Organizational Environments in Flux: The Impact of Regulatory Punctuations on Organizational Domains, CEO Succession, and Performance

A central debate in organizational theory concerns how organizations evolve. There are two diametrically opposing viewpoints. Adaptation theories predict that change occurs as fluid organizations adjust to meet shifting environmental demands, while selection theories predict that change occurs through the differential selection and replacement of inert organizations as environmental demands vary over time. Our paper bridges these polar opposites by using a punctuated equilibrium framework to examine organizations’ responses to discontinuous industrylevel change. This framework recognizes that the histories of many industries are occasionally punctuated by dramatic exogenous shocks, such as radical technological innovation, social and political turmoil, major changes in government regulation, and economic crashes. Our central thesis is that such environmental punctuations dramatically reduce pressures and rewards for organizational inertia and thereby alter both organizations’ propensities for change and their survival chances following change. We focus on one form of punctuation, major regulatory change, and study firms in two industries: general hospitals and savings and loan associations. For organizations in both industries, we examine three important outcomes: shifts in organizational domain, CEO succession, and changes in financial performance. Our analyses show that punctuational regulatory change prompts shifts in organizational domains and executive leadership. Additionally, post-punctuation domain change and post-punctuation CEO succession both affect subsequent performance. We discuss our results in light of current thinking about the content and process effects of core organizational change, which has been developed in the context of stable environments. Finally, we argue for the development of more temporally sensitive theories of organizational action. (Organizational Evolution; Punctuated Equilibrium; Deregulation; Organizational Change; Organizational Inertia; Organizational Performance; CEO Succession) Change in the core attributes of organizations is difficult and fraught with peril. Organizational ecologists have proposed that when organizations change, resources are diverted from operating to reorganizing, which reduces efficiency and survival chances (Hannan and Freeman 1984, 1989; Amburgey et al. 1993; Barnett and Carroll 1995). These process effects of core change—the costs associated with redirecting resources from operations to reorganization, learning new routines, and building new relations with exchange partners—are expected to be negative. In contrast, the content effects of core change—the impact of adjusting to fit environmental demands—may be positive or negative, depending on the luck and skill of organizational decision makers and implementers. Considering process and content effects together, core organizational change is likely to impair performance and may even lead to failure. Despite the inherent riskiness of core organizational change, it is sometimes necessary and occasionally beneficial. Organizational change can be precipitated by sudden, dramatic discontinuities in the environment, such as political upheavals, large-scale shifts in government regulation, and technological breakthroughs. Such environmental discontinuities, which punctuate periods of relative stability in organizational fields, can relocate or even obliterate boundaries between industries, rewrite the rules of competition and the norms of co-operation, and dramatically alter performance outcomes industrywide (Meyer et al. 1993). Such discontinuities disable organizations’ routinized responses, plunging decision makers into strange and bewildering new worlds. They force organizations to adjust or face serious negative consequences and, therefore, increase the likelihood that the content effects of core organizational change will be positive (Meyer 1982, Zammuto 1988, Haveman 1992). HEATHER A. HAVEMAN, MICHAEL V. RUSSO, AND ALAN D. MEYER Organizational Environments in Flux 254 ORGANIZATION SCIENCE/Vol. 12, No. 3, May–June 2001 Here, we examine the impact of one type of environmental discontinuity, regulatory punctuations, on the behavior and performance of hospitals and savings and loan associations in California. In doing so, we develop and test a model of organizational change and performance in the aftermath of punctuational regulatory change. Our model complements current thinking about organizational change and performance in stable and incrementally changing environments (Amburgey et al. 1993, Barnett and Carroll 1995). Our model also extends previous research on organizations’ reactions to punctuational regulatory change (e.g., Fligstein 1990; Miner et al. 1990; Edelman 1990, 1992; Dobbin and Dowd 2000). The final contribution of our paper is to redirect organizational theorists’ attention to temporal issues. We show that two important organizational responses to regulatory punctuations, shifts in organizational domain and executive leadership, vary over time. We also show that the timing of organizations’ responses to regulatory punctuations, particularly executive succession, moderates the impact of those responses on organizational performance. Punctuational Regulatory Change The General Punctuated-Equilibrium Model Over the last three decades, punctuated-equilibrium models of change have taken their place alongside gradualistic models. Following the lead of scientists in evolutionary biology, chemistry, and physics, organizational theorists have reconceptualized change among individuals, groups, organizations, and industries. The older gradualist position maintained that change unfolds piecemeal through the accumulation of many small adjustments. The newer punctuated-equilibrium view maintains that short bursts of discontinuous change are interspersed between longer periods of relative stability (Eldredge and Gould 1972, Gould and Eldredge 1977). Punctuations follow gradual accumulations of stress, which systems resist until they reach their breaking points or until triggering events precipitate discontinuous change. Organizational theorists who have adopted the punctuated-equilibrium perspective propose that organizational evolution has two distinct and recurring phases: (1) long periods of quasiequilibrium, during which organizations make only incremental changes in structure and activities, and (2) brief periods of disequilibrium, during which many new organizations appear and many existing ones are transmogrified (Tushman and Romanelli 1985, Tushman and Anderson 1986, Miner et al. 1990, Gersick 1991). Webs of symbiotic and commensalistic relations (Hawley 1950, pp. 33–65, Granovetter 1985) stabilize organizational communities between punctuations; these webs are sundered by punctuations. The exogenous shocks that punctuate equilibria can create uninhabited or underexploited habitats where new forms of organization can thrive (e.g., Baum et al. 1995, Sine et al. 2001, Russo 2001); they may also collapse existing habitats (Tushman and Anderson 1986, Anderson and Tushman 1990). They can render permeable the boundaries separating existing industries and so abruptly alter the balance of blending and segregating mechanisms that impinge on organizational forms (Hannan and Freeman 1989 pp. 45–65). In sum, exogenous shocks make it possible for novel organizational mutations, intentional or random, to take hold. Several forces may drive the sudden reordering of organizational environments. Astley (1985) argued that radical technological innovations restructure the contexts of competition and cooperation. Carroll (1987, p. 227) investigated social and political turmoil as sources of such punctuational changes and concluded that “exogenous punctuational change is probably more important, more pervasive, and more frequent than has been acknowledged by economists or organizational analysts.” Romanelli (1989, pp. 225–226) argued that technological innovation, changes in government regulation, economic crashes, and sudden swings in social mores can all create or reconfigure resources to support new organizational activities. In this paper, we focus on regulatory punctuations: sudden and extensive shifts in state constraints on business operations. Regulatory punctuations alter both technical and institutional features of organizational environments. They can alter technical environments by raising or lowering barriers to entry; e.g., deregulation in airlines in the 1970s and in telecommunications and financial services in the 1980s. They can also set prices or eliminate price controls, thereby altering profit formulae; e.g., deregulation of trucking in the early 1980s and electric utilities in the late 1990s. Regulatory punctuations can affect institutional environments by altering standards for accountability; e.g., rules for corporate financial reporting imposed when the Securities and Exchange Commission was founded in the 1930s, or requirements for reporting on human resources imposed by passage of Title VII of the Civil Rights Act in 1964. They can also sanction forms of organization; e.g., legislation in the 1930s that delegitimated trusts. Finally, they can modify relations between firms; e.g., passage of the Glass-Steagall Act in 1933, which erected barriers between commercial and investment banking, and passage of the Financial Services HEATHER A. HAVEMAN, MICHAEL V. RUSSO, AND ALAN D. MEYER Organizational Environments in Flux ORGANIZATION SCIENCE/Vol. 12, No. 3, May–June 2001 255 Modernization Act 1999, which basically annulled GlassSteagall. No matter what their content, large-scale regulatory changes trigger novel selection pressures that alter rewards and sanctions for organizational actions (Koza 1988, Wholey and Sanchez 1991). Institutional theorists argue that organizations are driven by coercive isomorphic pressures to conform to the legal and cultural expectations of the state (Meyer and Rowan 1977, DiMaggio and Powell 1983). When major changes in regulations occur, these coercive pressures cause organizations to adjust their structures, processes, and strategies. Realignment with the shifting dictates of the state has been documented in a wide array of settings. One extended stream of work focuses on antitrust law. Over more than a century of history, American corporations have responded to antitrust laws through merger and acquisition. Antitrust legislation outlawing cooperation among firms generated a massive merger wave between 1898 and 1903 (Roy 1997). More specifically, Dobbin and Dowd (2000) demonstrated that a Supreme Court ruling in 1897 enforcing antitrust laws spawned a market for amicable (rather than predatory) mergers among Massachusetts railroads. Later in history, the Celler-Kefauver Act of 1950, which discouraged merger among firms in the same industry, caused firms to grow through crossindustry acquisition (Fligstein 1990). Finally, Stearns and Allan (1996) argued that each of the four waves of mergers in the 20th century followed a relaxation in antitrust enforcement. Another large body of work examines firms’ responses to changing legal conceptions of employee civil rights. American employers responded to the 1964 Civil Rights Act with a host of structural and practical actions. They instituted formal grievance procedures (Edelman 1990, Sutton et al. 1994) and established equal employment opportunity and affirmative action departments (Edelman 1992). They also developed policies that supported internal labor markets (Dobbin et al. 1993) and created specialized units to manage human resources issues, including antidiscrimination, safety, and benefits departments (Dobbin and Sutton 1998). More recently, following passage of the Pregnancy Leave Act of 1978 and the Family and Medical Leave Act of 1993, employers became increasingly likely to offer paid maternity leave (Kelly and Dobbin 1999, Guthrie and Roth 1999). There has been some work on other types of regulatory punctuations. Mezias (1990) showed that the accounting practices of Fortune 200 companies vary in response to shifts in the policies of the Federal Accounting Standards Board, the Interstate Commerce Commission, and the Federal Power Commission. Miner et al. (1990) demonstrated that Finnish newspapers reacted to several external shocks, including changes in state laws and policies, by changing one or more organizational dimensions, including content, language, and editorship. Singh et al. (1991) found that voluntary social service organizations in Toronto adjusted their structures and goals in response to large-scale shifts in government funding. Most recently, Wade et al. (1998) showed how state laws prohibiting alcohol had ramifications not only for beer brewers in the focal state, but also for brewers in nearby states. Taken together, the literature reviewed here indicates that many regulatory changes are large in magnitude and drive organizations to fundamentally alter their strategies, structures, and activities. But do large-scale regulatory changes create conditions that are unexpected, or can managers foresee their effects and plan accordingly? We address this question below. Unanticipated Consequences of Large-Scale Regulatory Change Major regulatory initiatives rarely come as a complete surprise; instead, they often arise from extensive public reflection, debate, and negotiation. Prolonged public discourse may facilitate affected companies’ efforts to anticipate legislation. But anticipation of the timing and consequences of regulatory change can be only partial, for two reasons. First, many actions that organizations might take to prepare themselves for a new regulatory regime are barred until dates specified in legislation. Prior to such dates, affected organizations cannot finalize plans or implement change. For example, when the Airline Deregulation Act of 1978 was passed, airlines became free to enter and exit routes according to an explicit timetable set up in the act. Loosening of regulatory constraints took seven years, until the Civil Aeronautics Board was dismantled in 1985. According to one analyst, for this industry “the process of deregulation proved chaotic from the start” (Vietor 1989, p. 180) and was clarified only as much time passed. Between passage and full implementation of major legislation, many factors critical to performance can shift, further complicating attempts to plan and execute appropriate actions. Second and more critical is the fact that large-scale regulatory change generates unintended outcomes (Merton 1936). Despite investments in predictive intelligence, industry incumbents tend to make incorrect forecasts about how major regulatory change will actually play out (Leone 1985). A classic case of the unanticipated consequences of major regulatory change occurred after the breakup of AT&T. At issue was the question of whether AT&T, which retained its long-distance, equipment, and research functions, would outperform its offspring, the seven “Baby Bells,” which were to provide HEATHER A. HAVEMAN, MICHAEL V. RUSSO, AND ALAN D. MEYER Organizational Environments in Flux 256 ORGANIZATION SCIENCE/Vol. 12, No. 3, May–June 2001 local telephone service. In the Yale Journal on Regulation, two prominent participants in the AT&T divestiture proceedings argued that “[c]learly, AT&T has won by losing, by having been left with the cream of its old services but with the restrictions on its ability to compete in those services removed” (MacAvoy and Robinson 1983, p. 42). Roughly 18 months later, the same authors returned to the pages of the same journal with a second article (MacAvoy and Robinson 1985), in which they outlined how state regulators unexpectedly asserted themselves after the breakup and blocked plans to increase local rates, forcing AT&T to transfer long-distance revenues to local companies. Only at this point did it become clear that the Baby Bells, not AT&T, would perform better after the breakup. That state commissions would play such an activist role came as a revelation to virtually all analysts and industry executives (MacAvoy and Robinson 1985, p. 245). Thus, although it was the focus of widespread analysis and speculation, this regulatory punctuation propelled affected firms well beyond predicted bounds. Regulatory change also can produce unexpected results by fostering shifts in competitive conditions that ex ante appear limited, but that later overwhelm predictions. One seemingly innocuous regulatory intervention that produced enormous change was one part of the Public Utilities Regulatory Policies Act (PURPA) of 1978. Among other, more widely noted statutes in PURPA was a law mandating that utilities purchase power from third-party producers at a price equal to the cost the utility would have incurred had it produced the electricity itself. In less than a decade, the number of third-party producers grew enormously (Russo 2001), and their role in the interorganizational community shifted from supplier to direct competitor (Joskow 1988). In sum, although organizations affected by regulatory punctuations may act purposively, partial foresight and imprecise prediction of their impact generate substantial unintended consequences. The one sure thing is that conditions in a new regulatory regime will stabilize and become well understood only after a period of flux. Because of this, the aftermath of large-scale regulatory change can best be understood by applying a model of punctuated evolution. Regulatory Punctuations in Context: A Tale of Two Industries Regulatory regimes and regulatory punctuations vary greatly. Therefore, we cannot develop a general theory of the consequences of regulatory punctuations. Instead, we must develop mid range theories that are sensitive to context. Accordingly, this section describes in some detail the regulatory punctuations that occurred in our research sites, the hospital and the savings and loan industries. We chose to study these two industries because they experience strong pressures from both technical and institutional features of their environments (Scott 1998, p. 138, Table 6.2). Hence, organizations in both industries are likely to respond to major regulatory change. But, given clear differences in regulatory regime and content of regulatory punctuation, we expect interindustry differences in firm responses. A summary of our analysis appears in Table 1. California Hospitals. The regulatory punctuation affecting California hospitals released pressures for change that had been accumulating for some time (Meyer et al. 1993) and triggered a rapid reconfiguration of the California healthcare sector. The first source of pressure was two decades of unabated growth in hospital costs (Melnick and Zwanziger 1988). The second pressure source was substantial excess capacity, the legacy of a hospital building boom fueled by federal largesse during the 1960s and 1970s. In 1982, the California State Legislature released this pressure for change by enacting the nation’s first managed-competition program. The expectation was that healthcare costs could be contained by unleashing market forces. To this end, the legislature created incentives for healthcare providers to compete on price. They also dismantled the Certificate-of-Need review process, which had protected established providers from competition. Nonhospital entrepreneurs were now free to compete with hospitals by offering selected services at lower prices. Meanwhile, the federal government phased in a new prospective-payment system, in which Medicare reimbursed providers according to predetermined rates tied to patient diagnoses, rather than cost-plus reimbursement. In sum, falling reimbursement rates squeezed hospitals’ profit margins. These changes eroded boundaries separating three distinct sectors: acute-care hospitals, health-care financing, and independent and group-practice medicine. Many organizations found themselves in unfamiliar and hostile terrain: As hospitals set up primary-care clinics, they invaded doctors’ traditional turf; as insurers were transformed into health-maintenance organizations (HMOs), they confronted the complexities of actually delivering care; and as doctors signed preferred-provider contracts, they assumed unaccustomed financial risk. California Savings and Loan Associations. The field in which savings and loan associations (thrifts) operate— the financial-services sector—contains myriad instituHEATHER A. HAVEMAN, MICHAEL V. RUSSO, AND ALAN D. MEYER Organizational Environments in Flux ORGANIZATION SCIENCE/Vol. 12, No. 3, May–June 2001 257 Table 1 Regulatory Punctuations in the California Hospital and Savings & Loan Industries (1982) Content of Regulatory Punctuation Impact on Target Industry Hospitals The Certificate-of-Need program is eliminated. Sealed-bid contracting is required for low-income