Asia Pacific Journal of Management, 21, 171–188, 2004 c 2004 Kluwer Academic Publishers. Manufactured in The Netherlands.


The Institutions of Industrial Restructuring in Southeast Asia MICHAEL CARNEY [email protected] John Molson School of Business, Concordia University, 1455 de Maisonneuve Blvd., West, Montreal, Quebec, Canada H3G 1M8

Abstract. The expected restructuring of Asian corporations in the aftermath of the 1997 financial crisis has not materialized. This paper argues that restructuring in Asia will depend upon two institutional changes. First, the creation of high quality institutions that promotes the growth of new entrants and provides incentives to incumbents to restructure and or exit. Second, that the market scope of dominant incumbents be confronted and limited. The first condition creates pathways for new organizational populations to enter the economy and the second ensures room for their growth. The current debate emphasizes the former but neglects the latter. The absence of either inhibits the rate and direction of restructuring for two reasons. First, incumbents may lack the incentive and ability to exit or transform their structures and, secondly, incumbents can create a ‘blocking coalition’ to diminish competition from new entrants. Keywords: Asia, corporate restructuring, governance reform, institutional environment

1.

Introduction

The paper takes its title from Michael Best’s (1990) homily on the merits of collectivist state-business relations. Relational contracting is now unfashionable but in 1990 Best was sufficiently confident in it to open his book with Konosuke Matsushita’s ‘we will win and you will lose’ speech lauding Japanese industrial cooperation over obsolete Western adversarial relations. Hubristic statements that are profoundly wrong invite a certain schadenfreude and the Asian financial crisis provoked an inevitable backlash (Backman, 1999; Henderson, 1998). Extracting a consensus from the subsequent clamour of recent analysis is difficult because the crisis ignited a policy debate with highly divergent views about the type of legal-institutional environment that post-crisis economies should seek to establish. Behind the policy debate are contrasting academic theories about the process of macro-institutional change. On the one hand are ‘rational actor’ based theories, broadly identified as the new institutional economics (North, 1990, 1998), which characterize the Asian crisis and its consequences as a problem of missing institutions (World Bank, 2002). Central to this approach is a decidedly prescriptive agenda focused upon the design and implementation of high quality governance institutions that reduce transactions costs and promote economic growth by facilitating a broader range of transparent and arm’s-length market transactions (Walker and Fox, 2002). The normative dimension of the institution-building project inheres in the explicit preference and valuation of formal and legal institutional structures over prevalent

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informal and private arrangements that are viewed as a causal factor of the 1997 crisis (Johnson et al., 2000). On the other hand are ‘socialized actor’ (Granovetter, 1985) theories that are deeply skeptical about the efficacy of grafting universal formal-legal institutional systems into business systems characterized by unique cultural norms (Hall, 1990). A comparative capitalism perspective (Boyer and Hollingsworth, 1997; Hall and Soskice, 2001; Whitley, 1999) has formed that suggests ‘there are serious limitations on the extent to which a society may mimic the forms of economic governance and performance in others societies (Hollingsworth, 1997:265). Policy prescriptions in this perspective favor institution building that is more consistent with prevailing social norms. Institutional entrepreneurs (Kondra and Hinings, 1998) and new entrants, such as foreign firms or start-ups, possessing new cognitive models and superior capabilities (Peng, 2003; Khanna and Palepu, 1999) motivate change and slowly displace entrenched incumbents. One difficulty with both approaches is the absence of concern with power, resistance and conflict that often attend on change processes (Lewin, 1951). Macro-institutional change often entails a distributional struggle that mobilizes coalitions of actors to defend their shared interests. Such concerns are heightened in the parts of Asia most affected by the financial crisis because economic power has concentrated in the hands of a small number of politically connected incumbents who are in a position to perpetuate their elite positions and frustrate the entry of new agents into the economy (Bebchuk and Roe, 1999; Haggard, 2001). Moreover, to the extent that dominant actors have developed system specific strategies and capabilities that are not easily adaptable or portable to new geographical and product markets (Hu, 1995), then system bound agents may have few other choices than to seek to preserve the fundamental architecture of their current domains (Fligstein, 2001). In this paper I address post-crisis restructuring from a political actor perspective. This approach recognizes that actors are intendedly rational (Mintzberg and Waters, 1985) but their strategies are constrained by cultural and institutional norms. Specifically, I suggest that relational contracting (Rajan and Zingales, 1998) and its variants has become a dominant mode of action. However, I suggest that continuing structural and technological changes in regional economy will increasingly limit the both the efficacy and legitimacy of relational contracting. Thus the key questions posed in this paper are: To what extent should we expect firms to adopt a more active and innovative stance to structural change in their core markets? If firms do not innovate, what factors account for their passivity and the persistence of existing strategies? I characterize the problem as a classic single game prisoner’s dilemma in which an agent confronts the choice between two irreversible courses of action in the face of an uncertain future state of the world and a payoff that depends upon the decisions of other agents. The equilibrium solution in a single game prisoner’s dilemma is to seek to reduce uncertainty by coordinating action with others rather than attempting an autonomous choice (Axelrod, 1984). The focus is upon corporations but recognizes the web of linkages with the financial and state sectors. I begin with a brief review of the literature on corporate restructuring and change in Asia. In Section 3 I describe the strategic dilemmas confronting firms facing competence destroying environmental change. In Section 4 I identify the means and incentives for persistence and inertia, which I call the blocking coalition. Before concluding I discuss

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a cultural bias against adversarial restructuring processes that might otherwise dislodge entrenched incumbents. The conclusion discusses an alternative development model based upon functional rather than formal-legal institutional convergence. 2.

Corporate restructuring in Asia

Defined broadly corporate restructuring includes: (1) changes in the structure of incumbent organizations (such as ownership change, patterns of corporate governance, an expansion or contraction of firms’ product-market domains, the acquisition of new types of capability), (2) the birth of new organizational populations (venture capital partnerships, widely held firms, start-ups), (3) the diffusion of new business and managerial practice that alters the character of relations between firms and core stakeholders (between the financial sector and owners, between managers and employees, etc.). Some scholars suggest that Asian firms have undergone important changes in recent years. For example, Yeung and Soh (2000) suggest that as Asian firms become more international in scope their banking relationships become more isomorphic with global expectations about standards of corporate governance. However, the prevailing view is more indicative of marginal or piecemeal change and a persistence of fundamental structural elements. For example, in a study of the Korean experience of the Asian financial crisis Kim et al. (2002) observe that some Chaebol have become more narrowly focused in scope and have abandoned certain commitments, such as employment security, but key structural features such as ownership concentration and centralized control of resource allocation processes remain unaltered. Indeed, Whitley (1999) suggests that the only noticeable change in Korea’s business system has been the growing financial autonomy of Chaebol and a commensurate increase in their ability to resist the state’s reform agenda. Khanna and Palepu (2000) find that the benefits of business group affiliation diminish very slowly even in cases where there has been significant liberalization and strengthening of capital markets. Tan and Fock (2002) find that as Chinese family firms expand their domains they maintain their traditional structural features. In a case study of state enterprise reform in China, White (2002) describes how stakeholders continue to dominate managerial decision making in a fashion that worsens performance, despite a much-heralded stock market listing. Ten years after the collapse of Japan’s bubble economy, which produced a huge quantity of bad debt, Bard (2002) documents the banking and corporate sectors’ continued inability to find the means for restructuring that debt. Equally, studies of managerial behavior are suggestive of the persistence of established practice. In a study of Singapore manufacturing firms’ response to the Asian Crisis, Tan and See (2002) found that the majority of firms respond in a defensive and incremental manner and few if any firms adopted an innovative stance. Lee (2002) notes that, in the context of the Singaporean health care system, regardless of a nominal commitment toward improved communications and shared decision making both managers and employers exhibit a preference for a traditional, top down, managerial style. In a study of managerial values in Thailand, Deshpande and Farley (2002) find some evidence of increased belief in individualism and a preference for innovation over bureaucratic methods but they express doubts over the extent to which changing beliefs are reflected in managerial behavior.

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Maheshwari (2002) reports a remarkable tolerance for chronic underperformance in Indian manufacturing. A review of the limited evidence suggests that recent corporate restructuring in Asia is sporadic and glacially slow. Change is often symbolic and partial resulting in shifts in particular organizational characteristics without corresponding changes in other vital parts of the organization (Whitley, 1999). Moreover, with the exception of China, there is no evidence of the birth and emergence of new organizational populations with novel organizational features or capabilities. However, this does not imply an unchanging corporate landscape, on the contrary, restructuring in Asia is often swift and characterized by complex dynamics. The emergence of new organizational populations and far reaching organizational change is typically preceded by political discontinuity. Such shifts are then followed by long periods of continuous, incremental, or co-evolutionary change within that population. The emergence of new organizational populations typically coincides with the relative decline of others. Examples include, the substitution of keiretsu for zaibatsu in Japan (Morikawa, 1992), the decline and exit of the colonial trading house and emergence of overseas Chinese business groups (Carney and Gedajlovic, 2002), the decline of SOEs and corresponding growth of new organizational populations in post-Mao China. The displacement of specialist single-business firms by generalist, multi-business Chaebol in the years following the Korean War is another example (Amsden, 1997). Despite the evidence of punctuated changes in populations of Asian organizations prevalent theories of Asian business tend to emphasize continuity over change. For example it is frequently argued that the Japanese keiretsu are merely a reconstitution of the pre-war zaibatsu (Hamilton and Biggart, 1988). However, this view ignores substantive changes in the development of post war corporate organization in Japan. First, the zaibatsu were family-owned and controlled enterprises that focused upon trading and manufacturing in traditional industries. The emergent keiretsu were managerially controlled firms that entered more dynamic and scale intensive industries. Secondly, the reduction of family influence in the zaibatsu began after 1930 when Japan’s military government, increasingly dissatisfied with zaibatsu concern for short-term profits at the expense of building organizational capabilities, sought to increase the power of salaried managers to expand the production of armaments (Morikawa, 1997). The complete transition to professional management following World War II simply punctuated changes began some 20 years earlier. Although zaibatsu share a nominal identity with the emergent keiretsu the latter possessed very different governance structures and operational capability. As indicated in Table 1 below family-owned firms in Japan now control relatively few corporate assets. Similarly, in post-colonial Asian states the expatriate colonial trading houses that were the region’s dominant form of economic organization confronted a difficult choice. Having become accustomed to being the compatriots of colonial administrators, the trading houses now operated in hostile environments as newly constituted nationalist governments established far-reaching economic reforms. As symbols of the region’s colonial past, expatriate trading houses were especially vulnerable to anti-colonial sentiment. In a very short period of time, the benign operating environments previously enjoyed by expatriate firms transformed into one that was fundamentally hostile to them (Drabble and Drake, 1981).

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THE INSTITUTIONS OF INDUSTRIAL RESTRUCTURING IN SOUTHEAST ASIA Table 1.

The concentration of assets in Asian economies. % of total value of listed corporate assets that families control (1996)

Assets as a % of GDP (1996)

Number of firms

Average number of firms per family

Top 5 families

Top 15 families

Top 15 families

Hong Kong

330

2.36

26.5

34.4

84.2

Indonesia

178

4.09

40.7

61.7

21.5

Malaysia

238

1.97

17.3

28.3

76.2

The Philippines

120

2.68

42.8

55.1

46.7

Singapore

221

1.26

19.5

29.9

48.3

Taiwan

141

1.17

14.5

20.1

17

Thailand

167

1.68

32.2

53.3

39.3

1240

1.04

1.8

2.8

2.1

Country

Japan

Source: Claessens, Djankov and Lang (2000).

Some firms chose the option of remaining and adapting, but many more chose to sell out, repatriate their assets and exit the region (Jones and Wale, 1995). Into the vacuum created by departing colonial firms entered ethnic Chinese entrepreneurs that had worked as partners, and compradors along side the colonial era firms. The value of skills and contacts developed by the immigrant Chinese in the Colonial Era made them vitally important during the subsequent Nationalist Era when indigenous entrepreneurial skills were in short supply (Twang, 1998). The Chinese developed business models that allowed them to take advantage of the tremendous opportunities afforded them by the retreat of colonial businesses and the institution of nationalistic economic policies and to protect their interests in a business environment that was characterized by insecurity and bureaucratic ‘rent-seeking’ (McVey, 1992). That expatriate Chinese firms adopted the closely held, holding company structure was a well-adapted response to the opportunities and threats of that era. Subsequently, the major enterprises that emerged in the post-colonial era continue to dominate their economies today (Yoshihara, 1988). Similarly, the gradual dismantling of Chinese state owned enterprise and the emergence new organizational populations, including business groups (Keister, 1998), foreigndomestic international joint ventures (IJVs), Township and Village Enterprise (TVEs) and other hybrid organizations (Nee, 1992) can be traced to a post cold war re-orientation in Chinese political economy initiated by Deng Xiao Ping. This transformation is far from complete, as a process of state-guided experimentation continues (Child, 2000), but it is evident that the process was engendered by a significant change in the political environment. The lesson to be drawn from these examples is that tectonic shifts in the political substructure play a large part in shaping the conditions necessary for dislodging entrenched business interests and creating anti-incumbent institutions. The environments characterized by Japanese military government, American occupation, Nationalists governments in post Colonial South East Asia, and a reform-oriented Communist Party were not congenial or indifferent to the power of dominant, incumbent enterprises. Such shifts allow for simultaneous and comprehensive institutional change.

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Such examples also indicate the magnitude of the forces needed to stimulate organizational change. However, sweeping political changes initiated by military occupation, decolonization, and reduced Cold War tensions are infrequent events while industrial restructuring is, ideally, a more frequent and continuous process. To better understand the potential for restructuring among incumbents in Asia it is necessary to examine the dynamics of structural change and the dilemmas that it presents to dominant incumbents. 3.

Sustaining competitive advantages in the face of market and technological uncertainty

The Asian financial crisis and subsequent debate about governance has dominated discussions of organizational strategies in Asia but it is important to put the crisis into perspective. It is especially important to note that profound structural changes are occurring in Asian markets. Illustrative of structural changes are growing factor costs of labor and land, the emergence of new competition from China, Eastern Europe, and India, the growing integration of global commodity chains, the maturity of key technologies such as the PC, and the diffusion of disruptive technologies such as the Internet. The confluence of structural change exerts pressure on firms to adapt their strategies by migrating to new technologies, learning new capabilities, and adopting new business models. In short, structural change is a continuing challenge in mature industrial economies that pose a dilemma for incumbent firms. Responding to structural change presents a challenge for firms regardless of national context. The challenge is particularly traumatic for dominant incumbent firms that have developed winning strategies in prior market conditions. Successful incumbents have typically established their positions by bringing their strategies and structures into close alignment with those prior market conditions. The dominant logic (Pralahad and Bettis, 1986) of winning strategies is usually well understood but strategic change is characterized by risk and causal ambiguity. In the face of structural change there is a great deal of uncertainty about what environmental conditions will eventually prevail and what strategies will work in the future. Consequently, firms must frame, categorize, and decide how to respond to environmental threats that may or may not materialize (Dutton, 1986; Dutton and Duncan, 1987). Aggressive responses toward a threat that eventually materialize offer the firm first-mover advantages. Conversely, a passive response to a threat that transpires creates a late-mover penalty that may ultimately lead to a firm’s demise. For example, firms that delay their participation in a new technology may find that it is too late to catch up once a new standard emerges (Cohen and Levinthal, 1990). In contrast, aggressive action on threats that do not materialize can impose costly ‘over-reaction penalties’. For example, genomic science was widely perceived as a threat to pharmaceutical firms’ core knowledge base. However, firms that committed large investments to genetically modified food programs faced significant write downs in those investments in the light of their rejection by consumers and regulators. Finally, a scenario is rarely ever noted or even detected consists of passive responses to threats that do not materialize (Day and Shoemaker, 2000). Firms that respond in

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Business Group Strategic Choice

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1 2 First- mover FirstRestructure advantages movers penalties 4 3 StatusLate mover Passive quo penalties stance reinforced Formal/legal Relational norms marketpersist rules adopted and enforced

Institutional environment that eventually prevails

Figure 1.

The restructuring dilemma.

appropriately passive way to threats that do not eventually materialize are rewarded because they do not incur the costs of failed investments and are spared the costs of disrupting existing and proven strategies. Relative to their more proactive rivals, a firm that is passive in the face of an unmaterialized threat will typically find its competitive position reinforced. The Asian financial crisis, the subsequent actions of governments, and international organizations create uncertainty for incumbents because they threaten to change the institutional environment. In terms of figure 1 the essence of these proposed changes is to shift the institutional environment from one characterized by relational contracting toward one characterized by formal-legal market oriented institutions. Relational contracting refers to highly personalized exchange governed by private, tacit, extra-contractual commitments that values the preservation of a continuing relationship over the immediate quid per quo of any particular transaction (Ring and Van de Ven, 1992). Aspects of relational contracting are evident in phenomena such as guanxi (Park and Luo, 2001), reputation (Khanna and Palepu, 1997), and social capital (Uzzi, 1997). Relational contracting is a dominant practice Asia. Related practices such as the cultivation of networks, guanxi, and social capital may be Asian business groups’ source of competitive advantage. Lasserre and Schutte (1995) suggest that business groups succeed by cultivating close relationships with politicians and bureaucrats and exploiting market imperfections based upon privileged information. Park and Luo (2001) suggest that Chinese firms develop and utilize guanxi as a strategic mechanism to overcome competitive and resource disadvantages by cooperating and reciprocating favors with resource gatekeepers. Business group’s social capital is especially important in protected markets, that is, where states pursue nationalistic development policies aimed at protecting their domestic firms. Social capital helps insiders to navigate red tape and discretionary bureaucratic processes to secure access to foreign trading partners (Guillen, 2000). Additionally, relational contracting can also be viewed as a mechanism that fills institutional voids (Khanna and Palepu, 1997) or serves as a substitute for missing institutions (World Bank, 2002). Deficiencies in formal-legal institutions, or institutional voids, are

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endemic in emerging and developing economies, which cause economic agents to proliferate private, non-transparent, non-contractual devices as an alternative means of safeguarding transactions. In this view, business groups are the organizational embodiment of relational contracting. Business groups create value in underdeveloped institutional settings by imitating the functions of several institutions that are present only in advanced economies (Khanna and Rivkin, 2001). For example, business groups act as a source of capital where capital markets are imperfect. More generally, in the absence formal-legal institutions such as property rights, an independent judiciary, credit rating agencies, standards setting and accrediting agencies, and objective information flows (Khanna and Palepu, 1999) the reputation of a business group operates as a private-enforcement mechanism. As Khanna and Palepu put it: ‘because the misdeeds of one company in a group will damage the prospects of the other, all the group companies have credibility when they promise to honor their agreements with any single partner. They (business groups) provide a haven where property rights are respected’ (1997:17). The shift toward formal-legal market institutions threatens dominant incumbents’ competitive positions because an integral part of their success is the perfection of strategies based on relational contracting and market-oriented institutions will reduce the value of such assets (Rajan and Zingales, 1998). Moreover, market-oriented institutions favor new entrants and increase competition for incumbents (Rajan and Zingales, 2001). Deciding how to respond to the inchoate post-crisis environment is a source of ambiguity for business groups because they do not know how far governments will go in developing and enforcing new institutional arrangements. In these circumstances incumbents face at least two strategic choices. One choice is to modify their business practices and restructure their organizations in ways that that fits an incipient market-oriented institutional environment. This creates first-mover advantages if market oriented institutions are implemented, enforced and adopted by other actors (Cell 1 of figure 1). The second choice is to remain passive and maintain relational practices. Passive firms will be rewarded if the environment does not eventually shift toward market institutions (cell 4). Either choice is risky: if groups remain passive but find that institutional change is far reaching then they risk obsolescence in their distinctive competencies (cell 3). Alternatively, if a group restructures and radically alters their organizational processes then discover that commitment to institutional change is minimal they risk losing out to firms that maintained relational strategies (cell 2). The risks here are particularly severe because reversing back to a relational position once one has renounced and disrupted long standing relationships is not easy because relational ties are developed over the long term and they imply an expectation of fidelity in difficult times, such disruptions may radically reduce trust among former partners (Gulati, 1998). The threat of structural change of the sort precipitated by the Asian financial crisis is a common problem and is not unique to Asia. Change creates dilemmas for incumbents that they would rather not confront. Research on competence-destroying threats suggests that in the face of environmental uncertainty firms will typically choose either to delay commitment, wait and see or under-commit, or more generally, persist with existing business practices rather than make fundamental changes (Haveman, 1993; Tushman and Anderson, 1986). Because so many potential threats do not materialize betting on the status quo is

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often a safer bet than innovation (Day and Shoemaker, 2000). Indeed, firms may seek to hedge their bets by seeking to resist structural and institutional change. 4.

The blocking coalition

Oliver (1991) suggests that there are a variety of strategic responses to institutional processes including acquiescence, compromise, avoidance, defiance and manipulation. Socialized actor theories of Asian business typically focus upon acquiescence, compromise and behavior that conforms to prevailing social norms. For example, Granovetter suggests that business groups are governed by the rules of a moral economy such that ‘No single firm, however powerful, is exempt from duties; top financial institutions and industrial firms are bound by role expectations’ (1994:467). Allen and Gale (2000) note the tendency toward intertemporal smoothing in relational economies: a phenomenon in which powerful economic interests exhibit forbearance in their private interests during difficult economic conditions in expectation of government mediated reciprocity in more prosperous times. Equally, business groups might articulate political strategies characterized by defiance and manipulation. A political perspective suggests that political processes are engendered when interests are threatened and sufficiently concentrated to be coordinated (Olsen, 1971; Riker, 1962). Fligstein (2001) suggests that dominant firms set the rules and agendas for others and that new entrants and challenger firms can better assure their survival by finding ways to fit into the dominant scheme. For example by competing in markets that are peripheral to dominant firm interests. However, structural changes in Asian business groups core markets are such that business groups are seeking to extend their interests into the sectors that new entrants might be expected to stake out. Recent research suggests that incumbent business groups in Asia possess both the means and the incentive to block reforms that threaten their interests. Specifically, business groups and their allies in government and financial sectors may form a blocking coalition that preserves existing institutions in their current relational form. In a period of structural market change the preservation of outmoded institutions may shrink the pie but it may be rational for incumbents to do so if they are able to maintain the size of their own pieces (Bebchuk and Roe, 1999). In this regard, political theory suggests that incumbents may capture and derail institutional innovations (Haggard, 2001) and reverse institutional developments that create competition from new entrants (Rajan and Zingales, 2001). Several scholars have recognized that powerful interest groups can thwart or co-opt reform processes (Perez, 1997; Rosenbluth, 1989; Shleifer and Treisman, 2000). In Southeast Asia McVey (1992) describes a ‘pariahs to paragons’ process through which business group founders inserted themselves into the positions of political influence. While close links between the state and leading entrepreneurs was thought to facilitate the goals of the developmental state, particularly in the allocation of capital to high social return projects (World Bank, 1993), more recently attention has focused upon the costs of close government-business relations (Haggard, 2001). Several writers have noted the concentration of economic power in the hands of a relatively small group of entrepreneurs in Asia (Mackie, 1992; McIntyre, 1994; Yoshihara, 1988). Table 1 gives some indication of this concentration.

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Column 2 of table indicates the total number of publicly listed firms in Claessen et al.’s (2000) sample. Columns three and four show the percent of total assets that are concentrated in the hands of the top 5 and top 15 families respectively. The last column reports the corporate assets held by the largest 15 families in each country as a percentage of 1996 GDP. Claessens et al. (2000:109) suggest that these data indicate ‘a relatively small number of families effectively control most East Asian economies’. Other things being equal the domestic concentration of economic power facilitates close cooperation between business and government especially if the economy is relatively closed to external capital flows (Rajan and Zingales, 2001). Interest group politics favor incumbent firms because they tend to be wealthier and more powerful than new entrants. Incumbent firms can influence the political agenda and may resist regulations and rules that threaten their positions (Bebchuck and Roe, 1999). For example, incumbents are better placed to articulate the risks posed by foreign firms than are outsiders seeking entry. If the rules governing corporate structure provide incumbents with control rights or rents they will be reluctant to relinquish their rights and, maybe willing to invest substantial resources in activities that preserve those rights. That such investments pay dividends is evident in the notion of increasing returns to scale. As described above business groups’ competitive advantages stem in part from an ability to fill institutional voids and in their skill at negotiating ambiguous regulatory environments (Khanna and Palepu, 1997). If the fixed costs of creating and maintaining these assets are high, then larger more diversified groups can produce these assets at lower average costs than smaller groups. The phenomenon of increasing returns reinforces business groups’ power in an economy and it is likely that such scale effects would persist even after the introduction and enforcement of legal-formal market institutions (Davis, Trebilcock and Heys, 2001). Thus, a blocking coalition consists of a few, large, resource rich entrepreneurs who directly own multiple diversified business groups that are linked to influential decision-makers in the state and financial sector. In addition to possessing the power to influence the regulatory process, business groups also have several incentives to resist change. First, as noted above, incumbent business groups have sunk costs and investments in relational assets that are well adapted to existing environments. If the environment were to change radically business groups cannot quickly unlearn their routines and will see the value of their assets reduced. For example, in economies where capital is mainly mediated through banks funds tend to be more readily available to business groups with extensive social capital. Business groups’ superior capital raising ability is an important competitive advantage over new entrants (Khanna and Pelepu, 1997). Alternatively, a key resource of well-placed groups is the capacity to mediate access to domestic resources and foreign multinationals (Guillen, 2000). However, the move toward greater transparency or toward equity-market capital allocation will devalue the worth of relational assets. Secondly, and relatedly, much of the value of relational assets inheres in the individual, personal social capital of a founding entrepreneur and his or her network. Relational contracting creates highly personalized and idiosyncratic credits and debits that are intangible (Redding, 1990). Secondly, the frequent involvement of unincorporated business, often with undefined liability, leaves property rights ill defined and makes precise valuation

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problematic. Personalized social capital and ill-defined property rights are ‘sticky assets’ that are hard to value and trade on open markets (Root, 2001). Moreover, indebted closely held firms are less likely to convert debt into equity to restore financial stability. Debt-equity swaps facilitate restructuring in managerial firms due to equity’s superior liquidity. However, closely held firms in a similar predicament may be unwilling to engage in similar debt– equity swaps because of the potential for diluting control rights. Entrepreneurs that cannot capitalize and cash-out their assets in liquid factor markets are forced to hold onto them. Third, network externalities and complementarities are yet another reason for resisting reform because incumbents’ routines and assets tend to be complementary with other incumbent firms in a local environment. For example, if firms’ trading routines and cognitive biases are based upon relational contracting they will tend to find it more efficient to transact with firms possessing similar cognitive biases. If a firm were to unilaterally adopt a more transparent and arms-length approach in an economy dominated by relational firms it would faces difficulties in finding similar firms to trade with or would face increased costs of transacting with firms characterized by differing routines. The presence of significant transactional externalities and complementarities creates inertia, around established ways of doing business that cannot be shifted unless many firms simultaneously adopt new routines. Fourth, the notion of multiple optima suggests that the efficiency differences between alternative organizational modes may be small. For example, the benefits of market-based financial institutions may reduce the average cost of capital for a closely held firm. Given the risks and difficulties of changing from one system to another would impose significant transitional costs maintaining the status quo and living with higher capital costs may be efficient (Bebchuk and Roe, 1999). Finally, new firms entering the economy may be equipped with new business models and wide ownership that is better adapted to emergent environmental conditions. Such firms should be more competitive than incumbents (Peng, 2003). However, other things being equal, incumbent firms with a controlling shareholder will attach more value than widely dispersed shareholders to the assets of new firms and will bid higher for those assets because adding these assets to their control will increase their private control rights. Dispersed shareholders who receive only the returns to the assets and not private control benefits will put a lower value on those assets. As a result, new entrants into an economy dominated by closely held firms will tend to be acquired by incumbents even though such companies are not the most efficient users of these new assets (Bebchuk and Roe, 1999). Factors such as sunk costs, multiple optima, externalities, and the valuation of control rights provide positive incentives for maintaining existing institutional arrangements. At the same time there appear to be few incentives for incumbents to actively embrace and adopt new institutions. Indeed, their existing assets provide the means to preserve existing institutions. Given these factors, advocates of gradual reform may be underestimating the difficulty of building a soft-market infrastructure of high quality institutions. The emphasis given to improving the quality of institutions is based upon the supposition that these institutions will establish alternative pathways for newcomers to enter the economy. Peng (2003), for example, suggests that new entrants will be typically inclined to take up these new pathways and, as these alternatives become increasingly legitimate, incumbents will also follow them

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because returns to relational strategies will be reduced. However, if incumbents possess both the incentive and the power to frustrate initial changes then the virtuous circles of institutional upgrading may never begin. Stronger action may be called for. 5.

Adversarial restructuring processes

Sweeping political change can foster anti-incumbent institutions but such change is rare and the need for industrial restructuring is continuing (Rajan and Zingales, 2001). Relational contracting as advocated by Best (1990) facilitates incremental adjustment and growth among insiders and incumbents but provides little room to admit new entrants. Indeed relational contracting frustrates new entrants. For example, relational contracting in both Japan and in Korea limited market penetration by foreign rivals into their domestic markets. Nevertheless, there are several mechanisms for bringing about corporate restructuring of the type identified above. These mechanisms are anti-trust, power politics and markets. Such mechanisms are not well institutionalized in Asia but are prominent features of, so-called, Anglo-Saxon economies. 5.1.

Anti-trust institutions

Regulators in the US have shown a long-standing concern with the threat of monopoly, rent extraction and other abuses of market position stemming from the concentration of corporate power. The concern is manifested in vigorous anti-trust legislation and its enforcement, which over the years has seen the dismantling of giant monopolies such as AT&T and Standard Oil. The US Justice department has not hesitated to prosecute cases against national champions such as IBM in the 1960s and Microsoft in the late 1990s when it was perceived that their respective de facto monopolies might inhibit technical progress and the diffusion of superior technologies (Fisher, McGowan and Greenwood, 1983). Although not universally effective at limiting monopoly power anti-trust institutions are important as arbiters of competing economic logics. For example, over the years the US department of Justice had been unfriendly to vertical integration and mergers until arguments about their production efficiencies had been demonstrated. Anti-trust justices were typically inhospitable toward many non-standard forms of contract, such as franchising and territorial restrictions, until arguments based upon transaction cost reasoning became more widely accepted (Williamson, 1985). As such Anti-trust law and policy, under the glare of vested interest, rational debate, and legal argument, serves to monitor and govern the diffusion of certain business strategies and trading practice. 5.2.

Power politics

Periodically political parties and politicians are elected with radical reform agendas. In a departure from the politics of consensus and mutual adjustment such politicians are prepared to confront and challenge entrenched interests in a serious game of winner-takes-all. Illustrative of such power struggles are Reagan’s confrontation of the air traffic controllers and Thatcher’s clash with the British coal miners in the 1980s. These highly publicized and emotionally charged events mask more fundamental and comprehensive policies of

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restructuring that produce the wholesale destruction of organizational populations, industries, and even regions. For example, successive Reagan administrations’ presided over the de-industrialization of much of the US Northeast (Bluestone and Harrison, 1982). Similarly, Thatcher promoted the hollowing-out of the British Midlands through policies of privatization and dismantling of state owned industries. Both politicians shared the view that the decline of ‘rustbelt’ and ‘sunset’ industries was a necessary precondition for the emergence of a ‘sunrise’ new economy and were willing to confront a coalition of employer and labor interests that favored the preservation of mature industries (Krieger, 1990). 5.3.

Market forces

The market for corporate control is frequently a hostile process in which poorly performing public firms are acquired, often with the use of high yield debt, and taken private. Incumbent managers will fiercely contest such acquisitions contest because successful takeover will not be in their interests. This market has produced a population of organizations that facilitate specialize in leveraged buyouts (LBO) and management buyouts (MBO) (Thompson and Wright, 1995). Organizations specializing in LBO and MBO transactions are frequently portrayed as avaricious ‘assets strippers’ as these transactions bring redundancies, contractual renegotiation, asset liquidation, and further spin-offs that leave some stakeholders worse off. Adversarial legal, political and market processes constitute the institutions of creative destruction and are responsible job losses, reduced profits and damaging whole communities that depend upon mature industries. Such institutions are rarely popular. As Stinchcombe (1997) suggests, ‘the institutions of creative destruction enjoy a precarious legitimacy’ because they vividly destroy current, tangible, present value for the promise of an intangible future value. The institutional processes of creative destruction will be bitterly opposed by agents who are heavily invested in the threatened population. Consequently, ‘institutions that allow . . . livelihoods and capital to be destroyed by competition are rare’ (Stinchcombe, 1997:15). By any standards anti-trust, power politics, and the market for corporate control are adversarial processes characterized by conflict, invective, winners and losers, material loss as well as loss of face as such they are rarely heralded. Moreover, adversarial processes are even less welcomed in societies that attach great value to harmony, reciprocity and the preservation of face. Given cultural dispositions for harmony it is perhaps no surprise that Asia should exhibit a preference for cooperative over adversarial institutions of restructuring. However, the absence of non-cooperative restructuring processes further entrenches incumbents’ positions since the tools that might dig them out are blunted. 6.

Conclusion

Closely held business groups have emerged as the dominant organizational form in Asia. Their domination of the economy has important consequences because their characteristic ownership structure governs the range of capabilities a firm can acquire. The advantages and disadvantages inherent in closely held governance tend to induce certain capabilities while discouraging others (Carney and Gedajlovic, 2002). The disadvantages of closely

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held governance are well known and brought into sharp focus since the crisis (Johnson et al., 2000). However, business groups’ advantages with relational contracting and institutional void filling make them very strong at impeding institutional change. At the same time business groups have few incentives to transform or to exit so they remain and stifle the emergence of new entrants that might be better equipped to manage the structural shifts that are occurring in the marketplace. The economic problem for nations whose productive capacity is dominated by closely held firms is not that its firms lack valuable capabilities. That they do is suggested by the advantages enumerated above. The economic problem stems from a structural reliance upon a single dominant form of enterprise that possess similar capabilities, enjoys the same strengths and advantages but which is subject to the same threat. Organizational monocultures are structurally unstable because a crisis that infects one particular form of enterprise can have devastating consequences for the economy as a whole. Business and market strategies that were effective in the factor cost and investment driven stage are decreasingly effective in the more advanced innovation and information driven stage of development (Carney and Gedajlovic, 2000). In more technologically advanced economies the sheer volume and complexity of transactions will overwhelm the relational strategies that were perfected in a prior developmental stage (Peng, 2003). Consequently, restructuring must create pathways for firms with different governance characteristics to enter the economy or pathways for incumbents to either transform their governance systems, or, failing this to cash out and exit the economy. However, the analysis described above suggests that it is difficult for business groups to exit by selling their assets because their distinctive competences are highly personalized and not easily traded. More importantly, incumbents are likely to adopt passive or blocking strategies and are unlikely to adopt innovative strategies. The virtues of collective action and cooperation state-business relationships championed by Best (1990) and many others were clearly evident in the Asian development model. Relational institutions helped successive Asian states to start, (or restart), grow and catch up with industrialized economies in the west. However, the system of state led industrialization and the relational institutions under girding it were once a coherent and complementary system of formal and informal norms and practices. From the regulationist perspective, such coherence can give way to incoherence and conflict due to some combination of hyper-development in some parts of the system and retardation in other parts (Boyer and Yamada, 2000). Unless such states find the means to re-align institutions they may face slow decline due to an inability to effectively respond to incumbents vested interest, accumulated privilege, and system inertia (Olson, 1982). Building a soft market infrastructure and upgrading the quality of institutions is a part of the re-alignment that is well understood. Moreover, it is recognized that Asian economies need not slavishly emulate AngloSaxon models. Convergence on formal institutions, meaning the adoption of common rules and practices, may be impossible if it is politically blocked or is incompatible with cultural norms. In that case functional convergence (Coffee, 2000; Gilson, 2000) offers an alternative mode of institutional development. Functional convergence means that societies and firms find alternative mechanisms to accomplish the same end. Functional convergence is arrived

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at through processes of voluntary migration and substitution. For example, a new entrant whose home country has underdeveloped equity markets may seek a listing on a foreign market by agreeing to commit to the standards of those markets (Coffee, 2000), which is a growing practice in countries such as Chile and Korea (Khanna and Palepu, 2000). Similarly Gilson (2000) suggests that in the absence of hostile markets for corporate control German and Japanese firms have developed alternative mechanisms for replacing incompetent and under-performing managers. That such mechanisms are functionally equivalent is suggested by evidence that despite differences in corporate governance the tenure of senior management in the US, Germany and Japan is equally sensitive to poor financial performance (Kaplan, 1994) However, there are limits to the functional convergence argument. When applied in the context of Asia, scholars often adduce business groups as evidence of functional convergence (Bergloff and von Thadden, 1999). However, the argument advanced in this paper is suggestive of incumbent inertia in the face of continuing technological and market change and the absence of adversarial mechanisms to dislodge entrenched interests. If there is no appetite for confronting the blocking coalition through adversarial processes then other cooperative solutions must be sought that turn restructuring in to a positive sum game. Such solutions will frequently involve buying-out or compensating losers and simultaneously ensuring that those compensated exit the system. Bard’s (2002) analysis of Japan’s equity/debt repurchase system is indicative of such mechanisms. Such solutions are resource intensive and demand an expenditure of a social surplus. If a society and its firms are too far down the Olsonian decline curve there may be little surplus left to compensate those who lose out in the process of restructuring. References F. Allen and D. Gale, Comparing Financial Systems, The MIT Press: Cambridge, MA, 2000. A.H. Amsden, “South Korea: Enterprising groups and entrepreneurial government,” in A.D. Chandler, F. Amatori, and T. Hikino (eds.), Big Business and the Wealth of Nations, Cambridge University Press: Cambridge, 1997. R.M. Axelrod, The Evolution of Cooperation, Basic Books: New York, 1984. A. Bard, “Japan’s bank emergency purchasing corporation: An effective and equitable mechanism?” Paper Presented at Asia Pacific Journal of Management Conference on Crisis and Turnaround in Asia, Bangkok, Thailand, 2002. M. Backman, Asian Eclipse: Exposing the Dark side of Business in Asia, Wiley: Singapore, 1999. M. Best, The New Industrial Competition: Institutions of Industrial Restructuring, Harvard University Press: Cambridge, MA, 1990. L.A. Bebchuk and M.J. Roe, “A theory of path dependence in corporate governance and ownership,” Columbia Law School Center for Law and Economics, New York: 1999. E. Berglof and E.L. von Thadden, “The changing corporate governance paradigm: Implications for transition and developing Countries,” Center for Advanced Study in the Behavioural Sciences, Stanford, 1999. B. Bluestone and B. Harrison, The Deindustrialization of America: Plant Closings, Community Abandonment, and the Dismantling of Basic Industry, Basic Books: New York, 1982. R. Boyer and J.R. Hollingsworth, “From national embeddeness to spatial and institutional nestedness,” in R. Boyer and J.R. Hollingsworth (eds.), Contemporary Capitalism: The Embeddeness of Institutions, Cambridge University Press: Cambridge, 1987. R. Boyer and T. Yamada (eds.), Japanese Capitalism in Crisis A Regulationist Interpretation, Routledge: London, 2000. M. Carney and E. Gedajlovic, “East Asian financial systems and the transition from investment-driven to innovation driven economic development,” International Journal of Innovation Management, vol. 43, pp. 253–276, 2000.

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