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Journal of Management

DOI: 10.1177/014920630202800507 2002; 28; 695 Journal of Management

David D. Dawley, James J. Hoffman and Bruce T. Lamont Choice Situation, Refocusing, and Post-Bankruptcy Performance

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Journal of Management 2002 28(5) 695–717

Choice Situation, Refocusing, and Post-BankruptcyPerformance

David D. Dawley∗College of Business & Economics, West Virginia University, P.O. Box 6025, Morgantown, WV 26506, USA

James J. HoffmanArea of Management, Texas Tech University, Lubbock, TX 79409, USA

Bruce T. LamontCollege of Business Administration, Department of Management, Florida State University,

Tallahassee, FL, USA

Received 4 May 2000; received in revised form 31 August 2001; accepted 13 November 2001

The current study sheds additional light on how and when firms improve their performanceafter having filed for Chapter 11 reorganization protection. Based on the work of Hrebiniakand Joyce [Administrative Science Quarterly 30 (1985) 336] and Marlin, Lamont and Hoff-man [Strategic Management Journal 15 (1994) 229], a framework is developed that identi-fies which distressed firms have the best chances of surviving bankruptcy and the extent towhich refocusing, a popularly prescribed remedy for these ailing firms, will aid their plight.The results demonstrate the utility of viewing bankruptcy reorganizations as different choicesituations, where firms have varying levels of strategic choice, determined largely by theirstockpiles of redeployable resources, and face different degrees of environmental constraint.Only firms with relatively high strategic choice or low environmental constraint were foundto benefit from refocusing actions. That is, the performance effects of at least one popularremedy, refocusing-type business portfolio initiatives, appear contingent on the choice situationconfronting firms under Chapter 11 protection.© 2002 Elsevier Science Inc. All rights reserved.

Over the last 20 years, there has been a dramatic increase in corporate bankruptcy fil-ings. The increase is not due to an unhealthy economy, but rather due to the BankruptcyReform Act of 1978 (“the Act”) which was enacted to help rehabilitate rather than liquidateorganizations (or debtors’ estates) (Bradley & Rosenzweig, 1992). Of particular interest to

∗ Corresponding author. Tel.:+1-304-293-7923; fax:+1-304-293-5652.E-mail addresses: dddawley@mail.wvu.edu (D.D. Dawley), james.hoffman@ba.ttu.edu (J.J. Hoffman),

blamont@garnet.acns.fsu.edu (B.T. Lamont).

0149-2063/02/$ – see front matter © 2002 Elsevier Science Inc. All rights reserved.PII: S0149-2063(02)00162-9

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organizations is the Chapter 11 reorganization plan (11 U.S.C. § SEC 1306(b) of the FederalBankruptcy Code). Since this modified reorganization plan began in 1978, the annual num-ber of publicly traded companies filing Chapter 11 has doubled (New Generation Research,1998). The purpose of Chapter 11 reorganization is to provide firms with an alternative toliquidation in order to help protect the long-term interests of a broad range of stakeholders,creditors included. However, if a firm exits Chapter 11 without achieving financial recovery,it is questionable that this goal has been achieved.

Research suggests that the enactment of Chapter 11 reorganization has done more harmthan good to stakeholders of Chapter 11-filing firms. For example,Bradley and Rosenzweig(1992)found that while stockholders of Chapter 11-filing firms lost half of their investmentbefore the Act, stockholders lost nearly all of their investment after the Act. This may be dueto the rising direct costs of bankruptcy reorganizations (e.g., attorney’s fees, loss from dis-rupted operations), which frequently approach 20% of the firm’s total liabilities (Moulton &Thomas, 1993). Or, it may be due to the indirect and nonfinancial costs of bankruptcy reorga-nizations. Indirect costs, such as higher interest rates for lines of credit, reduced bargainingpower with suppliers, and difficulty in entering into long-term commitments (e.g., jointventures, strategic alliances), may exceed the direct costs (Moulton & Thomas, 1993). Andthe nonfinancial costs are equally significant, including the stigma of being associated witha bankrupt firm (Sutton & Callahan, 1987), managerial displacement (Gilson, 1989), andthe general loss of employment (Lynn & Neyland, 1992). Particularly troublesome may bethe ill effects that accrue to the displaced worker (Victor & Stephens, 1994).

Given the track record of firms filing for Chapter 11 reorganization, it is critical forstrategy and management scholars to help stakeholders of distressed firms understand thefactors that make financial recovery more likely to occur. Ideally, it would seem helpfulto identify the types of strategic changes that should be incorporated into reorganizationplans depending on the challenges facing particular firms. It would also seem useful toidentify situations where popularly prescribed reorganization plans are unlikely to helpfirms’ recovery efforts. In these situations, more novel remedies may be needed. Or, it maybe in the interest of creditors and other stakeholders to push for the sale of the firm insteadof accepting the likelihood of continued sub-par performance and the associated financialand nonfinancial costs.

Most of the previous research on bankruptcy reorganizations has sought to identify howand why firms get into such predicaments (cf.,Altman, Haldeman & Narayan, 1977; Bradley& Rosenzweig, 1992; Daily & Dalton, 1994a, 1994b; Gilson, 1990; Hambrick & D’Aveni,1992). The intent of the work has been to identify the antecedents to financial problems sothat they can be prevented. However, minimal research has examined the fate of firms oncebankruptcy has been declared (seeHotchkiss, 1995; Moulton & Thomas, 1993for notableexceptions). Additionally, no study has explicitly examined the utility of different strategicinitiatives in boosting firms’ odds of post-bankruptcy performance improvements.

Prior research on corporate turnarounds, however, offers plausible clues about the strategicinitiatives likely to improve post-bankruptcy performance. Whereas corporate turn-arounds are a more general and multi-faceted phenomenon than bankruptcy reorganizations,bankruptcy may be the ultimate turnaround challenge. Prior work on turnarounds ratherconsistently suggests the utility of retrenchment or refocusing in bolstering turnaround suc-cess in a variety of settings (Barker & Duhaime, 1997; Bibeault, 1982; Hall, 1980; Hambrick

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& Schecter, 1983; Pearce & Robbins, 1993). The extent to which and how refocusing, orthe reduction in the scope of a firm’s business activities, helps the turnaround of bankruptfirms is both empirically unexplored and theoretically unspecified, however.

The theoretical framework ofHrebiniak and Joyce (1985)holds promise in usefullydelineating situations where refocusing strategies of bankrupt firms may prove beneficial.The framework highlights the interplay between firm power and capabilities and envi-ronmental constraints in determining both the likelihood and merits of different strategicinitiatives. These issues of intentional restructuring of firm assets and capabilities in the faceof environmental selection pressures lie at the heart of the problem confronting managers ofbankrupt firms (Barker & Duhaime, 1997; Bibeault, 1982; Pearce & Robbins, 1993). Theapproach taken here, building on the Hrebiniak and Joyce framework, is consistent withother recent work that has identified the relative success of various strategic initiatives inan ecologically competitive and delimiting context (e.g.,Barnett, 1997; Baum, Li & Usher,2000; Baum & Singh, 1994; Lubatkin, Schulze, Mainkar & Cotterill, 2001).

The purpose of this study is to identify situations more and less conducive to bankruptcyreorganization success, in general, and through corporate refocusing, or the reduction inscope of a firm’s business activities, in particular. Toward these goals, we draw onHrebiniakand Joyce’s (1985)andMarlin, Lamont and Hoffman’s (1994)work on choice situations(marked by varying levels of strategic choice and environmental constraint) to explainwhen bankruptcy reorganizations are most likely to be associated with post-reorganizationperformance gains, in general. We also explain when and how the performance effects ofrefocusing initiatives among bankrupt firms are contingent on choice situation. In so doing,we integrate both the bankruptcy and turnaround literatures and extend them theoretically byspecifying boundary conditions under which bankruptcy turnarounds relying on refocusingare performance enhancing. We also empirically test these assertions. The importance ofthis study rests on the increasing frequency and costs of Chapter 11 reorganizations and ourrather limited understanding of what managers and other stakeholders of these firms shoulddo once they find themselves in such predicaments.

This paper is organized as follows. First,Hrebiniak and Joyce’s (1985)theoreticalframework is reviewed. Next, paralleling the tack ofMarlin et al. (1994)in applying theframework to more general competitive contexts, the theory is extended to post-bankruptcyperformance, where performance differences between choice situations, and performancedifferences between strategies within choice situations for bankrupt firms are hypothesized.Methods used in the study and results from the study are then reported. The paper concludeswith a discussion of the implications of the study’s findings for theory, practice, and futureresearch.

Theory and Hypotheses

Where early research in strategy and organizational ecology accentuated the differencesbetween the two theoretical perspectives (cf.,Aldrich, 1979; Astley & Van de Ven, 1983;Child, 1972; Hannan & Freeman, 1977), following the lead ofHrebiniak and Joyce (1985),more recent work has typically explored the intersections of the two literatures and theircomplementarities (Baum, 1996; Lubatkin et al., 2001; McKelvey & Baum, 1999). For

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example, early work in strategy and organizational ecology was characterized by divergentassumptions of effective adaptation, reflected in different research questions guiding theirrespective empirical efforts. Strategy scholars viewed organizational change as a manageri-ally determined process enacted in a manageable external environment (Child, 1972). Earlywork (e.g.,Miles & Snow, 1978; Schendel & Hofer, 1979), therefore, focused on iden-tifying strategy’s role in explaining adaptation to environmental change (Lubatkin et al.,2001). In contrast, early ecology theorists viewed organizational change as an environmen-tally determined process where top management had few strategic options and little or noeffect on a firm’s success or survival (Aldrich, 1979; Hannan & Freeman, 1977). From thisposition, early ecological research examined the effects of variables beyond the control ofmanagers (like density dependence, resource niche width, and time of founding) on thesurvival prospects of organizations (Baum, 1996). In their landmark synthesis of these twoapparently conflicting views,Hrebiniak and Joyce (1985)posited an orthogonal relation-ship between managerial choice and environmental constraint, where the early strategy andecological archetypical views captured only two of four possible choice situations. Situa-tions were also described in which management and environment were both weak or power-ful, highlighting the importance of considering the interactions between firm attributes andinitiatives and ecological constraints. Further reconciling the previously conflicting viewsof organizational change, Hrebiniak and Joyce posited that choice situation influences thenumber and form of available and effective strategic options.

More recent strategy-organizational ecology literature corroborates Hrebiniak and Joyce’stenet that strategic choice and ecological processes together determine the fate of orga-nizations (Barnett, 1997; Barnett & Burgelman, 1996; Barnett & Hansen, 1996; Baum,Li & Usher, 2000; Baum & Singh, 1994; Burgelman, 1991, 1994, 1996; Chang, 1996;Lewin & Volberda, 1999; Lubatkin et al., 2001; Marlin et al., 1994). What differentiatesthis growing body of literature from earlier work is its focus on managerially control-lable organization-level attributes as determinants of relative organizational success withina population of ecologically competitive firms. For example, some of the factors linkedto competitive viability include organizational learning (Barnett & Hansen, 1996; Barnett,Mischke & Ocasio, 2000), knowledge acquisition and restructuring (Chang, 1996), cor-porate entrepreneurship (Burgelman, 1996), and strategy (Baum & Singh, 1994; Marlinet al., 1994). This collective research suggests that the interplay between strategic choiceand environmental context determines firm performance. We build on this work below byusingHrebiniak and Joyce’s (1985)framework as a theoretical foundation for examiningpost-bankruptcy performance and extending current thought regarding the effect of contextand choice on post-bankruptcy performance.

Hrebiniak and Joyce’s theoretical framework rests on several premises about organization–environment relationships. First, the relationship is characterized by interdependence. Tosome extent, both organization and environment are dependent on, and have power over,each other. Second, the interdependence between organization and environment is not azero–sum relationship. Increased power of one party in the relationship does not neces-sarily reduce the power of the other. Relationships are possible where neither organizationnor environment have much influence over each other, where one dominates the other, andwhere both are powerful. Third, the relationship is one of dynamic interaction. Actions takenby either party in the relationship affect the other, possibly altering the balance of power in

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the relationship. For example, organizations may exercise their influence or adopt strategiesthat increase their power over external elements—customers, suppliers, and competitors.Or, external elements may exert their influence in similar attempts to increase their powerover an organization.

From these premises, Hrebiniak and Joyce developed a typology of organization–environment relationships, or choice situations. The level of strategic choice refers to thepower of the organization over its environment, whereas the level of environmental con-straint reflects the power of the environment over the organization. By dichotomizing thelevels of strategic choice and environmental constraint, four choice situations are identified:minimum choice, differentiated choice, maximum choice, and incremental choice.

Between-Situation Post-Bankruptcy Performance Differences

Hrebiniak and Joyce’s work implies that post-bankruptcy performance should be con-tingent upon the choice situation of the bankrupt firm. In general, one should expect theperformance effects of strategic choice to be positive and the performance effects of envi-ronmental constraints to be negative (Lawless & Finch, 1989), suggesting an ordinal rela-tionship between choice situation and performance (Marlin et al., 1994). That is, firms inmaximum choice situations should outperform those firms in differentiated and incrementalchoice situations, which should outperform those firms in minimum choice situations. Thesepredictions, depicted inFigure 1, rest on considerable theoretical and empirical researchin both strategy and organizational ecology, which we use to make similar predictions forbankrupt firms. Our rationale is very briefly amplified below.

Few would disagree with the position that the performance effects of greater strategicchoice should generally be positive. This tenet lies at the heart of much strategy and recent

Figure 1. Choice situations and performance.

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organizational ecology theory. Strategy researchers (cf.,Chen & Hambrick, 1995; Chen &MacMillan, 1992; Lubatkin & Chatterjee, 1994; Porter, 1980) frequently draw on a sub-stantial literature in economics (e.g.,Bain, 1956; Baumol, Panzar & Willig, 1982; Mason,1959; Stigler, 1964) to document that business firms with power over their environment willexploit their position and resource advantages to achieve financial gains. For example, largerrivals with dominant market positions typically shape industry competition by initiating thecompetitive moves to which smaller rivals must respond (Chen & Hambrick, 1995; Grimm &Smith, 1997).

Additionally, in an attempt to explain why some firms are more susceptible to selectionpressures than others, work in organizational ecology also identifies sources and benefitsof strategic choice for certain firms, typically large, powerful ones. For example, largersize confers legitimacy (Baum, 1996; Hannan & Freeman, 1977, 1984), mass dependence(Barnett & Amburgey, 1990), and niche overlap (Baum & Singh, 1994) advantages to firmsthat help them to better function and survive. Larger firms also typically have more slackthan smaller firms (Hannan & Freeman, 1984), which can protect the organization againstselection pressures and function as a “transformational shield” when major organizationalchange may be required that would reset a firm’s liability of newness clock (Baum, 1996),as is typical for bankrupt firms attempting to reorganize from Chapter 11 protection. Inshort, selection pressures are mitigated by size and its frequent correlate, slack.

The negative performance effect of environmental constraints is also a central tenet ofboth strategy and organizational ecology theory. The importance attached to industry po-sitioning among strategy scholars (e.g.,Porter, 1980) is illustrative of this point and sup-ported by considerable evidence documenting the role of industry membership (Chang &Singh, 2000; McGahan & Porter, 1997; Schmalensee, 1985) and positioning within in-dustries (Chang & Singh, 2000; Ketchen et al., 1997; Khanna & Rivkin, 2001; Mehra,1996) as determinants of firm performance. Additionally, for organizational ecologists, theperformance and survival constraints imposed by the environment is a given. Environmen-tal carrying capacity, competition density within resource niches, and the survival shocksof environmental discontinuities are all hallmarks of organizational ecology, with a richempirical base of support (seeBaum, 1996, for a review).

Although the performance effects of strategic choice and environmental constraint areviewed as broadly applicable by Hrebiniak and Joyce and other strategy and organizationalecology scholars, they may be particularly telling performance determinants in the case ofbankrupt firms. For example, organizational slack has been argued to be one of the mostcritical resources for implementing strategic change in turnaround situations (Barker &Duhaime, 1997; Grinyer, Mayes & McKierman, 1988), such as Chapter 11 protection.Similarly reflecting strategic choice, larger firms are better able than their smaller counter-parts to endure sustained periods of pitiful performance due to the relatively greater numberof external constituents dependent on the larger firm (Meyer & Zucker, 1989). This timeshould prove extremely valuable to firms in bankruptcy reorganization. This may be whyorganizational size has been found positively associated with bankruptcy reorganization suc-cess (Moulton & Thomas, 1993). Furthermore, since external jolts and impingements onperformance are common causes of firms filing for Chapter 11 protection in the first place(Barker & Duhaime, 1997; Bibeault, 1982; New Generation Research, 1998; Pearce &Robbins, 1993), those bankrupt firms facing extremely resource scarce and hostile contexts

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will undoubtedly face more daunting reorganization challenges than those bankrupt firmsin more hospitable contexts. In fact, without at least some adequate level of strategic choiceor environmental munificence, a bankrupt firm would have little basis for a successfulreorganization plan.

Thus, in line with Hrebiniak and Joyce’s theory,Marlin et al.’s (1994)assertions, theexisting evidence about bankruptcy survival (e.g.,Hotchkiss, 1995; Moulton & Thomas,1993), and the preponderance of current thought in strategy and organizational ecology, wespecify the following for empirical confirmation.

Hypothesis 1: Bankrupt firms in maximum choice situations will have higher post-bankruptcy performance than those in differentiated choice situations.

Hypothesis 2: Bankrupt firms in maximum choice situations will have higher post-bankruptcy performance than those firms in incremental choice situations.

Hypothesis 3: Bankrupt firms in maximum choice situations will have higher post-bankruptcy performance than those firms in minimum choice situations.

Hypothesis 4: Bankrupt firms in differentiated choice situations will have higher post-bankruptcy performance than those firms in minimum choice situations.

Hypothesis 5: Bankrupt firms in incremental choice situations will have higher post-bankruptcy performance than those firms in minimum choice situations.

Refocusing and Within-Situation Post-Bankruptcy Performance Differences

Given Hrebiniak and Joyce’s emphasis on the dynamic, interactive nature of organization–environment relationships and empirical findings fromMarlin et al. (1994), it is equally con-sistent with their framework to expect refocusing-related performance differences withinchoice situations. Refocusing is the process of contraction through reducing levels ofdiversification and/or segment divestitures (Hoskisson & Hitt, 1994; Markides, 1992). Thiscorporate strategy is an important one for bankrupt firms as it can improve their strategicchoice by increasing their cash flow and slack resources (Bibeault, 1982; Hall, 1980; Pearce& Robbins, 1993) and strengthening a firm’s stance relative to its competitors (Hoskisson &Hitt, 1994; Lubatkin & Chatterjee, 1994). Refocusing can also reduce the degree of environ-mental constraints confronting the bankrupt firm by redefining its environmental context(Chang & Singh, 2000; Ginsberg & Baum, 1994; McKelvey & Baum, 1999; Pfeffer &Salancik, 1978), particularly when it involves the redeployment of firm assets around amore hospitable and tractable core business.

The expectation that there may be refocusing-related performance differences withinchoice situations follows from: (1) the fact that levels of strategic choice and environmentaldeterminism are probably more accurately viewed as continuous rather than discrete vari-ables; (2) the promise that refocusing can boost a firm’s slack resources and alter the natureof the external constraints confronting the firm; and (3) the likelihood that strategic choice,determinism, and corporate strategy do not always change at the same rate, magnitude, or

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time. Within any particular choice situation there will be some range of strategic choice anddeterminism, the values of which at the limit, or boundary, approach those of another choicesituation. As organizations acquire (lose) strategic choice and resources that can be used forsustained competitive advantage or environmental elements gain (lose) efficacy, organiza-tional “positions” within, and possibly between, choice situations will change. Thus, their“positions” within, and movement between, choice situations is importantly a function oftheir corporate or refocusing strategy.

Refocusing should be especially beneficial for firms in differentiated and incrementalchoice situations. For example, in differentiated choice situations, where firms have strate-gic choice and face strong external constraints, it would seem useful to refocus a diversifiedfirm around a new or traditional core business with greater promise and less constraints.Such efforts would move the firm closer to a maximum choice situation. Refocusing wouldalso generate additional slack from nonessential activities, thereby further increasing thestrategic latitude of firms in differentiated choice situations. Such latitude would permit theredeployment of assets to improve competitive prospects in the newly defined core busi-nesses (Bibeault, 1982; Pearce & Robbins, 1993). It is important to note that nondiversifiedfirms cannot refocus, thus their options may be limited to divestitures and reorganizationsof various product lines (Hambrick & Schecter, 1983; Lubatkin et al., 2001). Indiscrimi-nant divestiture without refocusing (i.e., the sale of profitable, but marketable core businessassets), however, would only reduce the strategic choice of a firm in a differentiated choicesituation, moving it closer to the even less favorable minimum choice setting. This wouldundoubtedly worsen the firm’s post-bankruptcy performance prospects.

Similar predictions can be made for firms in incremental choice situations, but for dif-ferent reasons. In incremental choice situations, where firms have limited slack and power,but ample latitude to maneuver in reasonably hospitable core industries, refocusing, wherepossible, would generate the cash flow and resources to increase strategic choice, therebymoving the bankrupt firm closer to the maximum choice setting with its associated rosierperformance prospects. In this choice situation, however, the sale of assets without refo-cusing (i.e., simple asset reduction or downsizing) would increase slack, in some forms(unabsorbed), but decrease size and slack in others (absorbed). The net performance effectof such changes is probably zero, as it still leaves the firm in an incremental choice situa-tion after bankruptcy protection. Therefore, firms in incremental choice situations that canrefocus and choose to do so should have higher post-bankruptcy performance than otherbankrupt firms in incremental choice situations.

Thus, the following within choice situation performance effects are hypothesized:

Hypothesis 6: Refocusing leads to higher post-bankruptcy performance for bankruptfirms in differentiated choice situations.

Hypothesis 7: Refocusing leads to higher post-bankruptcy performance for bankruptfirms in incremental choice situations.

Refocusing is also likely to have a positive effect on post-bankruptcy performance forfirms in maximum choice situations. Maximum choice affords the bankrupt firm with arelatively more “target rich” environment than that of the other three quadrants. Accordingly,

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Marlin et al. (1994)found that firms operating under maximum choice situations had moredegrees of freedom, which allowed product differentiation and operating in multiple niches.Still, it is unlikely that firms will emerge from bankruptcy without a major restructuring andreorientation of their businesses, operations, and management (Hotchkiss, 1995; Moulton &Thomas, 1993). The relatively greater environmental carrying capacity of their contexts andthe relatively greater slack resources of these firms may be important transformation shields(Baum, 1996), thereby improving the odds of successful reorganization and transformationof the bankrupt firm. These transformational shields may buffer the bankrupt firm fromstringent selection pressures, thereby permitting more degrees of freedom for error andopportunities for learning. Appropriately enacted refocusing in maximum choice situationsshould improve the bankrupt firm’s power over its environment further, while improving ormaintaining favorable niche characteristics for future performance. Therefore, these firmsshould be prime candidates to enact effective refocusing strategies. Thus, the following ishypothesized:

Hypothesis 8: Refocusing will lead to higher post-bankruptcy performance for bankruptfirms in maximum choice situations.

Bankrupt firms in minimum choice situations are in particularly dire straits. The absenceof power and slack in a context of severe constraints and limited environmental carryingcapacity makes it extremely unlikely that any amount of refocusing will provide the neces-sary changes to move these firms to a more favorable choice situation in a reasonable timeframe. Bankrupt organizations operating in minimum choice situations have few resourceswith which to enact the strategic change necessary for a successful turnaround (Barker &Duhaime, 1997); and, if they had the resources, there are simply few opportunities to whichthey can be applied (Hrebiniak & Joyce, 1985). Refocusing around a new core businessmay bring about the type of change that would be needed to move a bankrupt firm froma minimum choice situation to one of greater promise. Unfortunately, such a dramatic re-orientation would also be fraught with all of the liabilities of newness associated with neworganizations (Hannan & Freeman, 1977, 1984). Additionally, these organizations wouldhave little in the way of transformational shields to protect them from the onerous selec-tion pressures facing bankrupt firms. Therefore, on balance, we expect refocusing to havelittle effect on post-bankruptcy performance for firms in this choice situation. Thus, it ishypothesized that:

Hypothesis 9: Refocusing will not lead to higher post-bankruptcy performance for bank-rupt firms in minimum choice situations.

Methodology

Sample and Data Collection

The sample for this study consists of all publicly traded manufacturing firms (operating inSIC industries 2000–3999) having assets greater than US$ 10 million that filed for Chapter

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11 reorganization between 1980 and 1992. These 207 firms were identified through theNewGeneration Research database of bankrupt firms. SIC industries 2000–3999 were chosen toaid data comparability. Publicly traded firms with assets greater than US$ 10 million werechosen for inclusion in the sample to increase the probabilities of finding sufficient data andhaving firms where refocusing is an option.

The time frame was chosen for two reasons. First, 1980 was selected as a starting yearbecause it was the first full year in which the Bankruptcy Act of 1978 laws applied. Second,1992 was selected as the ending year to allow all firms sufficient time to recover frombankruptcy. In keeping with prior research, it may take 2–5 years to assess the efficacy ofreorganization and refocusing strategies (Bruton, Oviatt & White, 1994; Hotchkiss, 1995;Markides, 1995; Bergh, 1996). Therefore, this study examined post-bankruptcy perfor-mance during 2–5 years following Chapter 11 filing.

All data were collected from secondary sources. Chapter 11-filing firms were identifiedthrough a database maintained byNew Generation Research (Daily, 1996). Refocusing,strategic choice, environmental constraint, and firm performance measures were identifiedthrough 1998 COMPUSTAT data tapes, annual reports, 10-k filings, and theCensus ofManufactures.

Choice Situation Classifications

In order to test the hypotheses, a cluster analysis was used to classify firms into one of fourchoice quadrants. For each bankrupt firm, multiple measures were taken of both strategicchoice and environmental constraint confronting them. The variables underlying the choiceand environmental constraint constructs were selected using a deductive approach. Thatis, the variables comprising the constructs were chosen on a theoretical basis (Ketchen &Shook, 1996).

Strategic choice. Size, absorbed slack, and unabsorbed slack were used to assess strategicchoice. Size was selected because greater size is believed to afford a firm with a greaterrange of strategic options, despite external forces (Baum, 1996; Marlin et al., 1994; Miles &Snow, 1978; Porter, 1980). Organizational size (SIZE) is operationalized as the naturallog of total assets, and is consistent with prior post-bankruptcy research (i.e.,Daily &Dalton, 1995). The slack measures were selected because slack has been theorized to beone the greatest tools for allowing strategic change in the face of organizational distress(Barker & Duhaime, 1997). Absorbed slack (ASLACK) is operationalized as the sum ofselling, general, and administrative (SG&A) expenses and working capital, divided by totalsales (Singh, 1986). Unabsorbed slack (USLACK) is operationalized as the sum of cashand marketable securities, divided by current liabilities (Bourgeois, 1981; Singh, 1986).Thus, these three variables were chosen to represent strategic choice on a theoretical basis(Aldenderfer & Blashfield, 1984).

Environmental constraint. As mentioned earlier, because distressed firms are especiallydependent on external resources for survival, the focus of the current study has been nar-rowed to examine environmental munificence or carrying capacity as the primary indicatorof environmental constraint. Given the looming survival issues confronting bankrupt firms,

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this focus seemed appropriate. Further, theMarlin et al. (1994)study used comparativeexternal resources (i.e., munificence) in the hospital market as its determinism construct forclassifying firms’ environmental constraints. Growth rates of the relevant industries, and forthe economy in general, were used to assess environmental constraints and scarcity relevantto bankrupt firms. Consistent with recent research, industry growth was operationalized asthe industry growth rate (by four digit SIC code) in the value of shipments for the 5-yearpost-bankruptcy period. This measure is similar to the munificence or carrying capacity mea-sures used byDess and Beard (1984),Hambrick and D’Aveni (1988),Staw and Szwajkowski(1975). Industry growth rate (in sales or total shipments) is the one measure that is commonamong the aforementioned research. Therefore, in this study the industry growth rate invalue of shipments (INDGROWTH) was used as one measure of constraint.

The value of shipments represents the total annual value of shipments ofall establishmentsclassified in a particular industry. This includes the shipments primary and secondary to theindustry, as well as miscellaneous receipts including resales, sale of scrap, and repair work.This ratio variable was calculated as the growth rate in the value of shipments for each firm’sprimary four digit SIC code for the 5-year period being evaluated. The data necessary forthis calculation was taken from the most current edition of theCensus of Manufactures.

The general economy is also likely to affect post-bankruptcy performance. Over thelast 20 years, there have been two recognized recessions (1981–1983 and 1989–1991)and one period of extraordinary growth (1994–1999). The expansive or recessive natureof the economy determines the cost of capital and thus is likely to affect post-bankruptcyperformance. Therefore, the general economic condition, reflected by gross national product(GNP) is calculated as the percentage GNP growth (standardized to 1980 dollars) from theyear bankruptcy was filed to 5 years after bankruptcy was filed.

Principal components analysis was performed using the five classification variablesidentified above. As expected, principal components analysis revealed two factors witheigenvalues greater than one. The first factor (eigenvalue= 1.84) showed high loadingsfor size, absorbed, and unabsorbed slack (loadings= .58, .80, and .67) and the secondfactor (eigenvalue= 1.84) showed high loadings for industry growth and growth in GNP(loadings= .58 and .69). Therefore, these two factor scores became our measures of choiceand constraint.

Cluster Analysis

Using the choice and constraint factor scores identified above, a two-stage cluster pro-cedure was used. Consistent with theory, the hierarchical procedure using Ward’s methodidentified four clusters as a feasible solution. The seed values were then used in the secondk-means stage of the analysis. In the context ofHrebiniak and Joyce’s (1985)framework, thisprocess classified the organizations as 47 in incremental choice, 48 in maximum choice,59 in differentiated choice, and 54 in minimum choice situations. The robustness of thecluster classifications was checked in a number of ways. Nonstandardized variables arereported here, although a separate analysis was also performed using standardized vari-ables (Ketchen & Shook, 1996). In general, the two solutions provided consistent clusterassignments. Average, median, and centroid clustering methods were also performed, andthere were no meaningful differences in final cluster assignments. Next, an ANOVA was

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Table 1Results from cluster analysis

Cluster N Choice factor score Constraint factor score (reverse) Quadrant

1 54 −1.0714a −.6441b Minimum (IV)2 59 .7142c −.6965b Differentiated (III)3 48 1.0319c 1.1067c Maximum (II)4 47 −.6207a .5647c Incremental (I)

a Significantly different from all other quadrants atp < .001, except QI vs. QIV wherep < .05.b Significantly different from all other quadrants atp < .001, except no significant difference between QIII

vs. QIV.c Significantly different from all other quadrants,p < .001.

run to examine whether the clusters differed on the choice (F = 152.29, p < .001) andconstraint (F = 80.71,p < .001) dimensions. Tukey comparisons were then performed toestablish the dimensions on which the clusters differed. The results from the cluster analysisand Tukey comparisons are shown inTable 1.

Measurement of the Variables

Post-bankruptcy performance. Consistent with prior turnaround research, we chose tomeasure post-bankruptcy performance using three criteria: 3–5 year averages of industry-adjusted ROA, ROS (Hambrick & Schecter, 1983; Pearce & Robbins, 1993; Ramanujam &Grant, 1989) and Altman’sZ-score (Altman, 1993). Altman’sZ-score uses specific weight-ings for five financial ratios to assess firm financial health and the likelihood that a firm willfile (or refile) for bankruptcy protection. However, ROA, ROS, and the Altman’sZ-scoreare likely to be correlated. Thus, these three performance measures were combined usingprincipal components analysis. The items loaded neatly (loadings= .94, .86, and .73) onone factor (eigenvalue= 2.17). Additionally, the three items were internally consistent(α = .73). The factor scores were used as the dependent variable in our analyses.

Refocusing. Similar to research byMarkides (1995), entropy indexes for diversificationwere calculated over the relevant period for each firm in order to measure a firm’s refocusingactivity. The entropy measures of diversification (Jacquemin & Berry, 1979; Palepu, 1985)were calculated as follows:

Entropy measure=∑ [

Pi ln

(1

pi

)]such thatpi �= 0

wherePi is the share of sales in segmenti and ln(1/pi) is the weight for each segmenti. Thisoperationalization seems appropriate in this study, because the entropy measure is typicallyhighly correlated with the number of unrelated business units in a portfolio (Hoskisson,Hitt & Hill, 1993). Levels of diversification were measured as the entropy measure for firmj at T0–5. Therefore, the degree of refocusing (REFOCUS) was calculated as the entropymeasure atT0 minus the respective entropy measure atT5.

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Control variables. Two financial measures commonly used as control variables inbankruptcy research are earnings before interest and tax (EBIT) and leverage (LEV) (e.g.,Daily & Dalton, 1994a, 1995; Flagg, Giroux & Wiggins, 1991; Hambrick & D’Aveni,1988). The use of pre-bankruptcy profitability and leverage as control variables allows forthe examination of the effect of refocusing beyond these financial considerations. Thesedata were determined from 1998 COMPUSTAT tapes. EBIT is an interval variables andis measured in the year bankruptcy is filed (e.g.,Daily & Dalton, 1995). LEV is a ratiovariable operationalized as the total long-term debt (LTD) divided by the total equity (TE),also measured in the year bankruptcy is filed.

We controlled for differentiation strategy by using advertising (ADV) and research anddevelopment (R&D) intensity. These proxies are intended to capture competitive differencesbetween the firms in our sample. This was considered important in light of the findings ofMarlin et al. (1994), documenting the importance of differentiation capabilities in affectingboth the evolution of firm choice situations and the associated performance advantages. Foreach firm, we measured advertising intensity by computing the ratio of advertising expensesto sales, and then adjusted the ratio for industry effects by subtracting the industry-averageadvertising intensity. R&D intensity was calculated in the same manner, and both measuresrepresent 2-year averages (the year before, and the year of bankruptcy filing).

We also controlled for firm age and initial level of diversity. Age and size effects arenot always intertwined, and age may have a greater effect than size on a firm’s propensityto change (Baum, 1996). Age (AGE) was measured as the age of the firm at the time ofbankruptcy. And, finally, since the level of refocusing that is possible for a firm dependson its level of diversification, we needed to control for the initial level of diversification foreach firm at the time of their Chapter 11 filing. TheT0 entropy score (ENTROPY0) wasused for this purpose in our analyses.

Data Analyses

ANOVA was used to test the between quadrant performance differences predicted byHypotheses 1–5. Hypotheses 6–9posit significant interactions between choice situation andrefocusing in predicting post-bankruptcy performance for three of the four choice situations.Analysis of covariance (ANCOVA) was used to testHypotheses 6–9simultaneously. Testingall hypotheses using one model allowed us to attain the power necessary to test our nullhypothesis (Hypothesis 9).1

Results

Descriptive statistics are presented inTable 2. Consistent with expectations, the threestrategic choice variables (SIZE, ASLACK, and USLACK) are positively correlated withall three measures of performance. Similarly, industry-specific growth (INDGROWTH) andthe change in general economic conditions (GNP) variables are positively correlated withthe three measures of performance. Therefore, the observed correlations fit the premisesunderlying this study.

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ANOVA was used to testHypotheses 1–5. Results from the analyses are reported inTable 3. The omnibus test for the ANOVA suggested performance differences among thefour quadrants (F = 11.84, p < .001). Results indicated no significant difference be-tween the post-bankruptcy performances of firms in maximum choice situations from thosein differentiated choice situations. Thus,Hypothesis 1was not supported. However, firmsin maximum choice situations outperformed firms in incremental choice situations (meandifference= .90, p < .001). Additionally, firms in maximum choice situations outper-formed firms in minimum choice situations (mean difference= .84, p < .01). Thus,support was found for bothHypotheses 2 and 3.

Support was also found forHypothesis 4, that bankrupt firms in differentiated choice sit-uations outperform firms in minimum choice situations (mean difference= .62,p < .01).However, the results did not supportHypothesis 5, that firms in incremental choice situationsoutperform firms in minimum choice situations. Overall, it appears that strategic choice wasa more important determinant of post-bankruptcy performance between the theoreticallyand empirically distinguishable choice situations than was environmental constraint.

Table 4gives ANCOVA results for the effects of refocusing by choice situation onpost-bankruptcy performance. Of the control variables, surprisingly, only advertising in-tensity was a significant predictor of post-bankruptcy performance, indicating that greater

Table 4ANCOVA results

Independent variables Model 1 parameter estimate Model 2 parameter estimate

Intercept .271 .242

Continuous variablesEBIT −.001 −.001LEV .006 .004ADV 2.07∗ 1.86+R&D −.522 −.531AGE −.001 −.001ENTROPY0 @ T0 1.458 1.458REFOCUS 1.074∗∗∗ 1.073∗∗∗

Categorical variableQUADRANT 5.892∗∗∗ 5.649∗∗∗

InteractionsINCR CHOICE× REFOCUS .390∗ –MAX CHOICE × REFOCUS .615∗∗∗ .469∗∗DIFF CHOICE× REFOCUS .719∗∗∗ .573∗∗∗MIN CHOICE × REFOCUS – .146

Model R2 .293 .286Model F 9.081∗∗∗ 8.795∗∗∗

N = 207.+ p < .1.∗ p < .05.∗∗ p < .01.∗∗∗ p < .001.

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advertising intensity had a positive effect on post-bankruptcy performance. Choice situation(QUADRANT) and REFOCUS were both found as positive predictors of post-bankruptcyperformance, in line with the ANOVA results inTable 3and the popular prescription thatbankrupt firms should refocus, respectively. The significant positive parameter estimatesfor the interaction terms in the ANCOVA model provide support forHypotheses 6–8. Thelack of significance for the MIN CHOICE× REFOCUS interaction term is consistent withthe prediction ofHypothesis 9.

Discussion

The purpose of this study was to shed additional light on what factors affect post-bank-ruptcy performance of firms that have entered into Chapter 11 reorganization. We found thatchoice situation and refocusing strategy were two important factors. More favorable choicesituations generally lead to higher post-bankruptcy performance. And corporate refocusingleads to higher post-bankruptcy performance in most, but not all, choice situations. Thatis, the performance effects of refocusing, a commonly recommended strategy for bankruptfirms, was found to be contingent on choice situation. These results usefully extend theoryon choice situations and our understanding of when refocusing is an effective bankruptcymanagement strategy.

Somewhat surprisingly, we found mixed support for the predictive utility of choice sit-uation as a determinant of post-bankruptcy performance. The results from this part of thestudy, testingHypotheses 1–5, indicate that firms in high strategic choice situations outper-form firms in low choice situations, regardless of environmental constraints. While this isstill consistent with the general thrust of the theory guiding the study, in that more favorablechoice situations should be associated with higher performance (Hrebiniak & Joyce, 1985),it does suggest that, at least for bankrupt firms, having a high level of strategic choice is moreimportant to subsequent performance than being located in a relatively munificent environ-ment. This may be limited to bankrupt firms in that even the most hospitable of environmentsare still rather threatening and hostile. That is, the pressures and demands of other impor-tant stakeholders such as creditors may dwarf the carrying capacity of a firm’s competitivecontext. Or, it may be that strategic choice is the more effective transformational shield forbankrupt firms. Given thatMarlin et al. (1994)found similar results in their study of hospi-tals facing external pressures for transformation, the cumulative, albeit tentative, evidencesuggests that strategic choice is more important than environmental constraint in shaping thesuccess of firms facing major reorganization challenges. Regardless, it appears that acceptedtheory on choice situations and performance requires one or more caveats for bankrupt firms.

However, our findings offered good support for the contingent performance effects of cor-porate refocusing on post-bankruptcy performance. Consistent withHypotheses 6 and 7,the results indicate that refocusing is especially beneficial for firms in differentiated andincremental choice situations, even though firms in incremental choice situations gener-ally did not perform well after bankruptcy reorganization. Our suspicion that differentiatedand incremental choice firms would refocus more intensely than maximum choice firmswas confirmed by an ANOVA of refocusing intensity by quadrant. Incremental choicefirms reduced their diversification levels significantly more than maximum choice firms

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712 D.D. Dawley et al. / Journal of Management 2002 28(5) 695–717

(p < .001), and differentiated choice firms reduced their diversification levels somewhat,but not significantly more than maximum choice firms (p = .21). Thesepost hoc analyseslead us to believe that firms in maximum choice situations might exercise other types ofturnaround strategies and undergo less refocusing activity than incremental and differenti-ated choice firms. This also suggests that refocusing, where feasible, is particularly criticalin incremental choice situations. Refocusing in such situations increases a firm’s level ofstrategic choice, moving it closer to a maximum choice situation, one particularly conduciveto successful reorganizations. Consistent withHypothesis 8, refocusing was also effectivein improving post-bankruptcy performance in maximum choice situations when bankruptfirms enjoy the benefits of greater relative choice and munificence. Additionally, resultsindicate that refocusing did not lead to higher post-bankruptcy performance for firms inminimum choice situations. No amount of refocusing appears to help firms in minimumchoice situations. These results are consistent withHypothesis 9.

In order to determine if the performance of firms in the minimum choice quadrant wasinitially lower than the performance of those firms in the other quadrants, we ran an ANOVAto compare average quadrant pre-bankruptcy performance EBITs. There were significantdifferences between group means, but the Tukeypost hoc tests showed thatincrementalchoice firms were initially worse off. Specifically, pre-bankruptcy EBIT means in incre-mental choice firms were significantly lower than differentiated choice firms (p = .009),maximum choice firms (p = .008), and minimum choice firms (p = .021). No otherposthoc comparisons showed significant differences. Thus thepost hoc comparisons, the in-clusion of EBIT as a control, and the finding that incremental choice firms improve theirpost-bankruptcy performance despite lower pre-bankruptcy performance, together suggestthat it is the interaction of choice situation and refocusing that matter, not the firms’ initialperformance levels.

Our study contributes to the ongoing dialogue between strategy theorists and organiza-tional ecologists on the interplay of strategic choice and environmental constraints in ex-plaining organizational change and adaptation, albeit in a special context: bankrupt firms.Where prior research documents the importance of the effects of both strategic choice andenvironmental carrying capacity on firm performance and survival (e.g.,Barnett & Hansen,1996; Baum, 1996; Marlin et al., 1994), our study indicates that strategic choice may be themore important factor when explaining reorganization success from bankruptcy. Bankruptcyreorganizations generally require significant organizational changes in strategy, structure,management, and processes at multiple hierarchical levels and, generally, simultaneously(Hambrick & D’Aveni, 1988). This is a daunting task, which probably explains why so fewsucceed (Hotchkiss, 1995; Moulton & Thomas, 1993). In this unique context of transfor-mation under time pressure and with limited resources, however, it appears that those firmswith relatively greater strategic choice are better able to successfully negotiate the requiredtransformation. In ecological terms, it appears that size and slack serve as important trans-formational shields (Baum, 1996) for bankrupt firms. This is not to say that environmentalcarrying capacity is not important for bankrupt firms. We found that firms in incrementalchoice situations, those with little choice and good environmental carrying capacity, couldachieve post-bankruptcy performance gains if they were able to refocus their business port-folios. So, the role of environmental carrying capacity played in affecting post-bankruptcyperformance was found to be a more complex function of strategy and choice interactions

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D.D. Dawley et al. / Journal of Management 2002 28(5) 695–717 713

than prior theory suggested. Regardless, the unique contribution of environmental carryingcapacity in explaining post-bankruptcy performance was far less than that of strategic choicefor our bankrupt firms. This seems to also be true for other types of distressed organizations(Marlin et al., 1994). If confirmed in future research, this could be an important boundarycondition for theory on choice situations and performance.

Our findings also extend bankruptcy research. Prior to the current study, researchers hadbegun to identify predictors of post-bankruptcy performance. Some factors included theeffects of board composition (Daily & Dalton, 1995) and executive turnover (Hotchkiss,1995). Implicit in this literature is that management changes lead to some types of strategicchanges, which then affect post-bankruptcy performance. Going beyond previous work, wetherefore, begin to get more directly at the determinants of post-bankruptcy performance inthis study by isolating one prominent type of change used by bankrupt firms, refocusing,and identifying choice situations where it is and is not likely to be useful. What’s more,the significance of advertising intensity, one proxy for differentiation or market power, asa predictor of post-bankruptcy performance found in this research suggests that strategicinitiatives that bolster differentiation advantages and market power may warrant additionalresearch attention as a form of strategic change in future bankruptcy research.

The results also help clarify the utility of a popular turnaround strategy, refocusing,albeit in a rather extreme context, bankrupt firms, thereby informing the more generalturnaround literature as well. Strategic refocusing, as opposed to more simple asset orcost reduction strategies, has long been recommended by turnaround strategy researchers(Barker & Duhaime, 1997; Bibeault, 1982; Hambrick & Schecter, 1983; Pearce & Robbins,1993) as the preferred option in successful turnarounds. Although bankruptcy is a prettyextreme case for turnaround, and probably not a likely occurrence (Hambrick & D’Aveni,1988), we document the particular utility of strategic focusing in incremental, differentiated,and maximum choice situations. It may be useful for future research on turnarounds tofurther consider the context of business turnarounds in terms of choice and environmentalconstraint. This should help to further delineate the situations where various turnaroundstrategies are more or less successful.

The findings discussed above also have implications for stakeholders and managers ofdistressed firms that are considering entering into Chapter 11 bankruptcy. From a stakeholderperspective, and as unappealing as it may be to managers, our results suggest that oneprudent action for distressed firms in minimum choice situations would be liquidation asopposed to entering Chapter 11 reorganization. This is because a firm facing this type ofchoice situation has little chance of surviving no matter what strategic actions are taken bymanagement. Regardless, the more conventional prescriptions of refocusing, at least, appearto offer little hope. More creative reorganization plans appear warranted. Our results alsorather clearly indicate that firms in high strategic choice situations are the best candidates forChapter 11 reorganization, since they stand a better chance of surviving than do firms in lowchoice situations. What’s more, our results suggest that refocusing has a positive effect onpost-bankruptcy performance for firms in maximum and differentiated choice situations, anda particularly positive effect for firms in incremental choice situations, where performanceimprovement is generally not likely.

As with any study, this study has certain limitations, beyond those already noted, thatlimit the generalizability of the results, but also provide opportunities for future research.

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One limitation of this study has to do with the possibility of selection bias associatedwith the sample. Due to the lack of data availability, a sample including privately held,nonmanufacturing, and/or smaller (<US$ 10 million in total assets) firms was not feasibleto collect, even though these types of firms might provide data with characteristics differentfrom that obtained for this study. In addition, future research efforts may want to examine alonger time frame than the one examined in the current study (i.e., the current study examined1980–1992). For example, increasing the time frame of the study would build on the currentstudy in two ways. First, a longer time frame would document the temporal stability of ourfindings. Second, extending the research to include firms before the Bankruptcy Reform Actof 1978 would provide pre- and post-Act data that could be used to analyze the effectivenessof this legislative action.

In sum, the goal of this study was to take a logical step in the examination of the de-terminants of post-bankruptcy performance. Toward this end, we took the position thatbankruptcies can be viewed as an extreme form of turnaround requiring major organiza-tional transformation, one form of which could be described as refocusing. We also sug-gested that it is useful to view these refocusing initiatives of bankrupt firms as occurring indifferent choice situations that help explain both the logic underlying their transformationsand the likelihood of their success. Our results generally supported these contentions andsuggest important avenues for future research on bankruptcy reorganizations, turnarounds,and choice situation/performance relationships. We can only hope that this work provesto play a useful part in the cumulative dialogue between strategy and organizational ecol-ogy theorists about the dynamics and outcomes of organization, strategy and environmentinteractions.

Note

1. SeeLane, Cannella and Lubatkin (1998)for an in-depth discussion of sample sizerequirements for null hypothesis testing. According to power tables and GPOWER2I,a shareware program for determining statistical power, a sample size of 197 wasnecessary to achieve power of .95. Since our sample size was 207, our power levelwas .97. Given this power level, “the conclusion is justified that no nontrivial effectsexist at theB = .05 level” (Cohen, 1990:1309).

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David D. Dawley is an Assistant Professor of Management at West Virginia University.He received his Ph.D. from Florida State University. His current research interests includeturnaround strategies and the effects of the external environment on firm performance.

James J. Hoffman is a Professor in the Area of Management at Texas Tech University. Hereceived his Ph.D. from the University of Nebraska. His research concentrates primarily inthe areas of business strategy and health care management.

Bruce T. Lamont is a Professor of Management at Florida State University. He received hisPh.D. from the University of North Carolina at Chapel Hill. His current research exploresthe challenges of integrating mergers of equals.

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