A matter of time: The influence of underperformance duration on corporate misconduct

• Published date: 01 March 2024
• Author: Amy Tong Zhao,Shufeng Xiao
• Date: 01 March 2024
• DOI: http://doi.org/10.1111/corg.12526

ORIGINAL ARTICLE

A matter of time: The influence of underperformance duration

on corporate misconduct

Amy Tong Zhao

1

| Shufeng Xiao

2

1

Department of Organization and Strategy

Management, Guanghua School of

Management, Peking University, No.

5 Yiheyuan Road, Haidian District, Beijing

100871, China

2

Department of Strategy, Innovation, and

Entrepreneurship, School of Management,

Shandong University, No. 27 Shandanan Road,

Licheng District, Jinan 250100, China

Correspondence

Shufeng Xiao, Department of Strategy,

Innovation, and Entrepreneurship, School of

Management, Shandong University,

No. 27 Shandanan Road, Licheng District,

Jinan 250100, China.

Email: xiaoshufeng@sdu.edu.cn

Funding information

National Natural Science Foundation of China,

Grant/Award Number: 72202124

Abstract

Research Question/Issue: This study examines firms' reactions to the duration of

underperformance. We posit that firms are more likely to engage in misconduct to

solve the problem of underperformance as the length of time a firm has been under-

performing prolongs. Further, we investigate how divergent external governance

actors shape underperforming firms' motivation for misconduct and consequently

affect their responses to underperformance duration.

Research Findings/Insights: Using bivariate probit estimations for panel data of

2662 Chinese publicly listed firms during 2007–2018, we uncover that underperfor-

mance duration is positively associated with the likelihood of a corporate misconduct

commission. In addition, the positive relationship between the duration of firm

underperformance and corporate misconduct is mitigated by the level of state own-

ership but reinforced by the number of analysts covering the firm.

Theoretical/Academic Implications: This study extends the behavioral theory of the

firm by incorporating the construct of underperformance duration from a time per-

spective, which is a proactive signal of firms' illicit decisions. We show that the dura-

tion of underperformance is positively associated with the likelihood of corporate

misconduct, which is moderated by the firms' external governance actors who have

different time pressures to solve financial problems.

Practitioner/Policy Implications: This study offers insights for regulators interested

in the prevention of ex-ant misconduct. Identifying underperformance duration as a

critical predictor of illegal activities helps to improve regulators' vigilance. Moreover,

a holistic executive evaluation system that shows more tolerance for short-term

underperformance is needed.

KEYWORDS

corporate governance, misconduct, behavioral theory, underperformance duration, time

1|INTRODUCTION

Corporate misconduct is prevalent and widely occurs both in develop-

ing and developed countries in recent years (Amiram et al., 2018;

Ernst & Young, 2016). Corporate misconduct refers to organizational

behavior that violates laws, social norms, or ethical rules differentiat-

ing right and wrong (Greve et al., 2010). In the United States, about

11% of large publicly traded firms commit securities fraud every year

(Dyck et al., 2021). In China, around 17% of Chinese listed companies

perpetrate misconduct each year (Zhao et al., 2021). Scholars from

different disciplines are concerned about corporate misconduct

because its potential consequences are far beyond what organizations

are capable to deal with, which can not only harm the reputation of

the focal firm (Fich & Shivdasani, 2007; Graffin et al., 2013; He et al.,

Received: 21 March 2022 Revised: 5 March 2023 Accepted: 6 March 2023

DOI: 10.1111/corg.12526

228 © 2023 John Wiley & Sons Ltd. Corp Govern Int Rev. 2024;32:228–248.wileyonlinelibrary.com/journal/corg

2020) but also disturb the order of the capital market and cause

unpredictable losses to society (Bowen et al., 2010;

Szwajkowski, 1985).

Prior studies on corporate governance have developed an extant

body of literature explaining the antecedents of corporate misconduct

(for reviews, see Culiberg & Miheliˇ

c, 2017; McKendall &

Wagner, 1997; Schnatterly et al., 2018). Among the performance-

driven misconduct literature, the impact of the performance gap on

misconduct has long been discussed. The behavioral theory of the

firm (BTOF) proposes a performance feedback mechanism through

which the strategic decisions are made, that is, aspiration serves as a

crucial reference point that helps decision-makers classify a firm as

either “success”or “failure”; performance below aspiration, that is,

underperformance, triggers a problemistic search for solutions

(Cyert & March, 1963; Gavetti et al., 2012; Greve, 2003). For example,

some scholars argue that the larger a firm's underperformance short-

fall, the higher the likelihood of misconduct is as it tends to take

higher risk-taking actions to achieve aspiration (e.g., Davis et al., 2021;

Harris & Bromiley, 2007; Ren et al., 2022), while others suggest that

firms with performance above aspiration are more inclined to engage

in misconduct due to loss aversion (e.g., Mishina et al., 2010). Thus,

prior research finds an inconsistent relationship between performance

intensity and the likelihood of a firm's misconduct activities.

Although the problemistic search has received large support in

empirical studies (e.g., Chen & Miller, 2007; Gonsalves, 2023;Xu

et al., 2019), our understanding of this process is far from complete

because our knowledge from existing studies is restricted to the

intensity of performance feedback. This single-dimensional focus on

underperformance intensity limits the explanatory power of perfor-

mance feedback, neglecting the influence of other important dimen-

sions of underperformance (Shinkle, 2012; Wiggins & Ruefli, 2002).

Recently, some scholars began to recognize the importance of the

temporal dimension of underperformance—duration—which is defined

as the persistent time that the actual performance of a firm is below

the aspiration, in influencing how firms evaluate different alternative

solutions (Yu et al., 2019). Compared with underperformance inten-

sity, which describes the level of performance gap departing from

aspiration, underperformance duration depicts the time that a firm's

performance has been lagging behind and shapes decision-makers dif-

ferently in the attribution and interpretation of feedback (Haleblian &

Rajagopalan, 2005; Piening et al., 2021). As underperformance dura-

tion incorporates the state of performance feedback over a while, it

allows researchers to examine the temporal cumulative effect of

underperformance (Hoorani et al., 2023), while underperformance

intensity captures the performance feedback at a particular point in

time, and the existing research has provided many insights into the

influence of current underperformance on firms' behaviors.

Following this line of inquiry, we investigate whether and how

underperformance duration dynamically influences firms' moral deci-

sions on misconduct. Rational decision-makers usually do not rashly

respond to a temporary performance signal but comprehensively

interpret the reliability of performance signals by analyzing the consis-

tency between the specific signal and multiple performance signals

within a duration of time (Gao et al., 2008). Therefore, we contend

that the temporal construct, that is, underperformance duration, can

provide additional insights into firms' strategic responses to perfor-

mance shortfall with misconduct. Persistent underperformance stimu-

lus is more probable to be considered as the real “poor”performance,

and decision-makers will attribute the failure to internal organizational

factors, triggering firms to adaptively problemistic search to restore

performance as soon as possible (Piening et al., 2021). Thus, we argue

that a firm's underperformance duration is positively associated with

the likelihood of corporate misconduct.

In addition, given that the original BTOF also indicates that a

firm's problemistic search in response to underperformance pressure

may be conditional upon the goals of the organization (Cyert &

March, 1963), we further explore the variations in firms' actions in

response to underperformance duration—Why do some firms, but not

others, rush to undertake misconduct in response to long-time under-

performance? We argue that a firm's response to the duration of

underperformance depends on the goal priorities of governance

actors. Since prior studies imply the lack of effectiveness of internal

governance actors in China (Xi, 2006; Xiao et al., 2004; Yang

et al., 2017), we focus on the conditional effect of external gover-

nance actors. Specifically, we suggest that state ownership alleviates

the impacts of underperformance duration on misconduct because it

is a secondary priority to achieving financial performance (Sun &

Tong, 2003), reducing firms' motivation to solve the problem of

underperformance at the expense of the firm's legitimacy, while finan-

cial analysts enhance the positive effects of underperformance dura-

tion on misconduct because the attention of more analysts places

additional time pressure on firms to meet short-term performance tar-

gets (He & Tian, 2013; Zhang & Gimeno, 2016).

To test the hypothesized relationships, we adopt a sample of pub-

licly Chinese listed firms between 2007 and 2018. China provides an

appropriate context for this research, as the weak legal system makes

corporate misconduct a prominent issue (Ding et al., 2010). Although

we are interested in firms that commit misconduct, we can only iden-

tify the firms that have been detected by the China Securities Regula-

tory Commission (CSRC). We therefore test our predictions using

bivariate probit estimation, which can distinguish the commission of

corporate misconduct from the detection of misconduct, thereby

reducing partial observability bias.

Our study makes several contributions. First, this study makes

contributions to organizational misconduct literature (Greve

et al., 2010; Palmer, 2017) by identifying an important but neglected

impact of the temporal dimension of underperformance. On one hand,

existing research on corporate misconduct mainly focuses on the

intensity attribute of performance feedback, which limits the explana-

tory power of underperformance. On the other hand, existing

research makes inconsistent conclusions about the influence of

underperformance intensity on corporate misconduct (e.g., Davis

et al., 2021; Harris & Bromiley, 2007; Ren et al., 2022). In recent

years, the antecedents of corporate misconduct have attracted not

only the attention of scholars but also the interest of the public. This

study examines the influence of the persistent duration of

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