Corporate Turnarounds: An Experimental Examination

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For decades, organizational change has been a topic of interest for scholars in economics and management. A particularly difficult and important sort of change occurs when under performing firms attempt to reinvent themselves. For such firms, executing a successful turnaround can determine whether the firm survives with both shareholder profits and employee security riding on the outcome. Understanding how to most efficiently turn around failing companies is therefore a topic of great economic import. Complicating such turnarounds, a need for coordinated changes in behavior and expectations often exists across widely diverse groups of managers and employees. Intuitively, this is like revamping a football team's passing game - signing the greatest wide receivers in the history of the NFL won't help if the quarterback keeps throwing the ball ten yards over their heads. To quote one well-known case study of a corporate turnaround, efforts to change the firm need to be 'right-away and all at once' (Knez and Simester, in press). In this study we examine how such coordinated changes across a firm can be made most effectively, and how the resulting improvements can be made permanent.To examine these questions, we plan to use controlled laboratory experiments to study corporate turnarounds. Such experiments serve as a valuable complement to field studies of corporate turnarounds because they allow us to look at a tightly controlled environment where we can easily observe all the possible causes of change. Our experiments look at the performance of a small simulated firm. Using a simple environment, we first push the experimental firm into a situation where it is performing poorly. Firm employees are coordinated on low effort levels, causing low productivity and producing low payoffs for both the firm and the employees. Critically, there exist alternative situations in which employees coordinate on higher effort levels, productivity is dramatically increased, and both firm and employees earn higher payoffs. Our study then focuses on two issues. First, how can the firm most efficiently be extricated from its bad situation and moved to a good situation? Possible tools we plan to examine include changes in the firm's incentive system for employees, improved communication within the firm, and the provision of high performing external examples. Second, does behavior by agents within the firm display sufficiently strong history dependence that a shift to a better situation can be maintained even after the mechanisms used to affect the change are removed? For example, suppose a good outcome is affected through a large increase in incentive pay. Can the firm increase the incentive pay without employees sliding back to their old unproductive ways?