Strategic change as a response to internal social comparison among business group affiliated firms

When do firms initiate strategic changes? The behavior theory of the firm (BTOF) regards strategic change as a response to unsatisfactory performance. Firms detect performance problems through historical and social comparisons. Convetional wisdom of BTOF suggests that, for social comparison, firms benchmark their performance against the performance of their industry peers as a social reference group. We argue that this conventional thinking does not fully reflect the multi-layered social context of business group (BG) affiliated firms. These firms are sensitive to performance feedback from multiple social reference groups – they engage in external social comparison with industry peers as well as internal social comparison among group sibling, regardless of industry difference. Our study, published in the Journal of Management Studies, reveals the importance of internal social comparison for BG affiliates, relative to the conventional idea of external social comparison.

Internal reference groups VS external reference groups

BG affiliates are legally independent firms nested under a higher-order organizational structure, namely the BG, which coordinates the functioning of its internal market and facilitates information and resource exchanges among the affiliates. In the BG context, apart from competing with industry peers in the external market, BG affiliates interact with group peers in a centrally coordinated internal market. Through the theoretical lens of organizational identification, we argue that BG affiliates constitute a prominent reference group for social comparison, which demands the attention of affiliates’ managers. We posit that internal comparison is highly relevant to BG affiliates because the BG as a social grouping is characterized by high distinctiveness, prestige, and out-group salience. As a result, a BG affiliate likely sees other affiliates as the most important reference group. Internal social comparison against this reference group is highly relevant for affiliate managers to set their performance aspirations, as good relative performance enhances their self-esteem and satisfies their need for self-verification.

Institutional Factors and External versus Internal Reference Groups

While BG affiliation is commonly conceptualized and operationalized as a dichotomous legal or organizational status, affiliates’ identification with the BG is a social construct that varies in strength. In practice, the prominence of a BG’s internal market varies with the BG’s external institutional environment and internal institutional arrangements such as state ownership and group leadership. Given their specific institutional conditions, BGs are heterogeneous and not equally distinct, prestigious, or exposed to competitive pressure from out-group rivals. Typically, we find that the salience of internal reference groups is contingent on a range of institutional factors, including market institutions, group-level state ownership, and mode of group CEO selection, which all alter the strength of the social identification of affiliate managers with their BGs.

Management takeaway

This study offers managerial implications for managers in BGs and their affiliated firms. Although BG affiliates have reference groups both externally from industry rivals and internally from other affiliates in the same BG, internal reference groups exert greater influence and attract more attention since affiliates have stronger identification with their BG than with their industry peers. Managers at the BG level need to be aware of the attention allocation mechanism of affiliate managers. One strategy managers could consider is to instill a stronger set of values, norms, and corporate culture that could further enhance the group’s distinctiveness, prestige, and out-group salience, and further strengthen affiliate managers’ identification with the group, such that when affiliates are performing below their internal social aspiration level, their managers will respond more proactively to initiate change and to remedy strategic mistakes. BG shareholders and managers could also facilitate change at the affiliate level through the reconfiguration of group strategy and structure. 

A potential side effect of a BG’s distinctiveness, prestige, and out-group salience may be that affiliate managers are more responsive to internal reference groups, to the extent that they become nonresponsive to external performance feedback and market signals. To reduce such risks, BG managers need to provide strong incentives for affiliates to stick to industry standards and benchmarks. The board of the BG could try to influence the behavioral orientation of affiliate managers by introducing non-state strategic investors, and selecting group CEOs from external candidates, which, according to our results, would increase the responsiveness of affiliate managers to external social comparison.