organizational coping with institutional upheaval in transition economies

Organizational coping with institutional upheaval intransition economies

Kendall Roth*, Tatiana Kostova1

International Business Department, Moore School of Business, University of South Carolina, Columbia, SC 29208, USA

Abstract

The radical change in corporate governance systems is fundamental to the period of institutional upheaval characterizing

transition economies. Using an institutional theory framework, this paper develops a model of responses to this change. The

model is tested with data from 1,723 firms in 22 countries in Central and Eastern Europe and the Newly Independent States. The

results suggest that a firm’s adaptation to the new governance order will be facilitated or hampered depending on the

characteristics of the institutional and organizational contexts it faces. A major implication of the study is the need to consider

cultural and contextual embeddedness in explaining how governance systems transform.

# 2003 Elsevier Inc. All rights reserved.

1. Introduction

Organizational responses during periods of extreme

institutional change are not well understood (Newman,

2000). In discussing extreme change, Greenwood

and Hinings observe that neo-institutional theory is

‘‘silent on why some organizations adopt radical

change whereas others do not, despite experiencing

the same institutional pressures’’ (1996: 1023). They

further observe that institutional theory provides

insights that, if developed, may help explain organi-

zational interpretations and responses to extreme

change.

Accordingly, the purpose of this study is to develop

a model of organizational responses to radical

change in the institutional environment. Referred to

as institutional upheaval, such change requires the

‘‘movement from one ‘template-in-use’ for organizing

to another . . .’’ however, the institutional context ‘‘no

longer provides organizing templates, models for

action and known sources of legitimacy’’ (Newman,

2000: 605). Furthermore, even if proper ways of

organizing were forthcoming from the institutional

context, the new templates may be so far from the

historical normative base that organizations may not

have the capabilities to recognize or adopt them.

Thus, an important question in this context is ‘‘how

do organizations react when there is such wholesale

change in their institutional environment?’’ We use

institutional theory as a foundation for answering this

question and suggest that in this context, the response

of organizations will be determined by the nature of

their embeddedness within the societal and organiza-

tional contexts (Greenwood & Hinings, 1996).

We also draw from the literature on corporate gov-

ernance and more particularly, corporate governance

in transition economies (e.g., McCarthy & Puffer,

2002a, 2002b; Peng, 2003; Puffer & McCarthy,

2003). Corporate governance is central to the transition

Journal of World Business 38 (2003) 314–330

* Corresponding author. Tel.: þ1-803-777-3604;

fax: þ1-803-777-3609.

E-mail addresses: [email protected] (K. Roth),

[email protected] (T. Kostova).1 Tel.: þ1-803-777-3553; fax: þ1-803-777-3609.

1090-9516/$ – see front matter # 2003 Elsevier Inc. All rights reserved.

doi:10.1016/j.jwb.2003.08.018

to a market economy as it captures both the changes

in the external institutional/governance system (e.g.,

courts, regulations) as well as the radical transforma-

tion of the corporate governance guiding firms’ activ-

ities (e.g., governance bodies, external control,

transparency). As suggested by Puffer and McCarthy

(2003: 12), ‘‘Initial efforts in the move toward res-

ponsible corporate governance included legislative,

judicial, and corporate initiatives to provide investors

with more disclosure, transparent information, and

voice, as well as redress within the legal system.’’

The institutional framework that we apply can improve

further our understanding of the corporate governance

transformation in transition economies by providing

theory-based explanations of important questions and

phenomena that have been recognized in the govern-

ance literature. These include, for example, the differ-

ent rate of change in corporate governance across

countries and across firms, as well as the pervasiveness

of some informal and sometimes illegitimate behaviors

(e.g., bribes) in transition countries.

We examine our model with 1,723 firms from 22

countries in Central and Eastern Europe (CEE) and

Newly Independent States from the former Soviet

Union (NIS).2 This is a particularly insightful setting

as the fall of communism is well documented as

institutional upheaval, with an unprecedented shock

to the full set of institutional structures and organiza-

tional sectors (see Newman, 2000; Peng & Heath,

1996; Peng & Luo, 2000; Ramamurti, 2000). Not

only were existing institutional entities destroyed,

but fundamental values, beliefs and assumptions held

by society were radically challenged. Furthermore, this

change is instructive in that it occurs independent of,

and exogenous to, organizations within the environ-

ment. Thus, our model and study isolates organiza-

tional activities in reaction to upheaval, where the

organizations themselves do not induce the change.

2. Theoretical foundation—institutionalupheaval

Institutional upheaval is defined as ‘‘a rapid and

pervasive change in the norms and values that underlie

and legitimate economic activity, which results in

fundamental change in a society’s political system,

its legal and regulatory frameworks, its economic

system, and its financial infrastructure’’ (Newman,

2000: 603). Institutional upheaval is a wholesale

change of major aspects of an institutional environ-

ment and governance systems, accompanied by

extreme uncertainty, and ambiguity. Using Green-

wood and Hining’s terminology, upheaval is a radical

and revolutionary change (1996: 1024).

Transition economies in the countries in Central and

Eastern European and the Newly Independent States

have been recognized as experiencing institutional

upheaval as a result of the fall of communism. As

noted by Newman, not only the political systems,

laws, regulations, and financial markets, but also

‘‘the underlying assumptions about the purpose of

economic activity were destroyed or significantly

changed within a short time’’ (2000: 602). Similarly,

Peng and Heath (1996) discuss the wide range of

institutional changes taking place in these countries,

changes that are at the very foundation of the govern-

ance systems such as the dismantling of the central

planning regime, the need for a new property-rights-

based legal framework, and the transition from ‘‘state-

policed firms’’ to market-based mechanisms restrict-

ing opportunistic behavior of firms. Thus, it is not only

that institutions and social structures are non-existent

or in disarray, but also that the existing ones are largely

inconsistent with the desired market-based economic

activity. As noted by Johnson, Smith, and Codling,

‘‘cognitive processes must be put in place that are the

reverse of those that led to institutionalization in the

first place’’ (2000: 576).

Building on ideas from institutional theory, we

propose two mechanisms that can explain firms’

responses to the upheaval: institutional imperfection

and institutional baggage. Institutional imperfection is

the gap between the existing and the desired institu-

tional arrangements and governance systems. It is the

degree to which institutions (e.g., structures, practices,

legitimating actors) are not well defined and estab-

lished as well as the inconsistency between these

institutions. As imperfection increases, organizational

members may lack the understanding of what the

desired structures and values should be, as well as

the expertise about how to change the organization.

Times of upheaval are characterized by significant

2 For clarity of the presentation, throughout the paper, we will

refer to these countries as ‘‘transition economies.’’

K. Roth, T. Kostova / Journal of World Business 38 (2003) 314–330 315

institutional imperfection, which is likely to diminish

over time as a result of the transformation of the society.

Institutional baggage is determined by the strength,

ingrainment, and pervasiveness of the institutional

arrangements that existed prior to the radical change.

Zucker observes that ‘‘every institutionalized system

tends to carry ‘baggage’ of related structures and

activities that become institutionalized over time

. . .’’ (1991: 105). High institutional baggage implies

that the establishment of a new institutional arrange-

ment will be very difficult. As North states, ‘‘although

formal rules may change overnight as the result of

political and judicial decisions, informal constraints

embodied in customs, traditions, and codes of conduct

are much more impervious to deliberate policies’’

(1990: 6). The more ingrained and pervasive beha-

viors, routines, and cognitive scripts are, the more

difficult it will be to destroy them and replace them

with a radically different new set of scripts and

behaviors. As observed by Oliver, ‘‘institutionalized

values and activities will exhibit inevitable resistance

to erosion or change’’ (1992: 580). She states that even

if organization members recognize the need for

change, or transition to a new set of values and

activities, they may be immobilized by the previously

institutionalized arrangements.

We argue that institutional upheaval is charac-

terized by both high institutional imperfection and

significant institutional baggage. These are important

to consider when analyzing firms’ behaviors during

such periods of time.

3. A model of organizational responses toinstitutional upheaval3

In this section, we develop a model of firms’

responses to institutional upheaval using institutional

imperfection and institutional baggage as explanatory

mechanisms. We consider two types of behaviors that

firms use to deal with these conditions—informal

substitutes and deinstitutionalization. In addition,

we examine firms’ perceptions (i.e., cognitive and

affective responses) about the context. We propose

that these organizational responses are determined

by the embeddedness of the firm in the past institu-

tional system, the current institutional system, and its

ownership structure. These are referred to as initial

condition, current condition, and ownership type.

Fig. 1 presents the overall model.

3.1. Responses to upheaval

Informal substitutes are initiatives taken by a

firm to reduce or circumvent the barriers created

by the underdeveloped formal institutional context

(e.g., codified governance system, political, judicial,

and economic rules). As summarized by Peng, transi-

tional contexts are characterized by: (1) the lack of

sufficient number of rules to govern all transactions

Firms Responses

Contextual Embeddedness

Initial Condition

Current Condition

Ownership Type

Informal Substitutes

Deinstitutionalization

Perceptions

Effecting Mechanisms

Institutional Imperfection

Institutional Baggage

Fig. 1. Model of firm responses to upheaval.

3 For clarity of the presentation and the subsequent empirical

examination of the model, we will refer to transition economies to

represent environments undergoing institutional upheaval.

316 K. Roth, T. Kostova / Journal of World Business 38 (2003) 314–330

(North, 1990); (2) the lack of credible enforcement

of the rules that do exist (Stiglitz, 1999); and (3) the

tremendous inertia, resistance, and lack of adaptation

on the part of some organizations (Newman, 2000;

Oliver, 1992) (2003: 281–282). Khanna and Palepu

(1997) refer to such conditions as ‘institutional voids,’

where it is likely that ‘‘managers and firms often

have to perform basic functions by themselves . . .’’(Peng & Luo, 2000: 487).

Given that the formal governance systems are

unable to support effective business activities, man-

agers may have to use informal substitutes during the

transition period (Xin & Pearce, 1996). Furthermore,

since governments in transition economies retain

considerable power, informal substitutes will often

be directed towards government officials in an attempt

to secure favorable treatment or ‘‘buy’’ market func-

tions. For example, if property rights are underdeve-

loped and ill protected, a firm cannot rely on the

formal infrastructure. It may, therefore, seek alterna-

tive ways of securing those rights, possibly through

‘‘private payments’’ to public officials and politicians

(Hellman, Jones, & Kaufmann, 2000). Preliminary

evidence suggests that these informal activities may

be quite important, as Peng and Luo (2000) found that

firm performance in transition economies is positively

related to a firm’s personal ties with government

officials.

Deinstitutionalization generally refers to ‘‘the ero-

sion or discontinuity of an institutionalized organiza-

tional practice’’ (Peng, 2003: 277). In this study, we

use the term to describe the actions which firms take to

facilitate the transformation from the old to the new

institutional model or governance system. An estab-

lished or accepted organizational practice loses its

legitimacy such that what was once taken for granted

is discontinued or abandoned (Oliver, 1992: 564). In

essence, deinstitutionalization attempts to rid the firm

of institutional baggage (i.e., dismantling of the old,

deeply ingrained, and widely shared structures and

templates). While institutional theory has recognized

deinstitutionalization as part of the institutional pro-

cess (e.g., Oliver, 1992; Scott, 2001), much more

attention has been given to the adoption of new

institutionalized structures than to the destruction

of the old ones. As Zucker notes, ‘‘there has been

little work on the processes by which institutions

disappear’’ (1991: 105). Even when researchers have

discussed deinstitutionalization, they have typically

taken a more incremental view. Under conditions of

upheaval, the need for deinstitutionalization is much

more radical in nature and becomes critical and central

to the transition to a new institutional arrangement.

Within transition economies, the fundamental need

is a change in governance systems to a market-based

model.4 However, adopting new market-based prac-

tices may not be possible if little or no knowledge of

these practices exists. And even if some level of

knowledge exists creating a catalyst by which change

is accepted throughout the organization may be quite

difficult. Therefore, to effect deinstitutionalization

within this context, firms will use as change agents

outside entities which carry and convey the new

market-based practices. Deinstitutionalization efforts

will include inviting equity ownership by foreign

enterprises, engaging in outside alliances, and parti-

cipating in foreign markets through activities such as

exporting. As previously argued, such activities will

facilitate the process of change by allowing firms to

experience directly the governance arrangements

associated with the capitalistic model (e.g., Fila-

totchev, Dyomina, Wright, & Buck, 2001; McMillan

& Woodruff, 2002; Peng, 2003). As asserted by Oliver,

firms that ‘‘diversify their operations into other sectors

or markets, particularly in different countries, are

likely to be exposed to alternative organizational

customs . . .’’ (1992: 577). Similarly, Newman notes

the need to import organizing templates from other

cultures, suggesting that ‘‘. . . for firms trying to

change without a foreign partner, the use of foreign

templates is not as effective, because the template

might not be relevant to the culture’’ (2000: 609).

The behavioral responses reflected in informal

substitutes and deinstitutionalization will also be

accompanied by managers’ perceptions about the

changing governance system. The underdevelopment,

ambiguity, and inconsistency within the environment

that reflect imperfection will result in firms ques-

tioning, to various degrees, the effectiveness of the

new institutional arrangements and cause firms to

4 While we recognize that the market-based models used in

different economies will vary due to cultural and historic

influences, we can expect that all of them will incorporate some

common fundamental principles of market governance, such as

transparency of business transactions expected by the World Trade

Organization.


form opinions about the different components of the

governance system (e.g., courts, government, infra-

structure). The institutional baggage that comes from

the previous institutional regime will also impact

these perceptual reactions, such that firms with a

different degree of entrenchment in the previous sys-

tem will form different views of the new governance

arrangements.

In the following sections, we develop hypotheses

on the effects of the three types of embeddedness

(initial condition, current condition, and ownership

type) on the three sets of outcome variables (informal

substitutes, deinstitutionalization, and perceptual

responses).

3.2. Initial condition

Initial condition characterizes the state of the insti-

tutional environment at the time of the upheaval

relative to the desired end-state. As noted by Spicer,

McDermott, and Kogut in reference to North (1990),

there is a path-dependence in country development,

such that ‘‘countries differ in their institutional con-

ditions, and these differences have powerful effects on

the subsequent evolution’’ (2000: 643). Initial condi-

tions reflect the starting point of a transition and is

essential to understanding the path dependence. In the

context of transition economies, initial condition is

relative to the market economy model. The European

Bank for Reconstruction and Development (EBRD)

views initial condition in transition economies as

comprised of the level of development, trade depen-

dence on the Council for Mutual Economic Assistance

(CMEA), macroeconomic disequilibria, distance to

the European Union, natural resource endowments,

market memory, and state capacity (Transition Report,

2000: 21). Thus, initial condition captures both how

far away from the market model the starting point is,

as well as how ingrained and pervasive the old institu-

tional and governance arrangements are. Based on

their initial condition, some countries will be in a more

favorable position than others. For example, a country

from Central and Eastern Europe that has previously

allowed for some type of private property to co-exist

with the predominant state property (e.g., Poland)

will have a more favorable starting position than a

country that has never had alternative ownership forms

(e.g., Uzbekistan).

We argue that the initial condition of a country will

affect firm responses to upheaval. A favorable initial

condition would mean a relatively smaller amount of

radical change in the institutional environment and

governance system in its movement towards the end

state compared to the change needed in countries with

an unfavorable initial condition. Thus, it is likely that

at any given point in time during the transition period,

countries with a favorable initial condition will have

less institutional imperfection as it will be easier for

them to build the new regulatory, economic, and legal

institutional elements and become closer to the desired

end state. As a result, firms operating in such envir-

onments will find less need to deal with institutional

imperfections and will use less informal substitutes. In

contrast, firms in countries with unfavorable initial

conditions will face more institutional imperfection

and are likely to use, as a result, more informal

substitutes.

Furthermore, an unfavorable initial condition

implies a significant amount of institutional baggage

due to the strong entrenchment of the previous system

in cognitive and behavioral scripts (Barley & Tolbert,

1997). Johnson et al. define scripts as ‘‘the cognitive

schema informing behavior and routines appropriate

in particular contexts’’ (2000: 573) and refer to them

as institutional templates. Institutional upheaval

requires a dramatic change in the institutional tem-

plates that are operative in an environment. Deinsti-

tutionalization implies getting rid of the old templates

and creating and adopting new ones. Depending on the

initial condition, firms in different counties will find it

more or less difficult to initiate and move through

these processes. Favorable initial conditions are char-

acterized by less entrenched templates and a tolerance

for alternative templates to co-exist or be created

(Johnson et al., 2000: 576). In contrast, unfavorable

initial conditions imply substantial institutional bag-

gage, and therefore, a higher need for change and

deinstitutionalization. At the same time, in the short

run, firms in such environments may not be able to

recognize the need for new institutional templates or

be able to create them due to the high levels of ‘‘taken-

for-grantedness.’’ For example, firms from the former

Soviet countries, where there was no social memory of

market-based templates, will find a greater need to

destroy the communist-era templates in an effort to

move to the new ones, compared to countries where


some institutional memory of market structures

remain.

Finally, the initial condition will affect firms’ per-

ceptions about the effectiveness of the changing gov-

ernance system. Favorable initial conditions will lead

to better views of the current arrangements because the

current arrangements would be closer to the desired

end state. Firms from unfavorable initial conditions

may have a more negative attitude about the changing

arrangements due to their lack of understanding of the

new ‘‘rules of the game’’ and their lack of psycholo-

gical readiness to mentally accommodate the new

template for business activity. Therefore, we propose:

H1: The initial condition of an institutional environ-

ment will influence firms’ responses to institutional

upheaval.

Specifically:

H1a: Firms from environments characterized by

unfavorable initial conditions will use more informal

substitutes compared to those with favorable initial

conditions.

H1b: Firms from environments characterized by

unfavorable initial conditions will engage in more

deinstitutionalization initiatives compared to those

with favorable initial conditions.

H1c: Firms from environments characterized by

unfavorable initial conditions will have worse percep-

tions about the institutional environment compared to

those with favorable initial conditions.

3.3. Current condition

Current condition characterizes the position of a

country’s institutional and governance systems at a

particular point in time after an institutional upheaval.

It reflects both the nature of their trajectory towards

the desired end-state5 as well as the gap that still

exists between the current state and the end state of

the transition (i.e., where economic transactions are

governed through formal market arrangements). As

North states, rule-based impersonal exchanges have

been regarded as ‘‘the critical underpinning of suc-

cessful modern economies involved in the complex

contracting necessary for modern economic growth’’

(1990: 35). The ‘‘end-state’’ of the transition is diffi-

cult to achieve and takes substantial time. In their

study of the evolution of corporate governance in

Russia, Puffer and McCarthy (2003) observe different

stages of transformation—commercialization, priva-

tization, nomenclature, and statization. These authors

suggest that although progressing along the trajectory

towards the market governance system, Russia is still

challenged by a number of problems related to the

underdeveloped and incompletely enforced legal sys-

tem, abuse of power, denial of minority shareholders

rights, and others. Peng (2003) also takes a temporal

view, proposing two stages in the transformation of the

governance system, and suggesting that this process is

extremely complex and lengthy and may take a gen-

eration to fully accomplish.

Countries vary in the degree to which they have

successfully adopted rule-based market governance

systems. Some are further along the transition trajectory

and can be said to have favorable current conditions

(e.g., Hungary, Poland, Czech Republic). Others have a

less favorable current condition as they lag behind the

adoption of market-based governance arrangements.

We argue that current condition affects firm

responses to upheaval because of its implications

for institutional imperfection. Where current condi-

tion is less favorable, there is an insufficient level of

development and/or enforcement of formal arrange-

ments capable of guiding economic transactions. The

absence of a reliable formal governance system allows

for, or may even necessitate, the use of alternative

informal substitutes for securing support for economic

activity (Peng & Heath, 1996). Such support may

range from facilitating day-to-day operational busi-

ness transactions (e.g., customs, court system) to

shaping laws and regulations in the interest of private

business entities. These may be achieved through

both legitimate and illegitimate means. Firms may

find it expedient or even necessary to use ‘‘private

payments’’ to influence the content of laws, decrees,

or regulations, such as parliamentary votes and pre-

sidential decrees to private interests, court decisions

in commercial cases, Central Bank handling of

funds, etc. Thus, corruption becomes a more pervasive

5 In this study, current condition is measured 9–10 years after the

initial point of upheaval.


practice in firms’ behavior. In summary, consistent

with Peng (2003), we expect that in environments

where the transition remains in its early stages, firms

will use more informal substitutes of this nature.

In addition to its effects on firms’ informal beha-

viors, current condition will also influence firms’

perceptions about the environment and the current

governance system. Unfavorable current conditions

will likely result in negative views about the integrity

of the governance system as a whole. Specifically,

firms will view governments as not sufficiently sup-

portive of economic activity, they will not expect

courts to be fair and honest, and will question the

protection of property rights. Thus, we propose:

H2: Current condition will influence firms’ responses

to institutional upheaval.

Specifically:

H2a: Firms facing unfavorable current conditions

will use more informal substitutes compared to firms

in favorable current conditions.

H2b: Firms facing unfavorable current conditions

will have worse perceptions about the institutional

environment and governance system compared to

firms in favorable current conditions.

3.4. Ownership type

Ownership type is defined by the party (e.g., the

state or private individuals) that holds the property

rights of a firm. Introducing new forms of ownership

and changing the ownership structure of existing firms

is central to the change in the governance systems in

transition economies. As noted by Zahra, Ireland,

Gutierrez, and Hitt (2000), the implications of changes

in the ownership type or form, for example through

privatization, ‘‘are so radical that a new organizational

mindset is needed to comprehend and capitalize on the

opportunities that become available to the firm (Smith,

Golden, & Pitcher, 1999)’’ (2000: 516). Similarly,

Johnson et al. assert that privatization constitutes a

change in ‘‘institutional templates—change that is

challenging and problematic’’ (2000: 572). We argue

that ownership type has an effect on firms’ responses

to the institutional context because each type has

specific constraints and is confronted with particular

institutional pressures (Peng, 2003). We suggest that

both previous and new ownership forms must be

considered in examining firms’ responses to institu-

tional upheaval.

In the context of transition economies, the pre-

upheaval governance system was based on state

ownership. As a result of the upheaval, ownership

types emerge that are generally consistent with the

market economy model, in particular, private and

publicly held firms. However, an important distinction

regarding these new forms should be considered.

Some private and pubic firms will result from priva-

tization processes and, therefore, will have a state-

affiliated history. New private and public firms with no

such former state affiliation will also emerge. Finally,

some state-based firms will continue to exist after the

upheaval. In the context of our study, the distinction

between these three types becomes very important.

This is because, while institutional imperfection and

institutional baggage are general characteristics of

transition environments that affect all firms, imperfec-

tion and baggage vary by these ownership types.

State firms are experiencing relatively lower imper-

fection than both formerly state and emergent private

and publicly held firms because it is the latter two that

are directly confronting the market-based institutional

arrangement, while the state firms are somewhat

buffered from it. Furthermore, state firms likely have

better support from the institutional environment, as

they can leverage their relationships with influential

actors in the environment. Peng and Luo note that

while state firms may have lost a lot of privileges

during the upheaval, they still have preferential access

to government officials (2000: 489). This access or

connectedness is based on both the stake of the state as

an owner of the firm and the firm’s historical contacts

prior to the upheaval. Some of these contacts will carry

forward after the upheaval and, as a consequence,

these firms will be able to correct for institutional

imperfections without having to buy services or sup-

port through alternative mechanisms (e.g., offer pay-

ments to officials). In contrast, formerly state and

emergent firms will use more informal substitutes

because they have less ability to utilize state-based

networks and, as argued by Peng, ‘‘. . . they have to

rapidly build ties to establish legitimacy, thus neces-

sitating an intense networking strategy’’ (2003: 285).


Ownership type will also have an important influ-

ence on the institutional baggage carried by a firm and,

therefore, on its deinstitutionalization initiatives. State

organizations will have substantial amounts of institu-

tional baggage. Furthermore, those private and pub-

licly held firms that were state-owned prior to the

upheaval will have more institutional baggage com-

pared to those emerging after the upheaval, as they

previously operated according to the old institutional

template for economic activity grounded in the cen-

trally-planned model. Hence, the higher need for

deinstitutionalization for state-owned and previously

state-owned. In contrast, organizations founded after

the upheaval, will have relatively lower institutional

baggage and need for deinstitutionalization. Although

some elements of the old template will enter these

newly founded organizations through the cognitive

scripts carried by their members, there will be less

residual from the old system to deal with. Thus, we

expect that they will engage in less deinstitutionaliza-

tion initiatives.

Finally, the different ownership types will be asso-

ciated with different attitudes and perceptions about

the institutional environment. As argued above, state

organizations will face less institutional imperfection

and thus are likely to form more favorable views than

others. The formerly state and emergent firms will

view the environment more negatively. Both formerly

state and emergent firms confront directly the new

market economy and governance system and thus, are

likely to report general dissatisfaction with the current

context. Therefore:

H3: The ownership type of a firm affects its responses

to institutional upheaval.

Specifically:

H3a: State firms will use less informal substitutes com-

pared to formerly state-affiliated and emergent firms.

H3b: State and formerly state-affiliated firms will

engage in more deinstitutionalization initiatives com-

pared to emergent firms.

H3c: State firms will have more positive perceptions

about the institutional environment compared to for-

merly state-affiliated and emergent firms.

4. Methods

4.1. Data and sample

To examine the relationships posited in our model

we used secondary data (Business Environment and

Enterprise Performance Survey) collected by the

World Bank, in conjunction with the European

Bank for Reconstruction and Development (EBRD),

Inter-American Development Bank, and the Harvard

Institute for International Development.6 The data

were collected in June–August 1999 in the following

countries: Albania, Armenia, Azerbaijan, Belarus,

Bulgaria, Croatia, the Czech Republic, Estonia,

Georgia, Hungary, Kazakhstan, Kyrgyzstan, Latvia,

Lithuania, Moldova, Poland, Romania, the Russian

Federation, the Slovak Republic, Slovenia, the

Ukraine and Uzbekistan. It consists of responses

from 3,438 firms, with the range of firms by country

varying from 112 to 150, with the exception of three

countries with larger samples—Poland (246),

Ukraine (247), and Russia (552). For the purpose

of examining our model, where the interest is in

organizational and not individual responses to up-

heaval, we removed single-owner proprietary-type

operations. This resulted in a data set for our study

consisting of 1,723 firms.

4.2. Measures

We selected measurement items from the Business

Environment and Enterprise Performance Survey

database to reflect the constructs of interest. In this

section, we describe the measurement item(s) for

each construct. We first describe the three variables

measuring organizational responses, followed by the

three variables measuring the contextual embedded-

ness.

4.2.1. Informal substitutes

Four measurement items were used to reflect infor-

mal substitutes that firms use. In the first item, respon-

dents were asked to indicate the percentage of senior

management time per year spent on dealing with

6 For a detailed description of the survey and survey methodol-

ogy, visit the World Bank website http://worldbank.org/wbi/

governance/data.html.


http://worldbank.org/wbi/

http://governance/data.html

government officials about the application and inter-

pretation of laws and regulations. The scale was 1: ‘‘up

to 1%,’’ 2: ‘‘1–5%,’’ 3: ‘‘6–10%,’’ 4: ‘‘11–25%,’’ 5:

‘‘26–50%,’’ and 6: ‘‘more than 50%.’’ For the second

item, respondents reported, on a 6-point Likert-type

scale, how common it is for ‘‘firms in my line of

business to have to pay some irregular additional

payments to get things done.’’ The scale varied from

1: ‘‘always’’ to 6: ‘‘never.’’ The third item asked

respondents, ‘‘If a government agent acts against

the rules I can usually go to another official or his

superior and get the correct treatment without

recourse to unofficial payments.’’ The scale ranged

from 1: ‘‘always’’ to 6: ‘‘never.’’ For the fourth item,

respondents were asked, ‘‘When a new law, rule,

regulation, or decree is being discussed that could

have a substantial impact on your business, how

much influence does your firm typically have at the

national level of government to try to influence the

content of that law, rule, regulation or decree?’’ This

question was asked for the executive, legislature,

and regulatory agencies. Respondents used a 6-point

scale ranging from 1: ‘‘never influential’’ to 6: ‘‘very

influential.’’

4.2.2. Deinstitutionalization

We measured deinstitutionalization through exter-

nal affiliations or activities, by which the firm attempts

to replace the old templates with new ones. We use

three items that measure external affiliations through

equity, export activities, and external control: (1)

percentage of the organization’s capital held by a

foreign company; (2) percentage of the firm’s

sales represented by exports; and (3) use of external

agents in the control structure of the organization

(1 ¼ owner, family, manager or worker-based control;

2 ¼ bank, domestic company group, or external board

of directors-based control).

4.2.3. Perceptions

These measures reflect the perceptions about both

the effectiveness of the new institutional and govern-

ance arrangements as well as their components. We

used five indices. The first index is comprised of three

items, using a 6-point scale (1: ‘‘very good,’’ 6: ‘‘very

bad’’), measuring the overall quality and efficiency of

services provided by the Government, Parliament, and

Central Bank. The second index is comprised of four

items (1: ‘‘very good,’’ 6: ‘‘very bad’’) measuring the

overall quality and efficiency of services provided by

public health care, education/schools, police, and

military. The third index asked respondents to indicate

how often (1: ‘‘always,’’ 6: ‘‘never’’) they associate

the following descriptions with the court system in

resolving business disputes: fair and impartial, honest/

uncorrupted, quick, affordable, consistent/reliable,

and able to enforce its decisions. The fourth index

asked respondents to indicate the extent to which they

agree (1: ‘‘fully agree’’ and 6: ‘‘strongly disagree’’)

that ‘‘the legal system will uphold their contract and

property rights in business disputes.’’ The final index

comprised five items indicating how problematic

(1: ‘‘no obstacle,’’ 4: ‘‘major obstacle’’) each of the

‘‘following are for the operation and growth of your

business’’: customs/foreign trade regulations in your

country, labor regulations, foreign currency/exchange

regulations, environmental regulations, and tax reg-

ulations/administration.

4.2.4. Initial condition

The initial condition measure was taken from

the EBRD Transition Report (2000). This report

provides an initial condition index for 1990, the start

of the upheaval period. The index is based on each

country’s level of development, trade dependence

on CMEA, macroeconomic disequilibria, distance to

the European Union, natural resource endowments,

market memory, and state capacity. Examining the

measure for the countries in our sample indicated

that it did not meet normal distribution assumptions.

The distribution was basically bimodal. Thus, consis-

tent with EBRD, we classified countries into two

groups—with favorable or unfavorable initial condi-

tion prior to the upheaval (see Table 2 for the lists of

countries).

4.2.5. Current condition

As an indicator of the progress that countries have

made on their transition paths towards a market econ-

omy, World Bank analysts have developed a measure

referred to as ‘‘state capture’’ (Hellman et al., 2000).

In capture economies, where state capture is high,

‘‘public officials appear to have created a private

market for the provision of normally public goods

(e.g., the security of property and contract rights)

and rent-seeking opportunities which a relatively


small share of firms can obtain’’ (Hellman, Jones,

Kaufmann, & Schankerman, 2000: 3). In high state

capture environments, private firms have the ability to

shape and affect the formation of ‘‘the rules of the

game’’ (e.g., laws, regulations) or to avoid them. This

is mostly done through private payments. Thus, high

state capture reflects a deviation from the transition

towards a market economy.

State capture is measured as the extent to which the

following activities have a direct impact on business

activities in a given country: sale of parliamentary

votes on laws to private interests, sale of presidential

decrees to private interests, Central Bank mishandling

of funds, sale of court decisions in criminal cases, sale

of court decisions in commercial cases, and illicit

contributions paid by private interests to political

parties and election campaigns. An analysis of this

measure also indicated that the distribution was not

normal. Therefore, the measure was transformed and,

consistent with the EBRD Transition Report (2000),

we classified countries into two groups—with favor-

able or unfavorable current condition (see Table 3 for

the lists of countries).

4.2.6. Ownership type

Respondents indicated if their firms were originally

private from the time of start-up, or if they were a result

of the privatization of a state-owned firm. They also

reported if they were a state-owned firm and, if not,

whether the legal ownership of the firm was privately- or

publicly-held (listed on a stock exchange). Using the

responses to these two questions, we categorized own-

ership type as: (1) state, (2) private/publicly-held, but

formerly state-owned, (3) emergent private/publicly-

held.

4.3. Analysis

To test our hypotheses, we conducted a series of

multivariate analysis of variance (MANOVA) proce-

dures. We first verified that a significant main effect

existed for the full model. However, to avoid loss of

information due to missing observations, each set of

hypotheses (H1, H2, H3) was examined with a sepa-

rate MANOVA procedure for each main effect.

As appropriate, post hoc analyses (using Duncan’s

multiple range test, with significant group differences

Table 1

Means, standard deviations, and correlations

Variable Mean SD 1 2 3 4 5 6 7 8 9 10 11

Informal substitutes

1. Time with

government

officials

2.72 1.42

2. Bribery 4.48 1.55 �0.11***

3. Negotiated

enforcement

3.71 1.69 �0.02 �0.24***

4. Influencing

government

2.22 0.99 0.11*** 0.03 �0.12***


5. Foreign

ownership

4.21 17.07 �0.06* 0.003 0.002 �0.01

6. Exporting 10.82 23.51 �0.08 �0.03 �0.03 �0.04 0.15***

7. External control 1.49 0.50* 0.02 0.18*** �0.06 0.13** 0.14*** �0.06

Perceptions

8. Government

services

3.62 1.19 0.10*** �0.22*** 0.23*** �0.11 �0.06* 0.04 �0.08*

9. Public services 3.47 0.95 0.13*** �0.31*** 0.14*** �0.01 �0.05 �0.06 �0.04 0.62***

10. Legal system 3.93 1.05 0.08** �0.19*** 0.28*** �0.08 �0.06* 0.06 �0.08* 0.42*** 0.42***

11. Property rights 3.90 1.90 0.09*** �0.16*** 0.18*** �0.03 �0.02 0.02 �0.09* 0.27*** 0.29*** 0.28***

12. Institutional

obstacles

2.09 0.65 0.11*** �0.22*** 0.09*** 0.06 0.03 0.05 �0.004 0.28*** 0.26*** 0.23*** 0.14***

* p < 0:05; ** p < 0:01; *** p < 0:001.


set at the p < 0:05 level) were conducted to examine

differences between groups.

5. Results

The descriptive statistics and correlations for the

variables are reported in Table 1. The results of the

MANOVA procedures are reported in Tables 2

through 4.

5.1. Initial condition

The first hypothesis concerns the influence of initial

condition and is reported in Table 2. For H1a, there

was a significant main effect (F ¼ 26:88, p < 0:001).

Firms from environments characterized by unfavor-

able initial conditions reported spending more senior

management time dealing with government officials,

using higher levels of payments, and having greater

influence on business-related governmental activities

compared to firms from favorable environments.

There was no difference in the negotiated enforce-

ment variable between the two groups. Based on

these results, support exists for H1a, as firms from

unfavorable environments were found to use more

informal substitutes compared to firms from favor-

able environments.

An overall main effect was found concerning dein-

stitutionalization activities (F ¼ 34:08, p < 0:001).

Firms from unfavorable conditions reported lower

levels of foreign ownership, lower levels of exports

and higher use of external control, compared to firms

from favorable initial condition environments. With

the exception of the use of external control these

results are in the opposite direction than posited in

our hypotheses. Therefore, our results generally do not

support H1b. Compared to firms from favorable initial

conditions, firms from unfavorable conditions were

also expected to have worse perceptions about the

institutional and governance environment (H1c). The

main effect was significant (F ¼ 18:27, p < 0:001)

and for four of the five variables (institutional obsta-

cles was not significant), firms from unfavorable

initial conditions reported higher dissatisfaction with

the components of the new institutional system com-

pared to firms with favorable initial conditions. This

finding provides strong support for H1c. In summary,

our overall conclusion is that the initial condition of an

institutional environment does influence firms’

responses to institutional upheaval.

5.2. Current condition

Our second hypothesis examines the influence of

current condition. The analysis of this hypothesis is

reported in Table 3. For H2a, there was a significant

main effect (F ¼ 5:51, p < 0:001). Firms from envir-

onments characterized by high state capture reported

spending more senior management time dealing

with government officials and using higher levels

of bribery and negotiated enforcement compared to

firms from low capture environments. There was

no difference in the use of influence on business-

related governmental regulation activities. Based on

these results, support exists for H2a as firms from

unfavorable current conditions generally used more

Table 2

MANOVA results—initial condition

Variable Initial conditiona F

Favorable Unfavorable


Time with government

officials

2.26 3.03 86.04***

Briberyb 4.65 4.27 15.77***

Negotiated enforcement 3.73 3.70 0.21

Influence government 2.09 2.38 21.92***


Foreign ownership 7.81 3.45 18.30***

Exports 19.37 7.56 80.76***

External controlc 1.44 1.52 8.14**

Perceptionsd

Government servicesy 3.29 3.73 24.29***

Public servicesy 3.12 3.68 67.81***

Legal systemy 3.75 3.91 4.16*

Property rights 3.07 3.53 20.67***

Institutional obstacles 2.16 2.08 0.14

y p < 0:10; * p < 0:05; ** p < 0:01; *** p < 0:001.a Favorable initial condition: Albania, Bulgaria, Croatia, Czech

Republic, Hungary, Poland, Romania, Slovak Republic, Slovenia.

Unfavorable initial condition: Armenia, Azerbaijan, Belarus,

Estonia, Georgia, Kazakhstan, Kyrgyzstan, Latvia, Lithuania,

Moldova, Russian Federation, Ukraine, Uzbekistan.b Lower values indicate more bribery.c 1: internal; 2: external.d Higher values indicate more negative perceptions.


informal substitutes compared to firms from favor-

able environments.

A significant main effect was found concerning the

perceptual response (F ¼ 11:30, p < 0:001). Firms in

high capture environments reported higher dissatisfac-

tion with the components of the new institutional

arrangements compared to low capture environments,

with the exception of institutional obstacles, where

there was no difference. Overall, this finding provides

support for H2b. In summary, based on the results

shown in Table 3, we conclude that the current con-

dition of a country has a significant effect on firms’

responses to institutional upheaval.

5.3. Ownership type

The third hypothesis suggests that the ownership

type of a firm will influence the response of the firm to

institutional upheaval. The analysis examining this

effect is shown in Table 4. For H3a, there was a

statistically significant main effect (F ¼ 12:01,

p < 0:001). State firms reported more time spent with

government officials compared to emergent firms.

Bribery varied between each type, with emergent

Table 3

MANOVA results—current condition

Variable State capturea F

Favorable Unfavorable


Time with government

officials

2.64 2.90 10.12**

Briberyb 4.57 4.28 11.45***

Negotiated enforcement 3.57 3.79 5.30*

Influence government 2.35 2.26 2.56

Perceptionsc

Government servicesy 3.19 3.77 41.95***

Public servicesy 3.21 3.59 28.98***

Legal systemy 3.63 3.98 21.11***

Property rights 3.01 3.55 27.54***

Institutional obstacles 2.11 2.12 0.02

y p < 0:10; * p < 0:05; ** p < 0:01; *** p < 0:001.a Favorable current condition (low state capture): Albania,

Armenia, Belarus, the Czech Republic, Estonia, Hungary, Kazakh-

stan, Lithuania, Poland, Slovenia, Uzbekistan. Unfavorable current

condition (high state capture): Azerbaijan, Bulgaria, Croatia,

Georgia, Kyrgyzstan, Latvia, Moldova, Romania, Russian Federa-

tion, Slovak Republic, Ukraine.b Lower values indicate more bribery.c Higher values indicate more negative perceptions.

Table 4

MANOVA results—ownership type

Variable Ownership type F

State (n ¼ 541) Former state (n ¼ 624) Emergent (n ¼ 558)


Time with government officials (e) 2.94 2.78 2.70 2.91*

Bribery (c)a 4.78 4.44 3.97 28.13***

Negotiated enforcement (a) 3.43 3.90 3.75 8.55***

Influence government (d) 2.48 2.25 2.17 9.97***


Foreign ownership (a) 1.54 13.36 9.90 8.59***

Exports 37.46 37.53 31.30 2.09

External control (b)b 1.71 1.62 1.36 20.36***

Perceptionsc

Government services (a) 3.19 3.68 3.76 16.05***

Public services (a) 3.28 3.45 3.61 7.06**

Legal system (a) 3.68 3.90 3.96 5.00**

Property rights (a) 3.02 3.50 3.49 10.03***

Institutional obstacles (a) 1.98 2.22 2.13 8.01***

Duncan’s test: (a) state < former state and emergent; (b) emergent < former state and state; (c) state < former state < emergent; (d) emergent

and former state < state; (e) state > emergent. * p < 0:05; ** p < 0:01; *** p < 0:001.a Lower values indicate more bribery.b 1: internal, 2: external.c Higher values indicate more negative perceptions.


firms reporting the highest level of bribery, while

state-owned firms reported the lowest level. Former

state and emergent firms reported higher use of nego-

tiated enforcement compared to state firms and state

firms reported having greater influence on business-

related governmental activities compared to both for-

merly state-affiliated and emergent firms. Thus, the

results are mixed for H3a, with the bribery and

negotiated enforcement variables as expected, the

time spent with government officials and the influence

government variable significant, but in the opposite

direction of what was posited.

For the deinstitutionalization hypothesis (H3b), the

overall effect was significant (F ¼ 45:57, p < 0:001).

The former state and emergent firms reported a sig-

nificantly higher level of foreign ownership compared

to state firms. The emergent firms reported the lowest

level of exports. The state firms reported the highest

use of external control and the emergent firms reported

the lowest use of external control. Thus, our findings

provide moderate support for H3b. Consistent with our

expectations, state and former state firms engaged in

more deinstitutionalization activity in the form of

external control and exporting than emergent firms.

However, counter to our expectations, state firms had

the lowest level of foreign ownership.

The final hypothesis (H3c) suggests that state firms

will have more positive perceptions about the envir-

onment than both former state and emergent firms.

This hypothesis is supported, as the main effect is

significant (F ¼ 4:80, p < 0:01) and each component

of the institutional context is viewed more favorably

by state firms than either formerly state-affiliated or

emergent firms.

6. Discussion and conclusions

We conducted this study to better understand the

responses of organizations to institutional upheaval,

particularly the fall of communism in transition econo-

mies, which led to a radical change of the corporate

governance systems in these countries. Our model

and findings provide an explanation of why the

liberalization and privatization of these economies

has not resulted in a fully developed market-based

governance arrangement. This study also attempts to

explain why firm responses to these changes will vary.

Our theorizing and examination of these issues was

guided by institutional theory, which we believe pro-

vides a very insightful approach.

6.1. Contribution and future research

6.1.1. Initial condition

Generally consistent with our model, the results

suggest that firm responses to institutional upheaval

are influenced by three types of embeddedness (initial

condition, current condition, and ownership type).

Initial condition has a strong effect on responses to

upheaval, particularly the use of informal substitutes

and perceptual responses. Unfavorable initial condi-

tions are associated with actions that circumvent, or

attempt to correct, the institutional imperfection and

lead to worse/more negative perceptions about the

institutional and governance contexts. It is important

to reiterate that the initial condition is captured at a

point in time that precedes the organizational response

measurement by approximately a decade. Despite this

time lag, the organizational responses are quite dis-

tinguishable. This result suggests that the embedded-

ness of firms within their institutional context, even

after extreme and radical change, has a lasting and

pervasive influence. Our study not only confirmed

arguments and observations offered in the governance

literature on transition economies (e.g., McCarthy &

Puffer, 2002a; Peng, 2003), but it also attempted to

provide a theoretical explanation of this effect.

Although the upheaval dismantled the old institu-

tional arrangements, the ability of firms to embrace

new institutional templates appears to be constrained

by their initial starting point. This result, the impor-

tance of the initial condition, is also a potentially

important result for institutional theory and research.

While institutional theory clearly recognizes the influ-

ence of conditions exogenous to an organization, less

attention is given to their initial state. If a similar initial

state leads to isomorphism among organizations (in

addition to current institutional pressures), then pay-

ing more attention, both theoretically and empirically,

to this initial state is important to understanding

institutional processes and outcomes.

Scott observes that ‘‘empirical studies of deinstitu-

tionalization are relatively rare’’ (2001: 183). While

we attempted to provide some insight into this activity,

our results concerning deinstitutionalization responses


are mixed. As expected, compared to favorable initial

conditions, unfavorable conditions were associated

with a higher use of external control. Counter to

our expectations, these firms had a lower level of

foreign ownership and export activities. The results

for ownership type were also mixed. A possible reason

for these results may be the limitations due to the use

of secondary data to measure deinstitutionalization

activities. In addition, foreign investment decisions are

not fully determined by the focal firm. In part, invest-

ments will flow to firms in attractive markets, firms in

progressive transitional environments, and firms that

have the potential to produce products appealing to

outside markets, even though other firms may need

them more to be able to deinstitutionalize. Further-

more, firms may seek outside investors for reasons

different from deinstitutionalization, such as raising

capital when the local financial markets are under-

developed (Hitt, Dacin, Levitas, Edhec, & Borza,

2000). Finally, we should note that there might be a

disconnect between the need for deinstitutionalization

and the actual deinstitutionalization activities. It is

possible that firms with the highest need for deinsti-

tutionalization may in fact be in the worst position to

take such actions because of inertia and other con-

straints. We would call for future research to further

develop and examine deinstitutionalization in the

context of upheaval.

6.1.2. Current condition

We also found that current condition influences

organizational responses to upheaval, such that firms

from unfavorable countries use more informal sub-

stitutes and have worse perceptions about the institu-

tional arrangements compared to firms from favorable

countries. This result, combined with the findings

concerning initial condition, supports the proposition

that organizations are indeed attempting to correct for

institutional imperfection that results from upheaval.

The use of informal substitutes apparently compen-

sates for the underdeveloped institutional and govern-

ance systems, as previously suggested by Peng (2003),

Peng and Heath (1996), North (1990), Xin and Pearce

(1996). However, such informal strategies might be

inconsistent with the market model and may actually

impede the establishment of the new governance

structures, norms, and value. Thus, while understand-

able, such informal substitutes (e.g., using bribes to

secure economic transactions or purchase favorable

treatment) can be detrimental or can change the

transition trajectory. Further examination of this com-

plex transition process as well as the possibilities to

proactively speed it up would be of great theoretical

and practical significance.

6.1.3. Ownership type

We found support for the importance of ownership

type as well. State firms generally use less informal

substitutes than former state and emergent firms.

These firms do not engage in more deinstitutionaliza-

tion activities. Presumably they are being somewhat

buffered from the upheaval such that they either

confront less imperfection or the imperfection has

little direct effect on their activities. As a consequence,

these firms may feel less of a need to change old

templates. This sustained embeddedness is thereby

accompanied with relatively favorable perceptual

responses with respect to the institutional and govern-

ance systems in the environment. Observing state

firms over a longer period of time would be insightful

in understanding if this position is effective and

sustainable, or if these firms are simply postponing

or prolonging deinstitutionalization and change pro-

cesses. The latter would be consistent with Peng’s

(2003) idea that the reforms in a transition economy

may advance to a degree (the ‘‘inflection point’’)

where the formal arrangements of the new governance

system are so well developed that firms using the

informal networks (i.e., ‘‘informal substitutes’’ in

our terminology) will find themselves no longer effi-

cient and will have to transform accordingly.

Perhaps an indirect approach to assessing this issue

is through examining performance. We did not

develop performance hypotheses because we were

primarily interested in firm responses to upheaval

and because performance is influenced by a wide

set of variables. However, it is interesting to observe

that the average sales growth for the three years

preceding the survey varied significantly (F ¼ 4:20,

p < 0:002), with state firms (8.96%) and former state

firms (11.13%) having lower reported sales growth

compared to emergent firms (31.33%). This finding is

robust even after controlling for organizational size

and age. Thus, consistent with Newman’s (2000) basic

argument, the embeddedness in the old system seems

to hinder firms from deinstitutionalizing and may


result in an inability or inhibited capability to adapt.

As she observes, ‘‘It is difficult to learn from experi-

ence during periods of significant institutional change,

because past experience is no longer an appropriate

guide for future action (Weick, 1979) . . . when insti-

tutional-level change is too extreme, when the under-

lying values, ideologies, and norms in society are in

question, and when the economic and political sys-

tems are in disarray, it is difficult for managers to

coalesce around a new set of value commitments and

almost impossible to find the ‘right’ new organizing

template’’ (2000: 605). State firms may be exemplify-

ing this description.

It is interesting that former state and emergent firms

appear to develop similar responses to upheaval

(including informal substitutes, deinstitutionalization

activities, and perceptions), which we did not antici-

pate. We expected a difference based on the organiza-

tional history, and therefore the larger institutional

baggage, of the former state firms. An interesting

explanation of this similarity might be that the institu-

tional baggage is determined not only by the organi-

zational history but is mostly ingrained in the

cognitive templates carried by the individual members

of a society. Thus, individuals who are starting new

firms, may bring with themselves essentially the same

values and beliefs as individuals moving into priva-

tized firms. The interesting theoretical implication of

this observation is that the actual building block for

radical change might be the individual. Therefore, the

organizational and government initiatives aimed at

improving the transition after upheaval should be

focused on changing individual values and beliefs.

An interesting distinction between the former state

and emergent firms is that emergent firms use more

bribery and less external control agents. This is prob-

ably so because emergent firms lack the external

informal networks and thus are more vulnerable in

the changing environment. It is also possible that

emergent firms are in a way experimenting or devising

their own templates, which may require the purchase

of additional institutional support through informal

(or illegitimate) activities.

6.2. Conclusions and implications

Considering institutional theory, this paper suggests

the potential use of alternative explanatory mechanisms

for explaining institutional effects. Unlike the mecha-

nisms of coercive, mimetic, and normative pressures

that are mostly used in institutional theory-based

models, we employed the notions of institutional

imperfection and institutional baggage. The corre-

sponding needs to correct imperfections and deinsti-

tutionalize, thereby, provided a means to frame firm

responses as they are striving to survive amid the

turmoil. We believe these mechanisms hold promise

for future research examining firms behaviors during

radical change, when the institutional environment is

underdeveloped and there is a limited understanding

of what is legitimate as well as who are the legitimat-

ing actors.

Addressing corporate governance, our paper

attempts to provide an explanation of ideas that have

been previously observed and described in the litera-

ture. For example, Johnson et al. (2000) observe that

the implicit assumption underlying privatization

seems to be that once organizations are subject to

new market forces, these forces will naturally initiate

desired changes in work processes. Based on our

study, we can suggest that much of what firms actually

do will be determined by the contexts in which firms

are embedded, and that under certain conditions,

firms will engage in behaviors counter to the market-

based model. This will be particularly likely when the

initial position of the firm is substantially different

from the desired end state, when firms are deeply

embedded in that initial state, and when there is an

inadequate level of understanding of the desired end

model. While these inconsistencies may be consid-

ered temporary experimental activities, they may

also be viewed as new emerging scripts or templates.

This may require, in turn, further shocks and deinsi-

titutionalization processes before the desired market-

based templates and arrangements will be esta-

blished. Newman (2000: 602) asserts that extreme

changes in the institutional context may inhibit orga-

nizational transformation, as the upheaval hinders

organizational learning. Without adequate organiza-

tional elites or formulated institutional pressures

(e.g., regulation), perhaps such learning is based on

expedient economic survival rather than an idealized

market model.

These ideas are important to consider when study-

ing corporate governance. They are in line with those

who emphasize the cultural constraints on corporate


governance models in general, and the ones developing

in transition economies, in particular (e.g., McCarthy

& Puffer, 2002a). Apparently, governance is best

understood by also understanding the cultural and

historical context. This would include not simply

end-states of changing governance systems, but also

the dynamics and path dependency of moving towards

this end-state. Consequently, it may be more important

to give additional attention to the specific conditions

surrounding the evolution of corporate governance in a

particular country. Furthermore, any cross-country

comparative discussions should be substantiated with

a deeper examination of the contextual factors shaping

the national governance systems. Thus, using common

and simple indexes to compare the progress that

countries and firms have made to transform them-

selves towards the market model may not adequately

reflect the actual national systems of corporate gov-

ernance. Research based on multiple disciplines and

perspectives may be much more adequate to study the

complex issues of corporate governance in transition

economies.

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