Sympathetic Political Actors A political actor’s policy preference is a key piece of information in determining the likelihood of a political actor supplying policy. House Armed Services Appropriations Committee Chairman John Murtha’s support of defense firms in his district is illustrative. In order to stimulate economic activity in his western Pennsylvania congressional district, Murtha often rewarded defense contractors that established operations there with no bid defense contracts for services the Department of Defense often did not want (Wilke, 2007). Market actors perceive moving to western Pennsylvania an opportunity to generate revenues through political means. Political actors that are perceived to be receptive to potential policy changes are viewed as political opportunities by those seeking policy (Bonardi, Hillman, & Keim, 2005; Buchanan, 1975). Political actors value votes, money, and information (Hillman & Hitt, 1999). Political actors are perceived to be receptive to policy changes when the policy change delivers more of these resources less the costs associated with losing such resources from offended constituents (Buchanan, 1975). Political opportunity also exists when political actors are likely to lose votes, money, and resources by not undertaking policy change. Ideological affiliation is another source of political opportunity. Political actors possess bias or perspectives on the societal roles of government and business. In the U.S., politicians in the Republican Party are often sympathetic to business interests, whereas Democratic Party members are viewed as more sympathetic to labor and environmental concerns. Hersch and McDougall (2000) found empirical evidence that suggested Republican Party Congressional Representatives were more likely to receive contributions from U.S. and Japanese automotive manufacturers’ PACs. Republican politicians are also perceived to be more sympathetic to international free trade policies, hence the Japanese contributions. Similarly, universities are likely to make contributions to alumni in the U.S. Senate (di Figueiredo & Silverman, 2006). Scholars have often focused on three aspects the relationship between potentially sympathetic political actors and political activity. The first is political actor dependence on the market actor’s economic activities, and the second is the threat of international competition. Because foreign market actors cannot vote, political actors can easily deliver policy to many constituents without worrying about losing constituent support. The political actor’s ability to deliver policy is the third factor. Senior, incumbent political actors in key positions are perceived to be more likely to deliver demanded policy.

Institutional Dependence on Firm Activities Society and government can become dependent on market actors (Miles, 1987; Pfeffer & Salancik, 1978). Although this contrary to the traditional direction of dependence in most organizational scholarship, society can become dependent on firms that provide essential

products and services that cannot be obtained from other market actors (Oliver, 1991). Utilities at the local level and defense contractors at the national level often have some level of societal dependence on the firm (Miles, 1987). Institutional dependence on firm market activities presents a nonmarket opportunity. Dependent on their product and services, nonmarket actors are limited in the extent they can regulate or constrain firm activities. Highly depended upon firms are likely to leverage this dependence into favorable institutional changes. Individual market actors can sometimes dominate economic activity in a Congressional district. These market actors are responsible for employing many of the Congressional Representatives voters as well as supplying campaign contributions and information regarding the district. Empirical evidence has suggested the number of automotive manufacturing employees in a district is positively related to employer PAC contributions (Hersch & McDougall, 2000). Similarly, automotive manufacturers’ PACs were likely to give to Congressional Representatives with home districts in Michigan (Hersch & McDougall, 2000). Scholars have also found empirical support that does not support the political actor dependence hypothesis. di Figueiredo & Silverman (2006) found mixed support. They did not find any support for a relationship between number of education employees or college age population in a district and University political contributions, however having a medical school and the number of departments ranked in the top 20 by the National Academy of Science were positively related to political contributions.

H4a: As government dependence on a firm increases, overall firm corporate political activity increases.

Political Actor Power Market actors must evaluate a political actor’s ability to deliver demanded policy. Junior politicians and politicians unlikely to win election or reelection are unlikely to be able to deliver policy. Senior incumbent politicians are a less risky investment. Hersch & McDougall (2000) found empirical evidence that suggested incumbent politicians were more likely to receive PAC contributions. Interestingly, they found that election margin or victory was negatively related to PAC contributions. Sympathetic politicians that occupy key positions are viewed as very attractive political opportunities. The Speaker of the House, Senate President, and committee chairs are extremely powerful in the U.S. Congress. The speaker and president determine which committees proposed legislation most pass before a vote by the entire House or Senate. Preferred legislation is often directed to only a few committees, whereas less preferred legislation is often sent to multiple committees. If the legislation fails to pass every committee, it does not come to a House or Senate vote. The House Speaker and Senate President can thus ‘committee a bill to death.’ Committee Chairs determine which pieces of legislation are heard and voted upon in a given committee. Legislation the chair favors are heard, whereas less favorable legislation often never come before the committee. Committee chairs allied with either the House Speaker or Senate President are powerful foes or friends to those seeking policy. di Figueiredo & Silverman (2006) found empirical evidence that suggested universities only contribute to alumni representatives on the House Appropriations Committee although contributions are made to alumni Senators on and off the Senate Appropriations Committee. They also found evidence that suggested universities located within House and Senate Appropriations Committee member

districts contributed to those members and received more earmarks in return (di Figueiredo & Silverman, 2006). Market actors do not necessarily contribute to representatives and senators on all committees. Committees that control the types of policy market actors seek are more likely to receive political contributions. Hersch & McDougall (2000) found that most U.S. and Japanese automotive manufacturers contributed to Representatives on the House Commerce and Ways and Means Committees, and no evidence of contributions to Science and Technology and Transportation Committee members. Only Ford had a positive relationship with contributing to Foreign Affairs Committee members with mixed results on the Banking Committee (Hersch & McDougall, 2000).

H4b: As the number of sympathetic House and Senate members on key committees increases, the level of overall firm political activity increases.

International Competition Raising barriers to entry for foreign competitors through institutional change is another type of nonmarket opportunity (Grier, Munger, & Roberts, 1994; Schuler, 1996). Obtaining protection from market competition through nonmarket activities is estimated to deliver as much as a 200% return on investment (Moran, 1985). Domestic market actors often find sympathetic political and social actors for devising protectionist measures against foreign competition (Epstein, 1969). High policy breadth is often beneficial as policy suppliers find broad support for policies offered in exchange for political resources. Firms that are affected the most by foreign competition often lead initiatives to increase barriers to entry and/or tariffs (Schuler, 1996; Schuler, 1999) Foreign competition is not excluded from participating in nonmarket activities in a different institutional context. Foreign firms often engage in competing nonmarket activities (Blumentritt, 2003; Hansen & Mitchell, 2000; Schuler et al., 2002). This increases both the salience and breadth of foreign trade policy, and thus the resources market actors must devote to this type of nonmarket activity. When foreign firms do engage in political activities, they often adopt the activities of the host country. Cognizant of sympathetic support for home firms and distaste for foreign participation in domestic politics, foreign firms are limited in the extent of political activity. Empirical evidence has suggested that foreign ownership is either unrelated or negatively related to political activities (Hansen & Mitchell, 2000, 2001; Mitchell et al., 1997). Having a positive rather than competing economic impact enables foreign firms more latitude in engaging in political activities. Hersch & McDougall (2000) found that the number of Japanese automotive manufacturer U.S. employees in a Congressional district was positively related to firm PAC contributions.

H4c: As foreign competition increases, the level of overall firm political activity increases.

Government Regulation Formal institutions come in the form of political rules, economic rules, and contracts (North, 1990). The three formal institutional forms can be conceptualized as nested within an institutional hierarchy. Political rules such as constitutions and common laws act as the basis from which economic rules and contracts are developed. As we move through the hierarchy from

political and economic rules to contracts, the level of specificity increases while the cost of modifying the formal institution decreases. Formal institution specificity decreases exchange uncertainty and the cost of contracting (North, 1990). When innovation creates new product markets, political rules and very broad economic rules are typically the only third party forms of governance. Contracting costs are high under these conditions because exchange participants must commit more time and resources to developing contracts. As the new product or service grows in adoption and use, social and political actors create and modify economic rules to the extent the innovation requires new forms of third party contract enforcement. Increasingly specific economic rules reduce the costs of contracting by constraining the contracting options available and providing enforcement of those available contracting options (North, 1990). The size of formal institution constituencies increases as we move up the formal institution hierarchy. This requires market actors to commit more resources to influence more social and political actors with increasing uncertainty surrounding the success of such efforts (North, 1990). Successfully shaping the institutional environment to a market actor’s advantage can provide a source of competitive advantage (Aharoni, 1993; Boddewyn, 1993; Mahon, 1993). Changes to formal institutions in the present lead to future economic opportunities the market actor is uniquely suited to exploit. Shaping economic rules is often the most attractive political opportunity for market actors. The perceived costs and risks of shaping political rules are likely too high for most market actors. Economic rules can have a significant impact on a market actor’s economic activities with much smaller constituencies than political rules. Additionally, there is often less variation amongst economic rule constituents reducing the potential for political competition and increasing the opportunity for cooperation. In general, economic institutions that are both highly specific and relevant to a market actor’s economic activities are likely to be targeted. Government regulation of economic activity often meets these criteria. Economic regulation is an attractive nonmarket opportunity for market actors for five primary reasons. First, market actors know how much regulation costs them and are thus able to develop more accurate valuations of successful nonmarket outcomes (Hart, 2001; Stigler, 1971). Second, because market actors can develop more accurate and specific institutional changes, collective action amongst market actors is more likely to occur. This reduces the costs of nonmarket activities and enhances the likelihood of success. Third, altering market regulation provides market actors with the opportunity to both increase barriers to entry and decrease costs. Baysinger (1984) described such activities as “domain maintenance” and “domain defense.” Fourth, most individuals remain rationally ignorant of economic regulation mitigating policy competition. The more specific the regulation and the smaller the market, the less likely other social actors are aware of attempts to change policy (Bonardi et al., 2005). Fifth, market actors often ‘capture’ the agencies that enforce regulation (Stigler, 1971). Over time, the agencies that regulate certain economic activities become dependent on those economic activities (Pfeffer & Salancik, 1978). If the market actors that engage in those economic activities are unable to sustain operations, the regulating agency often faces diminished budgets, positions, prestige, and resources. Regulating agencies thus have incentive to assist market actors regardless of social benefit or cost. This issue is exacerbated when funding for the agency comes directly from the regulated market actors (Stigler, 1971).

The empirical evidence summarized in Table 1 has suggested that regulation is a reliable predictor of industry and firm political activity. Regulation had a statistically significant relationship with political activity in eight of the nine studies. The one exception, Martin (1995), was likely due to a small sample size (58 subjects) and subsequent lack of power. Regulation is often operationalized as the presence of some regulating agency (e.g. Grier et al., 1994; Hart, 2001; Martin, 1995; Pittman, 1976, 1977), costs due to regulatory requirements (Hansen & Mitchell, 2000; Mitchell et al., 1997), or number of appearances before some regulatory body (Grier et al., 1994; Hansen & Mitchell, 2000; Mitchell et al., 1997).

H5: As regulation increases, the level of overall firm political activity increases.

Government Sales Political organizations enter into economic exchange with market actors to acquire products and services necessary in operating a government. The extent firm revenues are derived from government sales has been a traditional determinant of firm nonmarket activity (Hart, 2001; Hillman et al., 2004). As political organizations represent more and more of a firm’s revenues, the more the firm becomes dependent on government sales and contracts (Epstein, 1969; Pfeffer & Salancik, 1978). A market actor’s opportunity set becomes increasingly nonmarket oriented as this occurs. Government sales are a reliable predictor of political activity at the industry and firm level of analysis. Statistical significance was found in seven of the eight studies presented in Table 1. Government sales have been operationalized as total government sales (Hansen & Mitchell, 2000; Hart, 2001; Mitchell et al., 1997) and military sales (Boies, 1989; Hansen & Mitchell, 2000; Mitchell et al., 1997; Schuler et al., 2002). Empirical evidence has also suggested firms in industries with government sales are more likely to engage in political activities. Boies (1989) found a positive correlation between firms in aerospace and oil production and PAC contributions, and no significant correlation with chemical, automotive, pharmaceutical, and lumber and paper firms. Similarly, Masters and Keim (1985) found evidence that suggested manufacturing, mining, retail, and banking and finance industry membership was negatively related to having a firm PAC. Taylor’s (1997) finding that metal fabrication industry membership was positively related to PAC contributions does not seem to support the government sales-political activity relationship, however Taylor (1997) also found that chemical, transportation, and instrument manufacturing industry membership was not related to PAC contributions and machinery and equipment manufacturing industry membership was negatively related to PAC contributions.

H6: As government sales increase, the level of overall firm political activity increases.

Direct Government Investment Social and political actors can encourage desired economic activities through direct investment (North, 1990). Political actors encourage economic activity through offering resources and incentives. Resources often offset supply driven risks, whereas incentives offset demand driven risks. Resources are typically provided to enable desirable economic activity that would be unlikely to occur without institutional support. Capital (grants), capital at reduced costs (subsidized and collateralized loans), natural resources, and access to restricted or rare resources

area all means for social and political actors to enable economic activities. Incentives in the form of tax breaks and subsidies are often provided to reward economic activities. Incentives are typically rewarded at the completion of a specific economic activity. Market actors still bear product risks, however institutional actors increase the reward for such activities. Limited scholarship exists examining the role between direct investment and market actor political activity. di Figueiredo & Silverman (2006) study of academic earmarks provided evidence that suggested universities engaged in political activities to obtain direct investment from the U.S. Federal government. All U.S. universities negotiate an overhead rate on grants received from the Federal government. Universities typically prefer a higher overhead rate because it provides more discretion in use of grant funds, and enables them to put more grant funds into facilities (capital improvement) than research (operating expense). di Figueiredo & Silverman (2006) found university grant overhead rates were positively related to political contributions to Congressional Representatives.

H7a: As government direct investment increases, overall firm corporate political activity increases.

Indirect Government Investment and Social Exposure Social and political actors can foster overall economic activity through indirect support (North, 1990). Unlike direct support intended for specific economic activities, indirect support creates a context conducive to economic activities. Military, health, and education spending all indirectly support economic activities. Market actors can also engage in indirect investment through their philanthropic programs (Porter & Kramer, 2002). For example, educating disadvantaged children in computer programming increases the supply of human capital for high tech firms. Firms sensitive to the overall economic environment and uncertainty are often considered to be the most concerned with institutional indirect investment (Miles, 1987; Pfeffer & Salancik, 1978). Empirical evidence has suggested high environmental complexity and turbulence is positively related to political activity (Meznar & Nigh, 1995). Overall exposure is operationalized using the number of times a firm is mentioned in media outlets and firm size.

H7b: As investment in supporting economic activities increases, overall firm corporate political activity increases.

Firm size is perhaps the strongest predictor of firm nonmarket activity (Hillman et al., 2004). Large firms have a high degree of exposure to the overall social and economic environment and seek to maintain the overall health of the economy through both market and nonmarket activities (Miles, 1987). Fourteen of the fifteen studies that examined firm size and some form of political activity found support for a positive relationship. The only study not to yield empirical support had a small sample size (Martin, 1995). Large firms require extensive resources that often cannot be developed internally (Pfeffer & Salancik, 1978). Indirect institutional investment in the economy provides large market actors with more reliable access to external resources (Pfeffer & Salancik, 1978; Schuler & Rehbein, 1997). Similarly, larger firms represent often significant sections of the economy and often provide essential services. Nonmarket opportunities are likely more prevalent as political and social actors become more dependent on the firm (Pfeffer & Salancik, 1978).

H7c: As firm size increases, overall firm corporate political activity increases.

Large firms are also the most socially exposed. The more economic activity a firm engages in, the more likely other social actors are to contest the firm. Legal involvement is sometimes used as a measure of firm social exposure (Boies, 1989; Grier et al., 1994). Market actors involved in institutional enforcement through the courts can seek recourse from enforcement actions by changing formal institutions.

H7d: As legal exposure increases, overall firm corporate political activity increases.

Political Competition and Collaboration The economic benefits of an institutional change must outweigh the costs associated with obtaining the change. Political economists often value institutional change costs from a supply and demand perspective (Buchanan, 1975; Wilson, 1980). The cost of institutional change, or policy, is determined by the optimizing decisions of policy suppliers (political actors) and demanders (market and other social actors). Policy suppliers typically exchange policy with policy demanders for political resources: money, votes, and information in this perspective (Bonardi et al., 2005; Hillman & Hitt, 1999). Policy competition and salience are two key determinants in valuating nonmarket opportunities. Policy competition is the number of parties interested in or competing over a policy (Hillman & Hitt, 1999; Keim & Zeithaml, 1986; Yoffie, 1987). As the number of parties affected by an institutional change increases, a policy becomes more contested amongst policy demanders. The rise in competition amongst policy demanders both increases the costs and decreases the likelihood of obtaining policy (Bonardi et al., 2005). Market actors are thus most likely to be successful in exploiting institutional opportunities when few other market and social actors are affected or knowledgeable of an institutional change. The costs associated with actively monitoring and collecting information on the political process outweigh the benefits for most individuals. The average, self-interested optimizer thus remains rationally ignorant of most policy creation and changes. This benefits both suppliers and demanders of policy. Suppliers can supply policy and gain campaign contributions, votes, and information without alienating other political resource suppliers, and the cost of obtaining policy remains low (Bonardi et al., 2005). Limited empirical research does not support or contradict this assertion. Apollonio & La Raja (2004) study of 241 competing interest groups found no relationship between the number of competing interest groups and political activity. Policy salience, or the importance of the policy to an actor, is the second key determinant of political behavior. The more important a policy is to a market actor, the more likely they are to engage in nonmarket activities regardless of competition (Vogel, 1996). Market actors value nonmarket opportunities and threats by the extent nonmarket activities are likely to effect economic returns. Highly salient policy issues are likely to have a substantial effect on the price and/or cost a firm can obtain in the market place. Widely salient issues, policy important to many parties, is thus viewed as the least attractive type of nonmarket opportunity (Bonardi & Keim, 2005). Empirical evidence has suggested issue salience is more important than issue competition in pursuing nonmarket opportunities. Baumgartner and Leech’s (2001) study of 137 political issues in 1996 found that the majority of lobbying was focused on a just 26 issues. 81% of the

total lobbying took place on these 26 issues drawing more than 100 competing interest groups each of the 26 issues (Baumgartner & Leech, 2001). The top issue, the Omnibus Consolidated Appropriations Bill, drew 1,788 different lobbying organizations. Business interests accounted for 56% of the total lobbying spending on all issues (Baumgartner & Leech, 2001).

Labor unions. Political competition is primarily thought to come from social rather than market actors. Labor unions are perhaps the most studied potential political competitors. Unions are often interested in the same policies as market actors and are assumed to have competing interests. This should create the conditions for intense political competition between policy demanders, however competing policy demanders often cause policy suppliers to avoid supplying policy to avoid offending any competing constituents (Bonardi et al., 2005). Labor unions can also be political collaborators rather than competitors. Market actor interest (sustaining and growing economic returns) and union interests (sustaining and growing member employment) often align. For example, policy that limited carbon or greenhouse gas emissions represented a threat to both coal mining firms and coal labor unions. Policy, such as the Kyoto Treaty, was ratified by most industrialized countries although not in the U.S. A coalition between coal firms and unions is largely credited with blocking these policy changes. Coal mining firms had established relationships with Republican legislators and unions with Democrats. This enabled the coal interests to develop consensus against the policy amongst normally competing policy suppliers. Empirical research examining the presence of potential competing union interest and firm political activities is mixed. A relationship between the percent of union employees and political activity has been found at industry (Masters & Keim, 1985) and firm (Masters & Keim, 1985) levels. Although some studies found no relationship (Martin, 1995; Schuler et al., 2002), no negative relationship between unions and political activity has been found. Hansen & Mitchell’s (2000) study of large firms operating in the U.S. is perhaps the most insightful study on this topic. They studied the percent of union PAC contributions and lobbying expenditures attributable to each firm based on the number of union employees. A statistically significant relationship was found with firm PAC contributions and lobbying expenditures indicating that firms politically activity was related to competing union activity.

H8a: As competing social (nonmarket) actors’ political activity increases, overall firm corporate political activity increases.

Political Competition amongst Market Actors Scholars typically conceive other market actors as potential political collaborators rather than nonmarket competitors. Changes to policy are assumed to benefit all market actors equally, however policy changes that benefit some market actors can negatively affect the economic activities of others. Government contracts can prove the difference in one market actor surviving and one diminishing for example. Political competition is most likely to occur amongst market actors that have competing substitute products. Government subsidies to corn farmers are likely to be contested by sugar cane and beet growers since corn syrup is often used as a substitute for sugar. Hersch and McDougall’s (2000) study of automotive manufacturers in the U.S. is the one piece of scholarship to empirically examine political competition amongst market actors. They found empirical evidence that suggested auto maker PAC contributions were positively related to

competing automaker PAC contributions. The contributions of Ford and G.M. were positively related to Chrysler’s contributions, Ford and Chrysler’s to G.M.’s contributions, and G.M. and Chrysler’s to Ford’s (Hersch & McDougall, 2000). Scholars have also asserted that market actors must keep up with the political activities of their market competitors. Trust is the only viable governance mechanism for exchange of policy. Established relationships are necessary for market actors to obtain policy from political actors. Although political opportunities may not clearly exist and free riding opportunities may be present, market actors have a strong incentive to engage in political activities to avoid the risk of being shut out of future political opportunities. An incentive thus exists for market actors to engage in political activities to avoid being at a political disadvantage relative to other market competitors.

H8b: As competing market actors’ political activity increases, overall firm corporate political activity increases.

Industry Structure Market actors often cooperate rather than compete in nonmarket activities. Consensus provides advantage in obtaining policy (Olsen, 1965). The more policy demanders that have similar interests, the easier it is for policy suppliers to provide policy. Political collaboration is also essential in reducing the threat of free riding (Olsen, 1965). Because policy that benefits one market actor is likely to benefit all similar market actors, firms have an incentive to only engage in political activities when all similar market actors participate. Industry structure has been a traditional measure for the free riding threat. Scholars have asserted cooperation is easier to obtain in more consolidated industries than in more fragmented industries (Getz, 1997; Hillman et al., 2004). Although some studies have failed to find empirical support (Boies, 1989; Mitchell et al., 1997), the relationship between industry consolidation and industry (Grier, Munger, & Roberts, 1991; 1994; Pittman, 1976, 1977) and firm (Andres, 1985; Masters & Keim, 1985; Schuler & Rehbein, 1997) level political activity has primarily been an empirical success story. Research on the diversification and political activity relationship also has supported the free riding hypothesis. Bhuyan (2000), Taylor (1997), Grier et al. (1994) all found empirical evidence that suggested industry diversification was negatively related to political activity. di Figueiredo & Tiller (2001) study of firms lobbying the Federal Communications Commission (FCC) illustrates the importance of the free riding threat. Shared interests, free riding threat, and ability of participating firms to exclude nonparticipating firms were positively related to large firms engaging in collective action and small firms engaging in individual action. Interestingly, di Figueiredo & Tiller (2001) hypothesized that economic interests drove political actions. They tested this hypothesis by examining the effect of sharing economic competitive information with nonmarket collaborators. They found empirical support that suggested large firms were likely to engage in individual lobbying efforts when required to share proprietary information. This suggests economic competitive factors overshadow the free riding threat. Other empirical research has also suggested economic factors possibly overshadow the free riding threat. For example, Hersch and McDougall (2000) and Gray and Lowery (1997) both found evidence that suggested firms compete in nonmarket activities within consolidated industries. Market consolidation is likely to decrease market opportunity attractiveness. Consolidation of competitors in a given product market is often a sign that potential growth

opportunities are limited (D'Aveni, 1994; Porter, 1980). Consolidation enables market actors to obtain economies of scale, initially reduce competition, and raise barriers to entry. Although consolidation reduces some level of competition, consolidation typically leads to more intensified competition over time (D'Aveni, 1994). As economic opportunities become less attractive, investment in political activities may become an increasingly viable option (North, 1990).

H9: As market consolidation increases, overall firm corporate political activity increases.

Firm Nonmarket Capabilities Market actors evaluating political action must determine whether they have the ability to engage and compete in nonmarket activities (Baron, 1995; Hillman & Hitt, 1999). Resources and capabilities serve as sources of competitive advantage in both market (Barney, 1991; Teece et al., 1997) and political arenas (Aharoni, 1993; Boddewyn, 1993; Mahon, 1993). Market actors that do not posses sufficient nonmarket resources and capabilities are likely to engage in collective efforts. Going it alone requires nonmarket specific resources and capabilities. The nature of political exchange also affects a market actor’s decision to develop nonmarket capabilities. Because political exchange is governed by trust, relationships matter. Market actors must develop political capabilities today for political activity in the future. Investments in nonmarket resources and capabilities act as strategic inertia. Once a market actor has developed such capabilities, market actors are likely to continue to seek out political opportunities. Empirical evidence has suggested past political behavior is positively related to future political activity (Boies, 1989; Schuler, 1999). Empirical research examining nonmarket capabilities and political activity often focuses on the use of internal and external political consultants and firm political experience. Schuler (1999) found evidence that suggested all these factors were related political activity. Empirical evidence has suggested having a Washington D.C. office is typically positively related to political activity (Hart, 2001; Martin, 1995; Schuler, 1996), however Schuler (1996) found evidence that suggested having a D.C. office was negatively related to the amount of congressional testimony. Hart (2001) found that hiring external political consultants was positively related to forming a PAC and the amount contributed to PACs. Empirical support has also been found for the firm political experience and political activity relationship. Interestingly, firm political experience is typically negatively related to PAC contributions (Apollonio & La Raja, 2004; Hart, 2001). This suggests amount firms need to contribute decreases as they develop relationships and a better understanding of political activity.

H10: As investment in nonmarket based resources and capabilities increases, overall firm political activity increases.

Strategic Fit in Declining Product Markets As a product market enters decline due to increased competition and/or innovation, market actors find economic opportunities increasingly scarce. In product markets were political opportunities exist, market actors can seek to generate and/or protect economic returns through political activities. Existing political opportunities become increasingly attractive as economic opportunities decline. Investment decisions in this environment are driven by previously

discussed political factors and declining economic opportunities. This context was illustrated by the low market opportunity, high political opportunity quadrant of Figure 1.

Declining Economic Opportunities Attractive market opportunities are likely to encourage market actors to invest in market activities (North, 1990). Market growth potential is often greatest when a product market is in its earliest stages. Product market specific institutions are unlikely to exist in the early stages of market development (North, 1990). Market actors are likely to perceive market opportunities as attractive and nonmarket opportunities as unattractive under these conditions. Contracting or slowing market growth, increasing costs, and declining average economic returns are both indicators that economic opportunities are declining. Empirical evidence has suggested domestic steel demand is negatively related to political activity, whereas foreign competition is positively related (Schuler, 1999). Similarly Grier, Munger, and Roberts (1991) found empirical evidence that suggest industry sales had a negative and exponential relationship with the number of politically active firms in the industry.

H11a: As product market growth decreases, overall firm political activity increases.

Rising costs are another factor that reduces economic returns. Market actors can seek to have price controls, subsidies, and protective barriers established to alleviate and stabilize rising costs. Empirical evidence has suggested rising labor costs are positively related to political activity (Boies, 1989; Grier et al., 1994).

H11b: As economic activity costs increase, overall firm political activity increases.

Firm profitability has been hypothesized to have both positive and negative relationships with political activity. Economic returns create slack resources. Scholars have hypothesized that having excess economic resources gives managers more discretion in investing in political activities. Empirical evidence has not supported this assertion (Schuler, 1996; Schuler et al., 2002). These findings may be due to the low cost of policy. Market actors do need excess resources to effectively engage in political activities. Firm profitability has also been hypothesized to be negatively related to political activity. Economic returns indicate market actors should invest in economic rather than political activity (North, 1990), however no empirical evidence supports this assertion. Interestingly, almost no empirical relationship between profitability and political activity has been found (Boies, 1989; Martin, 1995; Masters & Keim, 1985; Taylor, 1997). Bhuyan’s (2000) findings that industry profit margin (net income/net sales) was positively related to political activity in his study of 35 food manufacturing industries is the one exception.

H11c: As product market profitability decreases, overall firm political activity increases.

Economic Competition The level of competition is a key determinant in evaluating market attractiveness (Porter, 1980). High levels of competition typically exist when numerous competitors or a few highly similar competitors exist (Bain, 1959; Porter, 1980). As competition rises to increasingly high levels, most firms have difficulty in even obtaining normal returns and eventually exit the market

place (D'Aveni, 1994). Low competition provides the opportunity for consistent economic returns. High barriers to entry, collusion, and government regulation can mitigate the level of competition in a given industry.

H12: As market competition increases, overall firm corporate political activity increases.

Firm Economic Capabilities Measures of economic capabilities are fairly common in scholarship examining political activities. Firm size is often included in most studies for example (Hillman et al., 2004). Because hypothesis relating size and slack to political activity have already been developed, no additional hypothesis on the enabling role of economic resources and political activity is made. Hypotheses regarding the constraining role of economic resources and political activity are developed. Lack of sufficient resources to pursue other economic opportunities can constrain an economic actor to a limited range of economic activities. The extent a firm is financially leveraged, or in debt, is an indicator of the extent firms have stretched their economic resources. Political opportunities provide a means to protect previous economic investment given a resources constrained range of other economic options. Because political activities cost little relative to economic activity, seeking to protect current means of generating economic returns through political activities can be an enticing option. Empirical evidence has suggested industry and firm debt levels are positively related to industry and firm political activity (Bhuyan, 2000; Grier et al., 1991; Taylor, 1997) although some studies have failed to find a relationship (di Figueiredo & Silverman, 2006; Schuler, 1996).

H13a: As debt level increases, overall firm political activity increases.

Market and nonmarket resources and capabilities constrain as well as enable strategic actions. Valuable resources and core competencies developed for perceived future strategic conditions may be unsuited for actual future strategic conditions. Market actors are committed to declining product markets to the extent their resources and capabilities limit diversification into other product markets. Once committed to a given basket of resources and capabilities, four factors limit market actors’ ability to develop or modify new resources and capabilities. First, Teece et al. (1997) observed that perhaps the greatest limitation of economic theory is the failure to account for sunk costs. Investment in resources and capabilities can commit market actors to pursuing strategies built around these internal factors even when market conditions are unfavorable. Second, resources and capabilities that provide competitive advantage tend to be developed through path dependent processes (Amit & Schoemaker, 1993; Barney, 1991). This constrains the degree new resources and capabilities can deviate from previously developed ones. The third factor is cognitive bias. Individuals tend to over value things they already possess. Managers can overall value existing resources and capabilities that have generated economic returns for a firm compared to the market valuation for similar strategic factors. Fourth, asset specificity limits the range of applications for any given resource or capability. Market actors that invest in resources and capabilities with a high degree of asset specificity are thus committed to pursuing market activities in limited or niche areas. Market actors constrained by their economic resources and capabilities may turn to nonmarket activities to reduce economic threats. Firm’s with resources and capabilities that are

either too costly to abandon or highly specific cannot easily or efficiently enter new product markets. Unable to exit maturing and declining product markets, nonmarket activities can slow the pace of market forces. Successful nonmarket activities could reduce competition, increase the value of the firm’s existing resources and capabilities, and slow the pace of disruptive innovation for example. Similar to Baysinger’s (1984) domain maintenance concept, firms utilize nonmarket activities to protect inflexible market positions.

H13b: As asset specificity increases, overall firm political activity increases.

H13c: As sunk costs in economic activity increase, overall firm political activity increases.

Performance Dynamic strategic fit to external and internal strategic factors likely affects market actor performance. Hypotheses 1-3 comprise an economic contingency model based on market factors. The extent market actor activity deviates (over or under invests) from the contingency model of change is likely to have a negative effect on economic performance. Hypotheses 4-13 comprise a nonmarket contingency model based on nonmarket and market factors. The extent market actor activity negatively deviates (under invests) from the contingency model of change is likely to have a negative effect on economic performance.

H14a: Deviation from the economic contingency model of change is negatively related to economic performance.

H14b: Negative deviation (underinvestment) from the nonmarket contingency model of change is negatively related to economic performance.

Chapter 2 Summary Social theory is comprised of what, how, why, when, and where (Dubin, 1969). What and how describe, why explains, and when and where provide important contextual limitations (Whetten, 1989). Chapter 2 began by defining what comprises key concepts in the paper. Economic Institutional Change Theory (North, 1990) was then reviewed to provide a theoretical basis to explain why and how environmental and internal factors influence economic and political activity choices. Although very useful at explaining differences in economic performance across institutional settings, economic institutional change theory has not been extended to explain market actors’ choices within a given institutional context. Chapter 2 progressed with extending economic institutional change theory to the product market/firm level of analysis. Innovation leads to new product markets. Political actors then create, change, modify, enforce, and remove institutions to foster economic exchange and new types of economic exchange. As political actors become more involved and institutions more specific to a product market, political opportunities evolve. Competition and new innovation erode the potential to generate economic returns in a given product market over time. In product markets were political opportunities exist, market actors are likely to utilize political means to enhance and protect sources of economic returns. The existence of economic and political opportunities to varying degrees creates four predominant opportunity sets present in any effective institutional environment.

What factors determine the attractiveness of political opportunities? Chapter 2 concluded with a view of political activity antecedents categorized into reward, risk, and capability factors across institutional, market, and firm levels of analysis. These factors were used to operationalize nonmarket opportunities for market actors. Hypotheses were developed that prescribed firm actions based on the presence of these factors. Finally, fit to market and nonmarket factors is hypothesized to determine firm performance.

CHAPTER 3

STATISTICAL ANALYSIS

Chapter 3 Introduction Three studies are designed and tested in Chapter 3. Four opportunity sets were developed in Chapter 2. Similar to what Venkatraman (1989) described this as “Fit as Gestalts” (432), hypotheses were developed to prescribe fit in three of the four opportunity sets. Empirical analysis of the fourth opportunity set (low market, low nonmarket opportunities) is not performed because firms are likely to enter decline or exit in the fourth opportunity set. In order to empirically evaluate three fit gestalts, profile deviation and moderation analyses (Venkatraman, 1989) are performed in each institutional opportunity set. Hypothesis 1-3 are tested in the first study, 1-10 in the second, and 1-13 in the third study. Hypothesis 14, deviation from fit is negatively related to performance is tested in all three studies.

Analysis of Strategic Fit Empirical analysis of strategic fit is most appropriate at the industry or product market level using longitudinal samples. Empirically investigating how strategic fit to external opportunities and internal resources and capabilities is difficult in either cross sectional or broad, economy wide samples. In order to examine how market actors dynamically adjust strategic fit, longitudinal samples over time rather cross sectional snap shots are required (Peteraf & Reed, 2007; Zajac et al., 2000). Broad samples create two methodological issues in examining dynamic strategic fit. First, because product markets develop differing levels of market specific institutions over time, market actors in different product markets will face different opportunity sets within the same overall institutional setting. The budding biotechnology and mature automotive industries face very different opportunity sets within the U.S. Second, fine grained measures are required to accurately evaluate strategic fit. Industry or product market specific measures are often required. The co-evolution of markets and institutions is likely to lead to four predominant types of opportunity sets. These opportunity sets vary based on economic activity, market size, level of market specific institutions, and time. Because scholars must utilize industry specific measures to accurately assess strategic fit, effective empirical investigation requires analysis of different product markets that approximate different market and nonmarket conditions. Empirically evaluating how market actors adopt to market and nonmarket opportunities requires analyses of three of the four different product markets within a given institutional setting. Strategic fit in the fourth opportunity set is not empirically studied. Without market or nonmarket opportunities to generate economic returns, market actors within this context are likely to rapidly exit or enter decline. The analog tape industry over roughly the same time frame used in this study is illustrative. The industry reached its peak in the late eighties, early nineties when it was comprised of five primary manufacturers with just over $1 billion in U.S. sales. Digital recording methods had largely made analog tape irrelevant by 2000, and Quantegy, Inc., the largest and last U.S. analog tape manufacturer, ceased operations in 2005 (Naujeck, 2005). Two measures of strategic fit are used within each context based on Zajac et al.’s (2000) research design. First, fit as profile deviation is evaluated (Venkatraman, 1989). Market and nonmarket based contingency factors were developed in Chapter 2. A general least squares

(GLS) model with contingency factors as independent variables and strategic change as the dependent variable is developed for each empirical context. Market and nonmarket strategic change is comprised of the change in economic and political activity investment in year 1 (t = 0) respectively. The GLS model is now the desired strategic change model. The residual absolute value is then used to measure deviation from strategic fit (Van de Ven & Drazin, 1985; Venkatraman, 1989). This is calculated by taking the absolute value of the difference between the desired strategic change model standardized residual and each observation. The residual absolute value at t = 0 is then used to evaluate economic performance at t = 1. This technique approximates what Venkatraman (1989) described as fit through moderation. By interacting the residual absolute value with a dichotomous variable for type of strategic change, I can examine whether insufficient or excessive strategic change has differing effects on performance (Zajac et al., 2000). Both insufficient and excessive economic strategic change should have negative implications on economic performance, however only insufficient nonmarket strategic change should have negative implications on economic performance. Excessive nonmarket strategic change is evaluated using the moderation technique described above as a control for Hypothesis 14b. The three studies provide different contexts in which varying nonmarket, market, and internal factors suggest three different desired strategies: a market based strategy, an integrated strategy, and a political based strategy. Different contingency models are thus developed and tested in each context. Strategic fit to market factors in a rapidly growing product market is the focus of Study 1. The extent economic activities deviate from economic contingency factors (over of under invest) affects economic performance (H1-3, and H14a). Strategic fit to market and nonmarket factors in a mature product market with viable political opportunities is examined in Study 2. The extent economic and nonmarket investments deviate from economic (over or under invest) and political (under invest) contingency factors affects economic performance (H1-10 and H14a, b). Study 3 focuses on these relationships in a mature to declining product market with viable political opportunities. Declining economic contingency factors in addition to nonmarket factors are positively related to nonmarket investments within this context (H1-13 and 14 a, b).

Overall Empirical Context Dynamic strategic fit to external market and nonmarket factors and internal resources and capabilities is evaluated on the semiconductor, pharmaceutical, and mining industries in the U.S. between 1987 and 2000. The market and nonmarket conditions in these three industries approximate the three different market and nonmarket opportunity sets. Four election cycles occurred during this period: 1987-’88, 1991-’92, 1995-’96, and 1999-’00. The U.S. context between 1987 and 2000 offers several advantages in examining market and nonmarket opportunities over time. First, the U.S. institutional structure is more susceptible to influence than other forms of democratic government. Power is more dispersed in the U.S. than in the Western European democracies where power is centered at the national level within the Parliament. Power is divided both horizontally and vertically in the U.S. Federalist system. Horizontally, powers are distributed across the three branches of federal government: Executive, Legislative, and Judicial. Power is also distributed vertically through different levels of government. Powers, or rights, are specified at the Federal, state/local, and individual levels. Dispersed power amongst institutional

actors enhances the likelihood that powerful actors or strong coalitions can enact institutional change. Economic growth, political administration, and higher level formal institutions were both fairly consistent from 1987 to 2000. Steady economic growth indicates that overall market opportunities were available and viable in the U.S. during this period. A brief economic recession in 1992 was the only exception. Political control was consistently divided between the Executive and Legislative branches of government with Democrats and Republicans controlling one branch at various times. The Democratic control of the Congress and Presidency from 1992 to 1994 was the only exception. Control of different Federal government branches by different political parties further distributed power. This divergence amongst the two branches was likely a major factor in the lack of change to higher order formal institutions (e.g. no constitutional amendments and the failure of health care reform). The economic and political stability helps control for bias introduced through over all variation in the sample. The three industries selected exemplify product markets at different stages of market and institutional co-evolution. The semiconductor industry was rapidly growing industry in the U.S. from 1987 to 2000. The pharmaceutical industry enjoyed both market and nonmarket opportunities over this period. The mining industry was the only major U.S. industry to decline between 1987 and 2000, however heavy regulation and increasing energy dependence provided ample political opportunity. Age variation amongst the industries also approximates the evolutionary model developed in Chapter 2. The semiconductor, pharmaceutical, and mining industries varied from approximately 20, 100, and 200 years respectively.

Study 1: U.S. Semiconductor Industry 1987-2000 The U.S. semiconductor industry (NAICS 334413 Semiconductor Manufacturing) provides the empirical setting for Study 1. Industry conditions between 1987 and 2000 approximate the high market, low nonmarket opportunity set. Industry revenues grew from just under $25 Billion in 1987 to over $200 Billion in 2000 a remarkable 700% increase. Although some political opportunities did exist for semiconductor manufacturers, industry PAC contributions totaled a mere $268,328 compared to total U.S. PAC contributions of $261,704,303 for the 1999-2000 election cycle. The U.S. semiconductor industry and U.S. institutions co-evolved in largely the same process described by North (1990). Informal institutions initially largely governed economic and information exchanges. Bell Laboratories established very liberal licensing agreements in the late 1960’s, which became the industry norm through the late 1970s (Angel, 1994). These licensing patterns began to fall apart in the late 1970s with the increased Japanese competition. Japanese semiconductor manufacturers quickly established themselves as superior in manufacturing to U.S. firms. Japanese produced circuits were twice the quality of U.S. ones throughout the 1980s and often produced at much lower costs. U.S. firms enjoyed research and development advantages, however new innovations developed in the U.S. were quickly copied by Japanese competitors (Angel, 1994). This led to the first product market specific institution, the 1984 Semiconductor Chip Protection Act. The act enabled patents to be filed on circuit designs, decreasing Japanese firms’ ability to rapidly copy U.S. designs and providing greater incentives for R&D investment (Arrow, 1962). Japanese firms continued to win market share throughout the 1980s. U.S. firms had almost 80% of the memory device market in 1978

compared to 23% for Japanese firms, however this had reversed by 1990 with Japanese firms controlling 65% compared to less than 20% for U.S. firms (Angel, 1994). High international competition and uncertainty surrounding R&D investment created political opportunities for U.S. semiconductor manufacturers. Lobbying by U.S. semiconductor firms resulted in anti-dumping actions by the U.S. government and the eventual creation of the semiconductor manufacturing technology consortium (SEMANTECH) in 1987. The U.S. government invested $850 million in SEMANTECH to spur semiconductor R&D. Given high competition and political opportunities, the semiconductor industry may have resembled conditions suitable for Study 2, however these conditions quickly changed. U.S. semiconductor firms maintained a lead over Japanese firms in microprocessors (Angel, 1994). Research innovations aided by SEMANTECH research enabled Intel Corp. to develop a new operational structure. Intel began co-locating sales, R&D, and manufacturing in the same location based on product line. This spurred cross development that led to faster product development times of products better suited to customer needs (Angel, 1994). U.S. semiconductor firms began to halve product development times and were uniquely positioned to exploit the growing personal computer (PC) boom. By the early 1990s, U.S. semiconductor firms were in the midst of an unprecedented market boom.

Study 2: U.S. Pharmaceutical Industry 1987-2000 The U.S. pharmaceutical industry (NAICS 325412 Pharmaceutical Preparations Manufacturing) provides the empirical setting for Study 2. Industry conditions between 1987 and 2000 approximate the high market, high nonmarket opportunity set. Industry revenues tripled as a share of U.S. GDP from 1980 to 2000 and were over $200 Billion in 2000 (Angell, 2004) and the U.S. government was the industries single largest customer. Industry PAC contributions totaled a $4,540,363 for the 1999-2000 election cycle. Only the banking and accounting industries contributed more. The U.S. pharmaceutical industry has multiple political opportunities. The Food and Drug Administration (FDA) regulates the industry and largely determines the speed at which new products and whether those products make it to market. The National Institutes of Health, Department of Agriculture, and FDA funds billions of dollars in basic research for pharma companies at U.S. universities, and the U.S. government is the industries single largest customer.

Study 3: U.S. Coal Mining Industry 1987-2000 The U.S. coal mining industry (NAICS 2121, 212111, & 212112 Coal Mining) provides the empirical setting for Study 3. Industry conditions between 1987 and 2000 approximate the low market, high nonmarket opportunity set. Coal production in the U.S. was largely stagnate over the study period due to increased environmental regulations. Industry revenues were $27 billion in 2000 and industry PAC contributions totaled only $817,302 for the 1999-2000 election cycle, however this number jumps to $6,238,229 when combined with coal fired electric utilities, a close political ally. As a percentage of revenue, PAC contributions represented 3% of revenue versus 2% for the pharmaceutical industry. Coal remains by the far the cheapest means of fossil fuel based electric energy production and conservative estimates put U.S. reserves at about 200 years including usage growth. Environmental regulations largely constrain electric utilities from developing new coal fired plants despite the high demand. Additionally, environmental and safety regulations constrain the

range of mining operations and raise costs. The U.S. coal industry thus finds itself in a position where economic growth is only possible through successful institutional change.

Data Data was obtained from two primary sources. Data for nonmarket factors were obtained from the Congressional Quarterly (CQ) MoneyLine database. The CQ MoneyLine database tracks all contributions from all sources made to elected Federal level politicians: members of the U.S. Congress and Presidential candidates. Data for market factors was obtained from the CRISP and COMPUSTAT databases. Supplemental data sources are identified in the measures section. Examining political and economic data concurrently creates two obstacles. First, because money, information, and votes are valuable to policy providers near elections, firm political activities occur primarily during election cycles. The election year and year prior are considered to be an election cycle as policy suppliers prepare for elections (Hart, 2001; Hillman et al., 2004). Unlike political activity, overall economic activity is ongoing. A weighted average of economic activity in the three years prior to an election cycle is used to remedy this issue. The weighted average is calculated by: WAVG = (Y-2 + (Y-1 x 2) + (Y0 x 3)) / 6 This technique allows for the effect of all interim election cycle economic data to be accounted for while weighting the importance of near term economic factors. To illustrate: the 1991-92 election cycle would be examined by taking the weighted average of economic data from 1989 to 1991 to determine the desired market strategic change for 1991. Strategic changes in the second year of the election cycle are predicted using actual observations rather than a weighted average (e.g. 1992 contingency factors for 1992 desired strategic change). The second obstacle in examining political data is the choice to engage or abstain from political activities (Grier et al., 1994). Economic organizations must engage in some form of economic activity, however market actors can abstain from political activities even when rational choice would suggest investment in political activities. Firms may perceive free riding to be an optimal choice (Olsen, 1965) or are decidedly against political activity due to managerial/owner choice (Epstein, 1969; Miles, 1987). Multiple political activity observations of $0 are likely in a given sample. As a result, market actor political activity samples often have biased distributions not suitable for ordinary least squares (OLS) regression analysis techniques. Two solutions exist. The first is to employ a Heckman two-step correction to the OLS model (Heckman, 1976, 1979). The effect of government sales on PAC contributions is used as an example. The first step of the Heckman correction process is to estimate a selection model: zi = β1X1i + ε1i The selection model is a probit model estimating whether a market actor engages in political activity (zi = 1) or does not engage in political activity (zi = 0) based on government sales (β1). The selection model residuals (ε1i) are used to construct a selection bias control known as λ. The equivalent of the Inverse Mill’s Ratio, λ summarizes all unobserved effects of government sales and is used as a control measure in the second step: yi = β2X2i + λ + v2i The OLS model predicts PAC contributions (yi) due to observed government sales (β2) while controlling for unobserved government sales (λ). The Heckman two-step correction has one draw back: the standard errors in the OLS model (v2i) are biased (Greene, 1990; Grier et al., 1994). Because strategic fit is measured as deviation from standard error, utilizing the Heckman two-step correction would introduce bias

into the evaluation of the fit-performance relationship. This form of correcting for biased sample distribution cannot be used. The second way to correct biased sample distribution is to throw out all zero observations in specifying a model for desired nonmarket strategic change. An OLS model would be developed using only politically active firm observations to specify desired nonmarket change. Deviation from desired strategic change would then be measured using all firm observations in Studies 2 and 3. This distribution correction is most appropriate. Political activity is theorized to be contextually dependent in this paper and is theoretically prescribed in the contingency-desired strategic change relationship. Market actors should engage in political activities under certain environmental conditions. Firms that abstain from political activities regardless of reason are likely to see negative effects on economic performance under these conditions. In studies seeking to identify antecedent effects on firm political activity, the Heckman two-step correction is appropriate. Four of the eleven studies using OLS analysis techniques in Table 1 utilized the Heckman correction for example. However, these studies were comprised of broad samples and sought generalizable results. Studies 2 and 3 are designed to evaluate the relationship between nonmarket activity underinvestment and economic performance. Specifying desired nonmarket strategic change including the zero observations would introduce downward bias decreasing nonmarket strategic fit values. This both detracts from testing the hypothesized relationship and decreases the likelihood of examining the true relationship between environmental factors, nonmarket strategic actions, and subsequent economic performance.

Contingency Measures Contingency measures are presented in the order of hypotheses development. Market level measures are developed for all three studies. Nonmarket measures are not developed for the semiconductor industry because no hypotheses are developed relating nonmarket factors and firm nonmarket activities in this context. Market measures are used to predict both market and nonmarket investment.

Product market and firm growth. The annual change in total industry revenue and profits are used to measure product market growth. Firm growth is measured through annual change in revenue and stock market capitalization. These measures indicate how firms are likely to perceive future economic opportunities.

Product market competition and consolidation. Competition is measured using annual changes in market share. Industries with fairly stable market share indicate some level of implicit or tactic collusion and/or competitive complacency, whereas large shifts in market share amongst competing firms indicates intense competition. Market share change is measured using the average of all firm market share changes. Change is the absolute value of market share t1 – market share t0. Consolidation is measured using a consolidation ratio. The ratio is obtained by dividing the combined sales of the four largest firms by total industry sales.

Economic resource value. The value of economic resources and capabilities requires developing product market specific measures. Innovation in the semiconductor industry occurs at a rapid pace. Viable products today are quickly made irrelevant by new product developments.

Existing products thus have limited economic value. A firm’s ability to create new and more powerful products is the true source of economic value in the semiconductor industry (Angel, 1994). This is measured utilizing the number of patents issued to a firm in a given year. Economic resource value in the pharmaceutical industry is largely determined by patent protection. Generic competitors easily copy and produce chemical compound based pharmaceutical products once patent protection lapses. Product economic resource value is measured by multiplying product annual sales and years of patent protection remaining. Firm economic value is obtained by multiplying product value and the number of products the firm has in the market. Products ‘in the pipeline’ that have not received FDA approval are not accounted for due to the high level of product failure in clinical trials. Proven reserves are used for economic resource value in the coal mining industry. Reserves are measured in short tones. The economic value of coal mining firm resources is determined by multiplying short tones of coal by the fourth quarter average price per short ton in a given year.

Government dependence. Two measures are used for government dependence on a firm’s market activities: supplier power and number of employees. The percentage of a product/service a firm supplies compared to the total number of like products or services obtained from other market actors serves as a measure for supplying power. The government would be more dependent on a firm that provides 100% of the government’s fighter aircraft versus 20% of a certain pharmaceutical. The number of employees is the second measure of government dependence. Votes are one of three primary forms of political capital and votes are often tied to jobs (Hillman & Hitt, 1999). The more constituents employed by a firm, the more dependent politicians are on the firm (di Figueiredo & Silverman, 2006; Hersch & McDougall, 2000).

Powerful political actors. Three measures for powerful and sympathetic political actors are utilized: the number of Republicans on key congressional committees (Hersch & McDougall, 2000); and key committee Senators and Representatives from market actor home states (di Figueiredo & Silverman, 2006; Hersch & McDougall, 2000). Key committees vary for market actors. The Senate Appropriations (SAC) is extremely important to pharmaceutical market actors. The committee oversees the Food and Drug Administration (FDA), the primary regulator of the pharmaceutical industry, and allocates money to the scientific programs that provide basic research. The Senate Energy and Natural Resources and Environment and Public Works Committees are both important to mining industry actors. The former regulates the mining industry in general and the later regulates environmental standards and nuclear energy, a coal substitute. The House Energy and Commerce Committee is important to both pharmaceutical and mining industry actors. Energy and Commerce has oversight of the FDA, and environmental and utility regulation. The pharmaceutical industry also follows the House Appropriations Committee because its members also influence how research monies are allocated. Similar to the Senate Energy and Natural Resources Committee, the House Natural Resources Committee oversees the mining industry in general. Because firm headquarters may be located separately from where actual economic activities occur, home states are determined by taking the top three states for pharmaceutical and

mining activity as opposed to using headquarter locations (Hersch & McDougall, 2000). Political actors are also likely to be sympathetic to a consensus of economic interests. New Jersey, California, and New York are considered home state for pharmaceutical market actors. These states have the largest number of pharmaceutical related employees with 50,300. 40,100, and 26,300 respectively in 2000 . Wyoming, West Virginia, and Kentucky comprise coal mining home states. They are the largest coal states producing 31.5, 14.9, and 12.3 percent of 2000 U.S. coal production respectively.

International competition. Foreign competition is measured using import sales divided by total industry sales. Although foreign competition is an issues in the semiconductor industry, foreign competition are minor players in both the U.S. pharmaceutical and coal mining industries.

Regulation. The level of government regulation a firm faces is measured by the number of regulatory interactions. Field corrections and recalls reported in the FDA Enforcement Report Index are used for pharmaceutical firm regulatory interactions. Mine orders, citations, and safeguards reported in the U.S. Department of Labor Mine Safety and Health Administration’s Mine Violation Report are used to measure regulatory interactions in the mining industry.

Government sales and investment. Firm revenue from the government is measured as a percentage of total government revenue in relation to total firm revenue. This measure indicates the importance rather than just the amount of government business. The total in grant funding received from the government is used to measure direct investment. Total sales were measured in Study 2 by multiplying firm market share to total Federal pharmaceutical expenditures across all agencies (e.g. Department of Defense, Veterans Administration, and Department of Health & Human Services).

Indirect investment and social exposure. The total government investment in related supporting activities is used to measure indirect investment. Total National Institutes of Health (NIH) and Department of Energy (DoE) grants are used to measure government indirect investment in pharmaceutical and mining activities respectively. These grants typically go to Universities and other research organizations that provide basic research and develop human capital for pharmaceutical and mining market actors. Firm size is measured by total sales. Total sales captures a market actor’s overall economic exposure compared to other size measures such as employees, market share, or assets. Legal exposure is measured using firm legal reserves. This measure provides an indication of the firm’s predicted future legal involvement and is thus appropriate for evaluating the relationship between legal exposure and firm nonmarket activity investment.

Nonmarket political competitors. Political competition from nonmarket competition is measured by total PAC contributions from competing social interest groups. Several social groups object to the high cost of pharmaceuticals. Physician and patients rights advocates engage in political activities to limit pharmaceutical prices (Angell, 2004). Total PAC contributions from the American Medical Association (AMA) are used to measure nonmarket political competition to pharmaceutical market actors. Mining labor union PAC contributions are used to measure mining industry nonmarket political competition.

Market political competitors. Two measures are used for political competition from market actors. First, overall industry political activity is measured. This provides a measure of intra-industry political competition. Although nonmarket activity by similar firms is likely to help rather than compete with a firm (Olsen, 1965), total political expenditures indicates the importance of engaging in nonmarket activities within a given product market. Because nonmarket opportunity is the underlying concept, total industry political expenditures also provide a valuation of nonmarket opportunity as perceived by other similar firms. Second, total political activities from competing market interests are used to measure inter-industry political activity. Total PAC contributions by health management firms are used to measure market based political activities competing against pharmaceutical interests. The American Hospital Association (AHA) has an interest in seeking to reduce pharmaceutical costs. Because patent protection provides pharmaceutical market actors much of their pricing power, efforts to reduce pharmaceutical costs are likely to involve nonmarket activities. Coal mining firms have two likely nonmarket competitors: atomic and petroleum electricity producers and railroads. The 91% of coal produced in the U.S. in 2001 was used for electricity production. Other sources of electricity production are substitute threats, however both atomic and petroleum energy producers are unlikely to vigorously attack coal fired electricity producers. Electricity producers often own and operate plants fueled by different energy sources. Atomic energy is not looked favorably upon by the public (Miles, 1987) and unlikely to make gains that reduce coal based production (during the study timeframe), and petroleum based electricity production produces similar levels of air pollution. Railroads and mining interests have an adversarial relationship. North American railroads possess largely geographic monopolies. Coal can only be effectively and efficiently transported by rail due to the massive volumes of coal required to fuel electricity production. Because railroads own the track leading to coal mines and electric power plants, railroads often enjoy tremendous pricing power over coal producers. Coal producing firms have thus sought government intervention to reduce these virtual transportation monopolies, and railroads are interested in protecting these advantages. Total railroad industry PAC contributions are used to measure market based political competition for coal producers.

Nonmarket resources. Investment in nonmarket resources is measured using the cost of political oriented employees (Bhuyan, 2000; Esty & Caves, 1983). Salary, office space, and benefits are calculated for firm sponsored PAC employees. The measure is calculated using total PAC disbursements less total contributions for PACs that receive contributions from a single firm. For example, Pfizer contributes to multiple PACs, however only Pfizer Inc. PAC would be used for this measure.

Economic factors. Input costs are measured using growth adjusted change in cost of goods sold (COGS). This is calculated by determining the percentage change in firm revenues and cost of goods sold. Total revenue change is then subtracted from change in cost of goods. The product is then multiplied with COGS in the beginning period to determine a growth adjusted COGS. The change between beginning COGS and growth adjusted COGS is used to measure economic costs. Total debt as a percentage of total assets is used to measure firm debt level.

Asset specificity and sunk costs. The percent of a firm’s revenues that comes from coal production is used measure asset specificity. Asset specificity is of interest in this study to evaluate resource driven constraints on strategic actions. Coal producers often own other mining interests enabling them to rely on other sources of economic returns. The percent of revenue from coal operations provides a measure of how dependent coal producers are on this type of economic activity. Accumulated depreciation, depletion, and amortization is used to measure sunk costs. This measure is appropriate for the coal industry because coal production is land and equipment intensive.

Investment Measures Desired strategic change is developed for both market and nonmarket investments. Contingency factors must be regressed onto market and nonmarket investments to determine desired strategic change. Strategic fit is measured by the deviation and moderation techniques described earlier. Deviation from desired strategic change produces the independent variable used to test the strategic fit-performance relationship. Market based measures. Research and development (R&D) costs are used to measure economic investment in Study 1 for two primary reasons. First, the semiconductor industry is characterized by rapid innovation. The number of transistors that can be placed on an integrated circuit doubles roughly every two years (Moore, 1965). Firms that fail to invest in new technologies cannot compete with other semiconductor manufacturers. Second, innovation is the only major advantage U.S. firms enjoy over Japanese competitors. Japanese semiconductor manufacturers have had a historic advantage over U.S. firms being able to produce integrated circuits of higher quality at lower costs. U.S. firms that relied on manufacturing existing circuit designs would likely rapidly lose out to superior Japanese manufacturers. The sum of advertising and research and development costs are used to measure market investment in Study 2. The majority of pharmaceutical firms’ revenues and profits come from existing drugs often with multiple similar competing products (Angell, 2004). Although R&D expenditures are required to compete in the future, drugs often take longer than a decade to develop reach the marketplace. Pharmaceutical firms thus find themselves competing on their ability to develop new and market existing pharmaceuticals to physicians and patients. Capital expenditures are used to measure economic investment in Study 3. Capital expenditures are funds spent on additions to plant, property, and equipment (PP&E). Because coal production is equipment and land intensive, changes in PP&E investment provide a strong indicator whether a coal producer is increasing and decreasing economic activities.

Nonmarket based measures. Direct and indirect political activity constitute overall firm political investment. Direct political activity is the total of firm and employee contributions made directly to members of the U.S. Congress and Presidential candidates. Indirect contributions include firm and employee contributions to political parties, special interest groups, and 527 organizations. Special interest groups are non-profit organizations registered under United States Internal Revenue Code 501(c). Two types of 501(c) organizations are relevant to nonmarket activities: 501(c)(4) Political Education Organizations and 501(c)(6) Business League and Chamber of Commerce. AARP and MoveOn.org are both examples of 501(c)(4) organizations, whereas the U.S. Chamber of Commerce and industry associations such as the Professional Golf

Association (PGA) and American Medical Association (AMA) typify 501(c)(6) organizations. 501(c) organizations are allowed to engage in limited political activity, however, they must exist for some other primary activity. Two types of political groups claim tax exempt status under United States Internal Revenue Code 527: political action committees (PACs) and 527 organizations. Both are legally formed as 527 organizations, and unlike 501(c) organizations, 527s are created specifically to elect or defeat politicians and/or legislation. PACs can contribute directly to campaigns and fall under Federal Elections Commission (FEC) oversight, which limits PAC contributions to campaigns. PACs are not limited in their non-campaign contributions and often fund research, pay legal fees, and hire lobbyists for example. 527 organizations do not directly contribute to campaigns and are not limited in non-campaign contributions by the FEC. Although firms and employees are limited in direct campaign and political party contributions, they are unlimited in the amount contributed to special interest groups, PACs, and 527 organizations. Contributions to 501(c) special interest groups are tax deductible up to 10% of earnings for corporations and 50% for individuals. Contributions to 527 organizations are not tax deductible even though the organizations themselves are tax exempt. Lobbying and sponsored travel expenditures are not included. Accurate data on firm lobbying activities does not exist prior to 1995 Lobbying Disclosure Act. Sponsored travel is not reported due to consistent under reporting of actual travel expenses. Political actors often travel on corporate aircraft, however they are only required to report equivalent first class commercial travel costs. This often grossly underreports the true value of market actor sponsored travel.

Dependent Variable Measures Two types of dependent variables exist in this research design. Economic performance is the overall dependent variable (DV). Return on assets (ROA) and firm survival are used to measure economic performance in Studies 1, 2, and 3 (Zajac et al., 2000). ROA is an appropriate performance measure given the use of market and nonmarket activity investments to evaluate strategic fit. Firm survival provides insight into whether nonmarket activities enable economically under performing firms to survive.

CHAPTER 4

RESULTS

Chapter 4 Introduction Empirical analysis results are presented in Chapter 4. The results are presented in seven tables covering the three empirical studies. Tables 2a, b, and c are the correlation tables for Studies 1, 2, and 3 respectively. Table 3a and b present the market and nonmarket contingency models developed for the U.S. Semiconductor Industry from 1986 to 2000. The affects of profile deviation from the market contingency model on return on assets (ROA) and firm survival are presented in Table 4. The market and nonmarket contingency models for the U.S. Pharmaceutical Industry (1986-2000) are presented in Tables 5a and b. The affects of profile deviation from both the market and nonmarket contingency models on firm economic performance are presented in Tables 6a and b respectively. The results for the study examining strategic fit to market and nonmarket factors in the U.S. Coal Mining Industry are presented in Tables 7a, 7b, 8a, and 8b.

Results Correlations and descriptive statistics are presented in Tables 2a-2f. Some hypotheses were not tested due to lack of that activity in the given empirical context. Hypothesis 7a was not evaluated because the Federal government did not make grants to any of the firms in either three of the studies. Similarly, none of the coal mining firms in Study 3 had any business dealings with the U.S. government. Hypotheses 4a and 6 were thus not evaluated in Study 3. Results are presented by study.

U.S. Semiconductor Industry Generalized least squares models (GLM) were developed to estimate a contingency model for market fit. Because no hypothesized relationships between nonmarket fit and performance were developed, a nonmarket contingency model was developed only as a control in Study 1. The hypothesized antecedents were regressed onto firm research & development (R&D) investment to develop the market contingency model. Firms making R&D investment decisions closest to those specified by the model should see higher economic performance. The market contingency model is presented in Table 3a. Estimation of the GLM using 640 observations over eight time periods resulted in only two statistically significant relationships with R&D investment: firm revenue change and firm asset value. The non- significant antecedents were then dropped to develop a modified economic fit model. The modified model is presented in the right half of Table 3a. Although several antecedents were dropped from the model, most dropped from the contingency model were at the industry level of analysis whereas the dependent variable (R&D investment) was at the firm level of analysis. Stock market capitalization was the only firm level antecedent dropped from the contingency model purely for empirical considerations. The modified model resulted in a contingency model with all significant relationships between the antecedents and strategic activity (R&D investment). Both the hypothesized and modified models were overall good fits to the data with chi square p values less than .001. This

goodness of fit test indicates that the independent variables produced a statistically different GLM than one with only the y-intercept term explaining R&D investment. A control nonmarket contingency model was developed utilizing nonmarket antecedents that might theoretically have a positive relationship with firm political activity investment in the U.S. Semiconductor Industry. Firm size as measured by firm sales and employees was selected do to the consistent observed relationship between size and political activity across multiple contexts. Foreign market share was also selected because of the competitive threat Japanese firms provided throughout the 1980s. Most previous semiconductor firm political activity was in response to this foreign competitive threat (Angel, 1994). No statistically significant results were obtained in estimating a GLM to explain firm political activity investment (Table 3b). Deviation from fit was measured using the absolute raw residual from the contingency fit model. The raw residual is the difference between the contingency model standard error and the actual observation. The absolute residual was then regressed onto ROA and firm survival to empirically evaluate the relationship between strategic fit and firm economic performance. No nonmarket contingency model was successfully developed for evaluating nonmarket fit in the U.S. Semiconductor Industry. Only the relationship between market contingency model deviation and performance is examined. The results presented in Table 4 suggest strategic fit to market factors does not affect firm performance. No statistically significant relationship was found between market contingency model deviation and economic performance. Fit through moderation (Model 2 in Table 4) was not tested because no direct relationship existed between deviation and performance.

U.S. Pharmaceutical Industry A market contingency model for change based on Hypotheses 1 through 3 was developed and evaluated in the U.S. Pharmaceutical Industry. The results presented in Table 5a show that all three firm level antecedents and one industry level antecedent, industry market share change are significantly related to combined firm R&D and advertising expenditures. A modified economic fit model resulted in only significant relationships with the firm level antecedents. It should be noted that industry market share change just made the statistical significance cut in the hypothesized model and just missed the p < .1 cutoff in the modified model. Both models fit the data well with chi square values significant at the p < .001 level based on analysis of 1165 observations. The hypothesized nonmarket contingency model also demonstrated significant relationships between nonmarket antecedents and total political investment (Table 5b). It should be again noted that the GLM was estimated using only observations were total political activity was greater than 0. A gamma rather than normal distribution was utilized to estimate the model. A gamma distribution is appropriate when dependent variable scores are all positive integers with no observations <= 0. When specifying the gamma distribution, the statistical software package used dropped all observations were antecedents had missing values resulting in 90 and 94 observations for the hypothesized and modified contingency models respectively. Statistical significance was found between four firm and one industry level antecedents and total political activity. Both models demonstrated goodness of fit with chi square p < .001. The modified nonmarket contingency model was selected to evaluate fit and performance because all antecedents were all firm level antecedents were statistically significant at p < .001. Fit to the market contingency model was positively related to firm ROA, however no statistical relationship was found with firm survival (Table 6a). The positive coefficient for the

absolute residual term in Model 1 is not in the hypothesized direction. This suggests that larger deviation from the contingency model rather than smaller deviation, which would be indicated by a negative coefficient, is positively related to firm ROA. Two possible conditions would explain these findings. First, both under and over investment in advertising and R&D relative industry averages are positively related to performance, or only one type of misfit is related to performance. The interaction effect tested in Model 2 addresses this question. Significant results for fit measured as moderation are also found. This suggests that there are differences between the two types of strategic misfit (excessive or overinvestment vs. insufficient or underinvestment). Because strategic misfit was found to be positively related to ROA, the negative coefficient for the moderation and deviation type interaction suggests insufficient change is positively related to ROA. Firms will likely outperform competitors if they minimize advertising and R&D expenditures relative to industry averages. This also suggests that pharmaceutical firms on average overinvest in advertising and R&D. Because the fit performance relationship is examined over a one year period, a more accurate conclusion is that advertising and R&D expenditures are unlikely to positively affect short term performance, however no conclusions can be made about long term performance implications. Deviation from the nonmarket contingency model was obtained using only observations where political activity is > 0. In order to measure the relationship between deviation and performance, the GLM standard error (the deviation between the estimated GLM standard error and zero, the score for all nonpolitically active firms) was used as the absolute residual for all active pharmaceutical firms with no political activities. As stated earlier, this substitution was necessary to approximate a normal distribution suitable for utilizing GLM estimation techniques. The substitute value = .2478 placing it approximately in the middle of the observation distribution, however this greatly reduced the amount of variation present in the data. No statistically significant relationships were found between deviation from the nonmarket contingency model and firm economic performance. The results are presented in Table 6b. Subsequent analysis of deviation from the nonmarket contingency model and performance using only politically active firms demonstrated statistically significant results, however no relationship appears to exist between exploiting nonmarket opportunities and performance for the entire pharmaceutical firm population.

U.S. Coal Mining Industry Empirical estimation of the hypothesized market contingency model is presented in Table 7a. Less than 25 public coal mining firms existed in the U.S. over the 1986 to 2000. The lack of statistical power likely contributed to only two firm level antecedents having a statistically significant relationship with capital investment in plant, property, and equipment (PPE). Firm revenue change and firm asset value were used to develop the modified contingency model in Table 7a. Both models fit the data well with statistically significant chi square scores. The hypothesized nonmarket contingency model is present in Table 7b. Hypotheses 1 through 13 were all utilized to estimate this GLM, however the lack of sample size required utilizing all coal mining firms as opposed to only politically active coal mining firms to estimate the model. A normal rather than the gamma distribution used in the previous two studies was used to specify the GLM model. Three antecedents demonstrated statistically significant relationships with total political activity. Although total political activity does not include PAC operating costs, it is not surprising that the two concepts are related.

Deviation from the market contingency model was not significantly related to firm economic performance. The results between absolute deviation and ROA and firm survival are presented in Table 8a. Additionally, the estimated GLM appeared to be rather poor fits to the data with chi square values less than 1 and not statistically significant. Statistically significant relationships were found for both a direct and moderated relationship between deviation from the nonmarket contingency model and firm ROA, however no relationship was found with firm survival. The results presented in Table 8b show a positive coefficient for the absolute residual in Model 1. This suggests that deviation from the GLM nonmarket contingency model is positively related to performance, which was not hypothesized. The findings could likely be the result of using multiple 0 political activity observations in specifying the GLM for total political activity. The significant positive interaction effect supports Hypothesis 14b.The positive coefficient on the absolute value X deviation type interaction suggests overinvesting in political activities relative to coal mining competitors is positively related to performance. This provides some insight into why greater deviation from the nonmarket contingency model was positively related to ROA given the sample distribution. The wide spread between politically active and non-active firms created an average level of political activity not representative of either group. Firms that took advantage of nonmarket opportunities and engaged in political activity saw higher ROA then firms that did not engage in political activity. Coupled with the lack of significant results between market fit and performance, the findings presented in Table 8b support the assertion that political activities have a greater affect on economic performance than economic activities in the U.S. Coal Mining context.

Chapter 4 Summary Empirical evidence supporting, non-supporting, and contradicting the hypotheses developed in Chapter 2 were presented in Chapter 4. Fit to market factors was hypothesized to affect firm performance in the high growth market context of Study 1. Results from the first study suggested that deviation from market contingency factors did not affect firm performance contrary to the developed hypotheses. No support was found for nonmarket contingency factors affecting firm performance supporting the assertion that nonmarket activities were not a factor in high growth product markets. Fit to both market and nonmarket factors were hypothesized to affect performance in contexts similar to the U.S. pharmaceutical industry, however empirical evidence does not support these hypotheses. Although deviation from market factors was significantly related to firm performance, the relationship was in the opposite hypothesized direction suggesting that not conforming to market factors was positively related to performance. Subsequent analysis by interacting the absolute residual with the type of strategic misfit suggested that firms under invest in advertising and research and development are more likely to obtain higher ROA in the near term. No significant relationship was found between deviation from the nonmarket contingency model and performance. Empirical evidence from Study 3 supports hypotheses developed regarding strategic fit in stagnate product markets were political opportunities exist. Statistically significant results were found supporting a relationship between deviation from the nonmarket contingency model and economic performance. Although the positive coefficient suggested deviation rather than fit was optimal, the large spread between non-participating and politically active firms suggests at fit model not representative of either strategy. Results from the subsequent moderation analysis

suggested that being politically active was the optimal strategy for obtaining ROA in the cola industry. No significant relationship was found between fit to the market contingency model and performance supporting the assertion that economic activity does not affect economic performance to the extent that nonmarket activities do in a declining market.

CHAPTER 5

DISCUSSION AND CONCLUSIONS

Chapter 5 Introduction Chapter 5 is comprised of three main components. First, results from Chapter 4 are interpreted. Second, the contributions introduced in Chapter 1 are revisited, and the extent these contributions have been achieved are reviewed. Third, the mixed results suggested research design modifications are necessary. Modifications to the current research design are first discussed. Future studies examining the market/non-market fit and performance relationship should incorporate these suggestions. Third, the theoretical development and subsequent empirical exploration in this paper identified several aspects of the market actor-nonmarket relationship not adequately addressed or explained by current knowledge. A series of basic research questions are developed to address these knowledge shortcomings.

Results Discussion Limited empirical support was found for the assertion that nonmarket and market opportunities exist to varying degrees and that fit to those opportunities is related to performance in a given institutional setting. In the first study, no empirical evidence was found that suggested fit to market factors was subsequently related to performance. The lack of empirical evidence suggesting that fit to nonmarket factors was related to subsequent performance provides limited support. Although not specifically hypothesized, nonmarket factors should not affect firm activity and performance in a high growth market. The results of Study 2 provided some unexpected findings. Fit to market factors was related to subsequent economic performance, however deviation rather than fit was related to performance. Moderation analysis suggested that underinvestment in market activities (advertising and research & development) was positively related to subsequent performance. Further analysis on advertising and research & development expenditures separately was performed. Findings from these analyses suggested that underinvestment in advertising was positively related to performance, whereas no statistically significant relationship existed between R&D expenditures and performance. Subsequent background research suggested these findings should have been anticipated. After the FDA lifted direct to consumer advertising restrictions in 1997, pharmaceutical firms engaged in excessive advertising. For example, Pfizer spent more on advertising Lipitor than Pepsi Co. spent on Pepsi. By 2002, pharmaceutical firms largely recognized the empirical findings of Study 2 and reduced advertising expenditures. No empirical evidence was found to support the assertion that fit to nonmarket factors was related to subsequent performance in the U.S. pharmaceutical industry. Empirical evidence found in Study 3 provides the strongest support for the theory developed in this paper. No empirical evidence was found that suggested fit to market factors was related to performance. This supported the assertion that nonmarket as opposed to market activity was related to economic performance in stagnate product markets with nonmarket opportunities. Empirical evidence also suggested fit to nonmarket factors was positively related to economic performance. The positive coefficient suggested deviation rather than fit to nonmarket factors was related to performance. Moderation analysis suggested over investing in nonmarket activities

was positively related to performance. This supported the assertion that under investing in nonmarket activities was detrimental to performance and that over investing was positively related to performance due to the low cost of policy.

Managerial Implications The empirical results provided three main insights for managers. First, several pharmaceutical firms were over investing in advertising in the late 1990s. This over investment was negatively related to performance. Second, managers in stagnate or declining product markets with political opportunities should invest in nonmarket activities rather than market activities. Empirical evidence suggested doing so was positively related to economic performance in the U.S. coal industry. The third managerial implication is that political activities are contextually dependent. Current theory and empirical evidence has suggested political activities are related to performance (Baron, 1995, 1997; Hillman et al., 1999), however when and where have not been adequately explored. North (1990) suggested that institutional settings determined the extent political opportunities existed. The theory developed and limited empirical evidence found in this paper suggested that market and political opportunities exist to varying degrees in different product markets within the same institutional setting. The review summarized in Table 1 and subsequent hypotheses development provides managers with some guidance on what factors are likely to make political activities economically attractive.

Contributions The theoretical development and empirical analysis in this paper were intended to make five primary contributions. One contribution was largely based on empirical evidence, three on theoretical development, and the fifth contribution was providing insight into a neglected area of organizational science. The empirical based contribution will be discussed first followed by research design recommendations for future studies. Theoretical contributions are next discussed along with recommendations for future research directions. The three studies comprise the first longitudinal study that examines nonmarket and market factor effects concurrently on firm actions and subsequent performance. Empirical evidence from these three studies does not completely support the theory developed in Chapter 2. Improvements in research design would likely enhance the probability of testing the actual hypothesized relationships and finding statistically significant results.

Research Design Improvements Sample selection is the first area for research design improvement. Although the U.S. semiconductor, pharmaceutical, and coal mining industries approximated the three conditions of market and nonmarket opportunity, their selection was arbitrary. Future research should quantitatively evaluate industries on both political and market opportunity for sample selection. Ranking industries by political activity (e.g. total political expenditures / total sales) and market opportunity (e.g. annual growth rate X total sales) would provide researchers an indication of what industries most closely approximate the three theorized opportunity sets. The review of political activity antecedents in Chapter 2 presented industry and firm level antecedents. Not surprisingly, industry level variables had almost no statistically significant relationship with firm level factors (foreign market share in Study 2 was the one exception). This

is likely due to a lack of variation with a common score for antecedents to predict variation in the dependent variable. A possible solution to this issue is to conduct two separate studies. The first study would evaluate the effect of the industry level antecedents organized in Table 1 with total industry political activity. The study would be the first since Grier et al.’s (1994) study. Their study the effect of examined traditional antecedents of PAC contributions across industries from 1978 to 1986. Examining a more complete list of political antecedents utilizing post 2000 data could be an impactful update on this line of political economy based industrial organizational economics scholarship. Results from this study would provide scholars with a more accurate method for evaluating the political opportunity level in a given product market/industry. Rather than relying solely on the political activity / total sales indicator discussed above, results from this study would enable scholars to more accurately identify competitive contexts were political activity likely leads to economic performance. The second proposed study would examine the relationship between firm level antecedents compiled in Table 1 and total political activity. The sample would be comprised of industries identified as conducive to political activity in study 1. The longitudinal examination of market and nonmarket activities concurrently is perhaps the greatest empirical contribution made. Two improvements should be made to future similar studies. First, studies should not include observations prior to 1999. The level and diversity of corporate political activity exponentially increased between the 1995-’96 campaign cycle and the 1999-’00 cycle. Additionally, accurate data on lobbying activity became available in 1999 and financed travel in 2000. Lobbying expenditures often outweigh PAC and direct campaign contributions by a multitude of three to four times. Studies post 1999 can take advantage of these more accurate data for political activity. Examining entire timeframes and not just compressed campaign cycle timeframes is the second longitudinal improvement. Aggregating economic data to compare with political data only during campaign cycles greatly diminishes measurement accuracy. Aggregate economic measures also make survival analysis nearly completely inaccurate if a firm failed in between election cycles. This likely greatly contributed to the lack of statistically significant findings in any of the studies. Many economic actors post 2000 engage in political activity that varies little from year to year regardless of campaign cycles. Examining political contribution data since 1987 indicated that firms tend to focus their political contributions on state and federal legislators and political parties, whereas individual citizens tend to make contributions to presidential candidates. Because many Congressional and Senate candidates are elected in midterm elections, political influence is a fulltime activity for firms. Interestingly, the U.S. Federalist system was largely designed to give the Congress a greater role in domestic matters and the Executive a greater role in foreign matters (Bentley, 1935). The difference between firm and individual citizen political activity suggests the more politically savvy firms have a better understanding this institutional setup. Finer grained measures are another improvement that should be made in future research design. Although industry specific firm level measures of strategic action were used in this paper, finer grained measures are likely necessary. This is perhaps best evidenced by the results in Study 2 were deviation from the contingency model was positively related to ROA. Other successful studies have examined strategic change at the product rather than firm level. Zajac et al. (Zajac et al., 2000) utilized mortgage lending decisions. Future studies should thus evaluate the fit of strategic actions to external and internal factors at the product level of analysis. This

would also introduce market competitors perhaps outside the primary industry adding more insight into the nature of market and nonmarket competition. The time lag between strategic action and performance should also be considered. Two studies relied on R&D investments to predict firm performance one year later when those investments may not have an affect on performance for years. Even if R&D expenditures are essential to competing in the semiconductor and pharmaceutical industries, other strategic investments are more likely to affect performance in the near term.

Future Scholarship Extending economic institutional change theory to the market/firm level of analysis to explain how nonmarket and market factors affect firm strategy is the first theoretical contribution made in this paper. The co-evolution of product markets and institutions creates four possible opportunity sets in any given institutional environment. The extent market and/or nonmarket opportunities are present for market actors are theorized to be dependent on the stage of market and institutional co-evolution. The empirical results from the three studies provide limited support for these assertions. Perhaps the strongest support comes from Study 3 were political activity was positively related to firm economic performance and no relationship was found with economic activity and performance. Future scholarship to advance developed theory should perhaps survey the extent the four opportunity sets exist in a given institutional context. The development of more accurate means for evaluating political opportunities previously discussed would greatly enhance this effort. Similar surveys have been utilized in theoretical development. For example, similar surveys were used in estimating the extent of transaction costs in the U.S. economy (Williamson, 1985) and in determining the effects of structural holes on performance in the U.S. economy (Burt, 1992). The co-evolution of product markets and institutions suggests that firms in the low market, low nonmarket opportunity set would exist only temporally. The survey would provide some insight into whether this is the case, however future scholarship should examine the conditions under which firms could survive in this context and whether such firm level success comes at a negative cost to the public good. An aspect not addressed in this paper is the role of deregulation in the co-evolution of product markets and institutions. The causal model developed in this paper made the assumption the product markets become more regulated over time. What happens if they become less regulated? Theory developed in this paper would suggest that incumbent firms would be at a decided disadvantage despite already having market share and market specific resources on hand. This is because firms would likely have developed resources and capabilities for obtaining economic rents through nonmarket activities. As those opportunities decline with deregulation, incumbents must learn to compete strictly in the market place while losing nonmarket based sources of revenues and rents. The second main theoretical contribution is extending institutional change theory to the market-firm level of analysis through operationalizing nonmarket and market opportunities. The first steps in this process were taken by reviewing and synthesizing existing scholarship and empirically examining their affects on market actor behavior and subsequent performance. Although the empirical evidence from studies 1-3 provided limited empirical support for the antecedents of political activity, Table 1 provides a solid foundation for future scholarship exploring this topic.

In contrasting market and nonmarket opportunities in Chapter 2, political activities have the potential for substantial economic benefit at a low economic cost, however most firms choose not to engage in political activities. If the assertion that firms will pursue political opportunities when the potential for returns is greater than economic activities holds true, we should be seeing more political activity. This appears to have somewhat changed since the 1999- ’00 election cycle, however little is known about why firms do not pursue political activities. Social sanction is presented as a unique risk to pursuing nonmarket opportunities, however little is known about when the public sanctions economic actors for engaging in legal political activities. Developing a better understanding of social sanction would enable scholars to perhaps better understand why firms do not engage in political activities. Conceptualizing the informal institutions that regulate acceptable influence behavior in a given institutional setting could provide the basis for understanding to what extent firms can engage in political activity without facing social sanction. The threats and opportunities involved in free riding may be another possible explanation for why firms do not engage in political activities. An important factor not considered in the free riding decision is the role of geographic proximity. Major clusters of similar firms create the opportunity for smaller firms to free ride while enhancing the ability of all firms to engage in successful political activities. Concentrated firm clusters such as semiconductor manufacturers in Silicon Valley or pharmaceutical manufacturers in Northern New Jersey are likely to have political actors extremely dependent on them enabling firms to effectively influence such political actors at much lower costs. This creates a situation were the free riding threat is effectively mitigated. Table 1 provides the basis for understanding what factors influence the decision to engage in political activity, however it does not address why. Although consensus exists amongst scholars that firms engage in political activities when such activities generate economic returns, four potential explanations for why political opportunities will be perceived as attractive/necessary. First, firms may engage in political activities simply to enter into economic exchange with the government. Relationships with government actors developed through political influence activities create enhancing the likelihood of obtaining future government transaction costs in contracting for goods and services. Second, is the resources dependence condition were firms engage in political activity to obtain/maintain essential resources from the government. Third, firms can seek to alter the competitive context through influencing beneficial institutional change (Krueger, 1974; Posner, 1975; Tullock, 1967) or maintain the current competitive context (Baysinger, 1984). Finally, firms may engage in political activities to encourage third party enforcement of contracts in order to reduce exchange uncertainty. All four of these reasons why firms might engage in politics involve differing levels of moral or ethical acceptability. Current attitudes towards firm political activity seem to conceptualize politics as manipulating the institutional environment in order to obtain economic rents at a social welfare loss. Politics are thus reviewed as unmoral or amoral at best (Mintzberg & Waters, 1985), however seeking to negate transaction costs and accommodate new innovations through political activity is beneficial to society (North, 1990, 1994). Future scholarship should examine in more detail why firms engage in politics and whether this positive, negative, or immaterial for an effective institutional environment. Based on the theory developed in this paper, the motivations behind political behavior could be contextually influenced. Political activity in high economic growth contexts may foster more innovation and

exchange, whereas political activity in maturing and declining markets could be purely self serving at a social welfare loss. Operationalizing political opportunities based on the research synthesized in Table 1 has one major shortcoming. Almost all of the research covered in Table 1 is based on the assumption that the rules of economic exchange apply to policy exchange. Despite the overwhelming acceptance of this assumption, it bears revisiting. First, how is policy exchange governed? Direct purchase of policy is banned in most effective institutional environments so contracts cannot be written or enforced. Without contracts, trust enforced by social sanction is the only means of exchange governance (Arrow, 1962; Williamson, 1975). Second, what is the nature of policy exchange? Economic exchange requires a specified product or service at a specified price exchanged at a specified time and place. This is all illegal in any effective institutional environment. Economic actors provide political actors money, votes, and information in exchange for unspecified favors delivered at an unspecified time in the future. The exchange of unspecified obligations governed by trust and enforced by social sanction seems much more like social rather than economic exchange (Blau, 1964). Modeling policy exchange as an economic exchange may be what Cropanzano and Mitchell (2005) described as an economic exchange in a social relationship mismatch. This occurs when economic theory is used to explain behavior in a social relationship. Further scholarship examining policy exchange as social exchange is likely to be of extremely high impact as it challenges the basic premise of the political economy field. The third theoretical development in this paper suggested market and nonmarket opportunities change over time. Mentioned earlier was the motivation behind engaging in political activity and how it affected the social good. In the high nonmarket, low market opportunity context of a declining product market, economic actors are perhaps more likely to engage in a more self-serving manner compared to firms in other stages of product market and institutional co-evolution. Successful political influence attempts could negatively affect social welfare by negating competitive forces and stifle innovation. This raises the question, why does activity detrimental to the social good exist in an effective institutional environment? Effective institutional environments essentially require three components: first, formal institutions that encourage socially beneficial economic activity (the efficient use of resources and innovation); second, effective enforcement of those formal institutions; and third, the mechanisms by which to amend formal institutions in order to foster new types and forms of economic exchange. This last criterion for effective institutions creates the problem. Mechanisms used to amend and modify formal institutions for the social good can also be used to amend institutions for individual benefit. This is what I describe as the paradox of effective economic institutions. Future scholarship should examine the means by which economic actors successfully alter the institutional environment for social welfare loss. Understanding this phenomenon will inform policy makers on how to develop safeguards that enable socially beneficial change while retarding self serving actions.

TABLE 1 Antecedents of Political Activity

Authors Year Outlet1 Sample DA2 IV Measure3, 4 DV Measure3 Results5, 6 C S.E. Political Opportunities Sympathetic Political Actors: Institutional Dependence Pittman 1976 PC Contributors to OLS # of employees in voting Industry campaign 19,722*** 5,183.73 three 1972 region (North-central contributions Senate elections U.S.) Meznar & 1995 AMJ 110 of 405 PLS Resource importance. Political buffering 0.10*** Nigh largest One survey item activities (PAC international measuring importance contributions, companies on of firm goods from 1 lobbying, activist Business Week luxuries to 7 necessities. advertising) Six 1000 survey items, 0 to 7. Political bridging NS activities (e.g. regulatory compliance). Three survey items, 0 to 7. # of congressional 6.336**** 5.783 testimony appearances per year PAC contribution 63824.6*** 7351.32 # of candidate 56.83*** 5.53 contributions Hersch & 2000 PC Contributions TR # of G.M. employees in G.M. PAC .1427*** .04719 McDougall made to 357 district contributions incumbent # of Ford employees in Ford PAC .2272*** .0500 congressional district contributions candidates # of Chrysler employees Chrysler PAC .0761** .0388

54 TABLE 1 Continued Antecedents of Political Activity