Sustaining superior performance in an emerging economy: an empirical test in the Indian context

Abstract

We demonstrate a negative relationship between pro-market reforms and the sustainability of superior profits in an emerging economy. The decline in sustainability of superior profits shows that pro-market reforms bring significant threats in addition to the various opportunities such as greater availability of production factors and greater freedom to enter and operate businesses highlighted in the extant literature. Our study thus contributes to a more complete conceptual understanding of the performance consequences of pro-market reforms in emerging economies. We also show that investment in research and development and greater investments in marketing and advertising are firm-level resources that provide a measure of protection against the erosion in sustainability of superior profits associated with pro-market reforms. Copyright © 2011 John Wiley & Sons, Ltd.

Full text

Page 1

SUSTAINING SUPERIOR PERFORMANCE IN AN EMERGING ECONOMY: AN EMPIRICAL TEST IN
THE INDIAN CONTEXT


Murali D.R. Chari*
Associate Professor of Management
Indiana University South Bend
1700 Mishawaka Avenue
South Bend, IN 46634
Phone (574) 520 4291
rmuralid@iusb.edu


Parthiban David
Collis Chair in Strategic Management
Kogod School of Business
American University
4400 Massachusetts Ave NW
Washington, DC 20016-8044
Phone (405) 476 3682
parthiban.david@american.edu


*Corresponding author

Running head: Research Notes and Commentaries.
Key Words: Pro-market reforms; emerging economy; firm performance; sustained profitability; profit
persistence; India.


Acknowledgements: The authors acknowledge helpful comments and suggestions from the Associate
Editor Stephen Tallman and two anonymous reviewers. Comments and suggestions from seminar
participants at the Rutgers Business School, especially from Professor John Cantwell, are gratefully
acknowledged. The authors also thank Mr. Sethuraman of the Center for Monitoring the Indian
Economy for help with the data.

Page 2

1

SUSTAINING SUPERIOR PERFORMANCE IN AN EMERGING ECONOMY: AN EMPIRICAL TEST IN THE
INDIAN CONTEXT




















Running head: Research Notes and Commentaries
Key Words: Pro-market reforms; emerging economy; firm performance; sustained profitability; profit
persistence; India

Page 3

2


Sustaining Superior Performance in an Emerging Economy: An Empirical Test in the Indian
Context


Abstract

We demonstrate a negative relationship between pro-market reforms and the sustainability of
superior profits in an emerging economy. The decline in sustainability of superior profits shows
that pro-market reforms bring significant threats in addition to the various opportunities such as
greater availability of production factors and greater freedom to enter and operate businesses
highlighted in the extant literature. Our study thus contributes to a more complete conceptual
understanding of the performance consequences of pro-market reforms in emerging economies.
We also show that investment in R&D and greater investments in marketing and advertising are
firm level resources that provide a measure of protection against the erosion in sustainability of
superior profits associated with pro-market reforms.

Page 4

3

Introduction
Emerging economies have initiated pro-market reforms to transition their economies from closed
socialistic systems to open market based systems (Hoskisson et al., 2000). The reforms are
enacted through changes in laws and regulations to improve the functioning of product and factor
markets, including liberalization of product market entry, strengthening of shareholder and
creditor protections, and liberalization of labor laws (Cuervo-Cazurra and Dau, 2009a; Khanna
and Palepu, 2000a; Melo et al., 1996; Panagaria, 2008; Ramamurti, 2000). Because they present
a historic opportunity to study the effects of fundamental changes in country contexts, pro-
market reforms have attracted considerable scholarly attention (Peng, 2003).
Extant research has highlighted a number of opportunities that arise in emerging
economies following reform initiation. For example, following liberalization of entry into
product markets, both local and foreign firms gain greater freedom to enter and operate
businesses (Kale and Anand, 2006; Mujumdar, 2008; Piramal, 1996). The rollback of direct state
participation in the economies through privatization opens up markets that were previously
closed to private sector firms (Panagaria, 2008; Ramamurti, 2000). These liberalization measures
provide firms with growth opportunities, including greater access to large swaths of middle class
customers in emerging economies (Khanna and Palepu, 2006; Prahalad and Lieberthal, 2003).
Similarly, strengthening shareholder protection increases access to capital in the economy at
reduced prices (La Porta et al., 1997). Further, the influx of competitors following reforms
enables better comparison of managerial behavior by market participants, raising productivity
and efficiency which in turn can contribute to greater firm profits (Cuervo-Cazurra and Dau,
2009a).
Unlike the emphasis on opportunities following reform initiation in the extant literature,
we argue that the reform process also brings threats in the form of greater competition, with
implications for firm performance that require further investigation. Specifically, while
liberalization of entry indeed provides greater opportunities for incumbents to enter and exploit

Page 5

4

previously closed and less accessible markets, these opportunities can also be exploited by their
current rivals and potential entrants. Similarly, while the strengthening of shareholder and
creditor protections provides the opportunity of greater access to production factors at lower
prices, the opportunity is available not only to incumbents but also to their current rivals and
potential entrants. Therefore, while the reform process does indeed create opportunities that can
lead to greater profits as highlighted in the extant literature (Cuervo-Cazurra and Dau, 2009a), it
also strengthens competition in the economy, which we argue leads to a decline in the
sustainability of superior profits1. A decline in the sustainability of superior profits is important
because, as Porter (1991:96) notes, a firm’s success is manifested in attaining ‘superior and
sustainable financial performance.’
Rather than a onetime event, pro-market reforms are a process that unfolds over time.
Reforms are initiated with a set of changes in laws and regulations aimed at strengthening
markets, which are subsequently reinforced with more changes that further strengthen the
functioning of markets as the reform process progresses (Ramamurti, 2000). The extent of pro-
market reforms in a country thus increases as the reform process unfolds over time. We exploit
differences in the extent of pro-market reforms as the reform process has unfolded in one large
emerging economy, India, to test the relationship between pro-market reforms and sustainability
of superior profits. Using firm level data we demonstrate a negative relationship between pro-
market reforms and sustainability of superior profits, such that greater pro-market reforms are
associated with lower sustainability of superior profits. By drawing attention to the adverse effect
on sustainability of superior profits, we bring greater balance to the literature on emerging
economies which highlights various opportunities arising from the reform process. Our study
also makes a related contribution by identifying firm level resources that provide a measure of
protection against the decline in sustainability of superior profits.

1 We define sustainability of superior profits as the ability of firms to sustain financial performance that is above
the industry norm across time periods. We use the terms superior performance and superior profits
interchangeably.