Much of the attention in the risk literature focuses on organizational risk. This research argues that industry-level risk indirectly influences firm performance in addition to the direct effects of organizational risk. We contend industry-level risk norms influence market performance. Our general hypothesis is that when managers pursue strategies that deviate from industry risk norms, the firm's market performance will decline. We also test for the moderating effects of performance relative to targets and managerial ownership. The general hypothesis was supported for market risk and returns risk, but not for strategic risk. In addition, performance relative to target moderates this deviation-market performance relationship for market and returns risk. These findings have implications for the risk literature, particularly a firm's risk premium, and institutional theory, in terms of the tradeoff related to conformity to norms.
Risk is a critical component of strategic management due to its influence on managerial decisions and organizational performance. Behavioral and agency explanations of the risk avoiding/seeking choices of managers have been supported by numerous scholars (Bromiley et al., 2001), providing evidence of strong linkages between firm risk, managerial choice and organizational performance (e.g., Bromiley, 1991, Miller and Bromiley, 1990, Miller and Leiblein, 1996, Palmer and Wiseman, 1999, Singh, 1986 and Wiseman and Bromiley, 1996). These findings center on multiple dimensions of risk at the organizational level.
However, risk at the industry level also appears to be relevant to strategists. Prior research supports an indirect effect of industry risk factors on firm risk, managerial risk-taking, and performance (e.g., Bettis and Hall, 1982, Fiegenbaum and Thomas, 1986, Lubatkin and O'Neill, 1987 and Palmer and Wiseman, 1999). Industry risk characteristics have also often been included as control or categorization variables.
Other perspectives suggest a direct effect of industry risk. Financial theory suggests investors' market risk assessments, i.e., systematic and unsystematic risk, are influenced by industry structure (Lubatkin and Chatterjee, 1994 and Lubatkin and O'Neill, 1987). New conceptualizations of the risk premium, critical to the valuation of companies, involve the pressures and norms present in the industry (Chatterjee et al., 1999). Investors appear to form expectations of firm risk based upon the risk levels of industry participants.
These arguments related to the risk premium suggest that industry risk impacts the firm's market performance. Institutional theory indicates an important role for industry risk through the pressures faced by firms from the external environment that demand certain types of actions (DiMaggio and Powell, 1983 and Meyer and Rowan, 1977). Outside stakeholders can pressure firms to conform to industry norms. Conformity can lead to legitimacy and economic gains (Oliver, 1991), and superior performance (Chen and Hambrick, 1995, Deephouse, 1999 and Geletkanycz and Hambrick, 1997), while non-conformity can lead to negative consequences.
We argue that industry norms exist for multiple dimensions of risk: strategic risk, returns variability, and market risk. Extending the arguments of Chatterjee et al. (1999), we suggest that investors form expectations for organizational risk based upon industry-level risk. Deviation from such norms may lead to shareholder losses, more difficulty garnering support from constituents, or higher resource acquisition costs (Geletkanycz and Hambrick, 1997, Deephouse, 1999 and McNamara et al., 2003). Our main hypothesis is that firms will be penalized by investors with reduced market performance for pursuing strategies with substantially higher or lower levels of risk relative to industry norms. We use behavioral and agency arguments to demonstrate that performance relative to targets and managerial ownership may moderate our general alignment hypothesis.
The findings highlight the critical role that industry risk, in the form of norms, plays in determining market performance. Furthermore, our findings extend the model of risk premium proposed by Chatterjee et al. (1999) to include a broader conceptualization of the role of industry risk norms, with norms existing along multiple dimensions. Moving beyond industry risk characteristics as a control or antecedent, this research provides a more detailed picture of the role of industry risk in the risk-strategy-performance model.
