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

Much has been written in the strategic management literature on whether slack resources help or hinder the successful management of the 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 the firm by providing necessary means to solve resource problems (Cyert and March, 1963). Second, it improves information processing within the 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 the firm in different environments (Martinez and Artz, 2006; O'Brien, 2003; Cheng and Kesner, 1997). When considering the relationship between slack and firm performance, these researchers maintain, context matters. As in the 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 the other, however, this cushion can slow a firm's reaction by insulating managers from the immediate requirements relating to environmental discontinuities (Yasai-Ardekani, 1986; Litschert and Bonham, 1978). A particular situation representing one of the 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 the following reasons. For one, findings on the 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 the potential influence of certain environments on the nature of the 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 the firm. Also, previous empirical studies on the slack-performance relationship gravitate toward cross-sectional inquiries, with less emphasis on its changing characteristics over the course of environmental disruptions. By drawing attention to the role of firm slack over the course of context-specific time periods, research on the link between firm adaptability, decision making, and performance can be greatly enhanced. Our study is an attempt to better understand the previously proposed role of slack under circumstances of extreme environmental duress. We investigate the interplay between slack and firm performance during economic recession to answer the following research question: To what extent, if at all, does organizational slack at the onset of a recession help or hinder the subsequent performance of the firm during the recession and recovery? …