The Nature Of Firm Strategy And Its Governance Effects

After more than half a century’s development, a jungle of strategictheories has been formed with regard to firm strategy and strategicmanagement. However, in recent years, the firm strategy theories seem tohave encountered a bottleneck—the traditional paradigm which takes apersonified firm as the basic analytical unit seem to be incapable ofgiving a satisfying answer to such questions as why firm strategy existsand what its nature is. This thesis follows the mainstream paradigm of thetheory of the firm, viewing the firm as a bundle of contracts amongvarious investors who input production factors; and taking not apersonified firm but transaction or contract as the basic analytical unit itexplores the basic issues of firm strategy. Therefore, this thesis, takingtransaction or contract as the basic analytical unit, and based on theTheory of the Firm, Transaction Cost Economics, Agency Theory and other relevant theories, together with findings from the firm strategy andstrategic management theories, aims to summarize the concept of firmstrategy, seek evidence for its existence, grasp its nature and investigateits governance effects; and ultimately to guide the practice of strategicmanagement and corporate governance as well as to contribute to thetheory of firm strategy.This thesis is mainly a theoretical research supplemented by anempirical research. In the theoretical research, Chapter3is the core of thelogical framework. By combining the research background in Chapter1and the literature review and definition of firm strategy in Chapter2,Chapter3focuses on exploring the origin of firm strategy, proposing twoaspects of its nature—organizational rationality and credible commitment,and investigating the governance effects of firm strategy. On the basis ofChapter3, the two aspects of nature of firm strategy—organizationalrationality and credible commitment are demonstrated respectively in Chapter4and Chapter5; while in Chapter6, the governance effects ofthe firm strategy process are discussed from the two stages of strategyformulation and strategy implementation. The empirical research of thisthesis is to further test the inductive and deductive conclusions from thetheoretical research. In Chapter7, firstly, by analyzing the officialstatement of the strategy in the study samples by means of contentanalysis, this thesis confirms that the statement of firm strategy indeedreflects the nature of organizational rationality and credible commitment;secondly, statistical analysis and regression analysis are used to examinethe impact of firm strategy on the agency costs in companies and on theincentive alignment between managers and shareholders, and the impactof the outcome of strategy implementation on corporate value andmanagers’ turnover. Through empirical study, this thesis further confirmsmost conclusions of the theoretical research. The first conclusion of this thesis explains the reason to theexistence of firm strategy. By taking transaction or contract as the basicanalytical unit, this thesis believes that the central party to the contractsor the managers of the firm will ex ante consider the rationality of theirown and other contractors’ to determine the future decisions, objectivesand plans regarding resource allocation and make commitmentssubsequently, which helps form a common goal and a rationalexpectation within the firm, and facilitates the transmission ofinformation, thereby reducing managers’ shirking and holdup behaviorsand decreasing the management costs. Therefore, this thesis believes,after the appearance of the firm, the reason to the existence of firmstrategy lies in the saving of management costs—costs spent onorganizing resources within the firm.Based on analysis about the origin of firm strategy, the secondconclusion of this thesis is—the nature of firm strategy lies in organizational rationality and credible commitment. In moderncorporations, since a firm’s strategy is formulated ex ante, managers haveto accept influence from shareholders, the board of directors and otherstakeholders in formulating the strategy, thus the final strategy would bea consensus among all corporate stakeholders. The reason to therealization of such a consensus lies in the fact that among all types ofstakeholders, there is not only interest divergence, there is also and moreimportantly, interest consistency, therefore a strategic consensus reflectsthe organizational rationality. The organizational rationality impliescoordination and compromise of rational interest among all stakeholdersof the firm. Although the strategic consensus is reached among allstakeholders under the dynamism of organizational rationality, the actualauthority of resource allocation is still rested in the managers; therefore,to guarantee the realization of organizational rationality managers stillneed to make commitments to future decisions, objectives and plans regarding resources allocation. Since the presence of the incentive andsupervision mechanism on managers can increase their default cost andstrengthen penalties for their breach of the contracts, the strategiccommitment is credible; therefore credible commitment constitutesanother aspect of the nature of firm strategy.The third conclusion of this thesis believes that corporategovernance is the mechanisms that ensure shareholders get satisfyingresidual earnings, managers and other stakeholders get normal interestsand the contracts inside and outside the corporate core structure can bereached. The organizational rationality aspect of firm strategy canimprove the extent of incentive alignment between managers andshareholders and then reduce the residual loss; the credible commitmentaspect of firm strategy, on the other hand, can provide the board ofdirectors a tool to supervise managers, thus reducing both the monitoringexpenditures and the bonding expenditures; therefore, the firm strategy can reduce agency costs, promote the realization of the contract, andexert governance effects. Specifically, the governance effects of the firmstrategy process can be reflected in two stages—strategy formulation andstrategy implementation, which shows that the firm strategy process canpromote the protection of shareholders’ interests, improve the efficiencyof the board of directors, substitute the incentive mechanisms (to acertain extent), introduce the governance of stakeholders’ relationship,and strengthen the external governance mechanisms.The innovations of this thesis lie in three aspects: First, this thesisbreaks through the paradigm of traditional firm strategy theory whichtakes the firm as the basic analytical unit by assuming a personified firm,but discusses the strategic issues of firms by taking transaction orcontract as the basic analytical unit, making it easy to profoundly studysuch basic issues as the origin of firm strategy as well as its nature.Second, this thesis breaks through the practice of traditional firm strategy theory which attributes the origin of firm strategy to competitiveadvantage, but views the firm as a contract bundle and attributes theexistence of firm strategy to saving of management costs, thus apparentlyget out of the plight of traditional theories in this regard. Third, this thesisbreaks through the traditional perspective in discussing the relationshipbetween firm strategy and corporate governance which places one-sidedemphasis on impact of corporate governance on firm strategy, arguingthat firm strategy can also exert governance effcets.