The Performance Implications of Financial Slack during Economic Recession and Recovery: Observations from the Software Industry (2001-2003) *

Much has been written in strategic management literature on whether slack resources help or hinder successful management of firm (e.g., O'Brien, 2003; Cheng and Kesner, 1997; Nohria and Gulati, 1996, 1995; Singh, 1986; Bourgeois, 1981; Cyert and March, 1963). In general, scholars have identified four major functions of firm slack (Tan and Peng, 2003). First, it alleviates goal conflict within firm by providing necessary means to solve resource problems (Cyert and March, 1963). Second, it improves information processing within organization by reducing interdependences between subunits (Galbraith, 1973). Third, slack represents a catalyst for strategic change by facilitating innovation, including new product development and new market entry (Nohria and Gulati, 1995; Hambrick and Snow, 1977; Bourgeois, 1981). Lastly, slack smoothes a firm's environmental adaptation by offering a buffer in face of environmental turbulence (Cheng and Kesner, 1997; Meyer, 1982; Bourgeois, 1981; Thompson, 1967). While all four perspectives have received ample attention, some scholars have recently returned focus on furthering an understanding of how organizational slack affects firm in different environments (Martinez and Artz, 2006; O'Brien, 2003; Cheng and Kesner, 1997). When considering relationship between slack and firm performance, these researchers maintain, context matters. As in more general literature on slack resources, these environment-specific arguments indicate that slack can be a double-edged sword. On one hand, it provides what Bourgeois (1981: 30) refers to as a shock absorber that can help firms cope with shifting environmental demands (Tan and Peng, 2003; Cheng and Kesnet, 1997; Cyert and March, 1963). On other, however, this cushion can slow a firm's reaction by insulating managers from immediate requirements relating to environmental discontinuities (Yasai-Ardekani, 1986; Litschert and Bonham, 1978). A particular situation representing one of most significant environmental threats to a firm's viability and continued profitability and purported to make critical use of slack is economic recession (Pearce and Michael, 2006; Mascarenhas and Aaker, 1989). As sales decline, margins decrease and credit dries up, a firm's slack is deemed to become increasingly scarce and thus critically valuable; in fact, Cheng and Kesner maintain that the presence of slack resources serves a positive role by helping firms withstand severe economic recessions (1997: 3). While Cheng and Kesner's assertion may seem intuitively apparent, its empirical validation is warranted for following reasons. For one, findings on impact of organizational slack on firm performance remain inconclusive (see meta-analysis by Daniel et al., 2004). As a consequence, researchers (Tan and Peng, 2003; Cheng and Kesner, 1997) suggest a contingency approach that stipulates potential influence of certain environments on nature of slack performance relationship. Thus, while any given firm may indeed have an optimal level of organizational slack (Sharfman et al., 1988), it may be that these levels vary depending on specific circumstances encountered by firm. Also, previous empirical studies on slack-performance relationship gravitate toward cross-sectional inquiries, with less emphasis on its changing characteristics over course of environmental disruptions. By drawing attention to role of firm slack over course of context-specific time periods, research on link between firm adaptability, decision making, and performance can be greatly enhanced. Our study is an attempt to better understand previously proposed role of slack under circumstances of extreme environmental duress. We investigate interplay between slack and firm performance during economic recession to answer following research question: To what extent, if at all, does organizational slack at onset of a recession help or hinder subsequent performance of firm during recession and recovery? …