Banking on Ambidexterity: A Longitudinal Study of Ambidexterity, Volatility and Performance ABSTRACT

Transcription

1 Banking on Ambidexterity: A Longitudinal Study of Ambidexterity, Volatility and Performance ABSTRACT While some argue that organizations should concentrate on only one direction in order to avoid risking mediocrity in their exploration and exploitation activities, recent literature has indicated that ambidexterity can positively affect organizational performance. The scant respondent-dependent and cross-sectional studies advanced in support of the relationship between organizational ambidexterity and performance render inconclusive the actual value of ambidexterity. Further uncertainty stems from the lack of knowledge of the antecedents of ambidexterity. In this paper, we address both the theoretical and the empirical uncertainties surrounding ambidexterity. We provide a theoretical framework that links volatility in organizational engagement in exploration and exploitation, ambidexterity and firm performance. We argue that such volatility hampers the learning required for the attainment of ambidexterity, rendering the organization unable to reap the benefits of simultaneously executing exploration and exploitation. We further argue that ambidexterity in turn mediates the relationship between volatility and firm performance. A longitudinal analysis of 467 bankyear observations collected from the Norwegian banking industry over the period 1995 to 2003 provides strong empirical support for our theoretical model. Keywords: Ambidextrous organization, banking, longitudinal analysis. 1

2 Banking on Ambidexterity: A Longitudinal Study of Ambidexterity, Volatility and Performance While exploration and exploitation are necessary for enhancing an organization s performance, the simultaneous pursuit of exploration and exploitation has long been considered a major organizational challenge (see further: March, 1991; Tushman & O'Reilly, 1996). Research has identified a variety of organizational arrangements, including structural, task and temporal separations, and an organizational context, that enable organizations to exploit current resources and capabilities and simultaneously explore new territories (Benner & Tushman, 2003; Gibson & Birkinshaw, 2004; Tushman & O'Reilly, 1996). Some researchers, however, doubt whether ambidexterity, the simultaneous pursuit of exploration and exploitation activities, enhances performance, arguing that organizations should primarily concentrate on their resources, management routines and knowledge flows in only one direction so as to avoid running the risk of being mediocre at both (for further discussion see: Lubatkin et al., 2006; Raisch & Birkinshaw, 2008). The uncertainty surrounding the actual value of ambidexterity stems from both theoretical and empirical issues. A theory that explicates the emergence of ambidexterity is absent (Alder et al., 1999; Gibson & Birkinshaw, 2004). While the key research question is '[H]ow does a business unit become ambidextrous?' (Gibson & Birkinshaw, 2004: 212), previous studies have advanced conditions, such as temporal, task and structure segregations and empowerment initiatives (see: Gibson & Birkinshaw, 2004), under which ambidexterity may materialize. There is a need to further specify the factors that directly impact ambidexterity in the first place prior to examining its actual value as well as consider mediators that may affect the ambidexterity-performance relationship (Raisch et al., 2009). The lack of knowledge of such factors distorts the evaluation of the viability of the investment 2

3 required, prevents the appreciation of the cost and time involved as well as prevents a constructive debate on the costs and benefits of embarking on the journey to ambidexterity. From a methodological point of view, the current research can be improved on four important points. First, the scant empirical work that directly addresses the ambidexterity hypothesis is cross-sectional in nature (Gibson & Birkinshaw, 2004; He & Wong, 2004; Lubatkin et al., 2006). Research has been advanced elucidating anecdotal evidence (Tushman & O'Reilly, 1996, 1997), simulation studies (e.g., Rivkin & Siggelkow, 2003) and crosssectional surveys (e.g., Gibson & Birkinshaw, 2004; He & Wong, 2004; Jansen et al., 2009) in studying organizational ambidexterity. Second, research relies on perceptual ambidexterity as well as on self-reported perceptual performance. Third, it utilizes very heterogeneous samples but assumes that the dissimilar organizations studied should all strive to use the same, identical, levels of exploration and exploitation. Finally, the empirical work directly addressing the viability of the ambidexterity hypothesis discounts the dimension of time, which is so central for the materialization of the effects of exploration and exploitation on performance (March, 1991). Studies that take a longitudinal perspective of organizational ambidexterity are scarce (Raisch, et al., 2009: 693). Uncertainty with regard to how ambidexterity can be achieved and to the value of ambidexterity presents a challenge for organizations in deciding whether to either focus on one direction only or explore and exploit simultaneously (Lubatkin et al., 2006). In this paper, we directly address the issue of underspecified antecedents of organizational ambidexterity by theorizing how volatility in organizational behavior with respect to exploration and exploitation affects the attainment of ambidexterity and firm performance. Volatility refers to the instability of a firm s utilization of exploration and exploitation. We argue that high volatility injects uncertainty into the organization and that this hinders learning how to simultaneously explore and exploit. High variation in terms of the 3

4 organizational utilization of exploration and exploitation prevents the internalization of experiences and increases organizational uncertainty, which renders the organization less effective in the simultaneous execution of those activities. In addition, we examine the demand-side market/customer dimension of organizational activities. The literature on ambidextrous organizations has primarily focused on supply-side, technological and product innovations (e.g., He & Wong, 2004; Katila & Ahuja, 2002; Lubatkin et al., 2006; Tushman & O Reilly, 1996). Exploration and exploitation are, however, conceptualized as having both supply-side technology/product and demand-side market/customer dimensions (Benner & Tushman, 2003). The literature that examines demand-side ambidexterity is in its infancy (for one notable exception see: Sidhu et al., 2007). We provide an empirical contribution to the literature on ambidextrous organizations by testing the ambidexterity hypothesis through the use of a methodology that utilizes timeseries panel data and objective measures of exploration, exploitation, organizational performance and ambidexterity. We address some of the methodological issues, including heterogeneity, cross-sectional designs and perception-based measurement, evident in previous research into the ambidexterity hypothesis, by testing our hypotheses that link volatility, ambidexterity and performance on a large sample of banks operating in Norway between 1995 and The banking industry is especially conducive for the longitudinal empirical examination of demand-side ambidexterity-based hypotheses. Fundamental exploration and exploitation activities in banking are demand-side activities that are aligned with the raison d être of banks, i.e., the amelioration of information asymmetries (Bhattacharya & Thakor, 1993). Furthermore, due to the role of banks in the economy, banks are highly regulated. These characteristics result in standardized and reliable information about the banking industry. 4

5 We find that organizational volatility impairs organizational performance, but that these effects are indirect. Organizational volatility affects a firm s ability to become ambidextrous. Ambidexterity is found not only to affect organizational performance but also to mediate the relationship between organizational volatility and performance. The strong empirical support for the ambidexterity hypothesis and the explication of the factors that affect ambidexterity are important steps toward reconciling the proponents of ambidexterity and those who focus on only one direction. By developing a theory that explicates the antecedents of ambidexterity and empirically testing it, we here begin to address the call for the development of a theory on the attainment of ambidexterity over time (Alder et al., 1999; Gibson & Birkinshaw, 2004). THEORY The concepts of exploration and exploitation have been employed in multiple contexts, including organizational learning, technical innovation, post-merger integration, organizational adaptation, organizational survival and competitive advantage (Benner & Tushman, 2003; Katila & Ahuja, 2002; Levinthal & March, 1993; March, 1991). Exploration involves radical innovation, risk-taking, broad searching and increased internal variation, change and experimentation. It allows an organization to develop new capabilities and to adapt to a changing environment (Gilbert, 2006). Exploitation involves incremental innovation, efficiency, coordination, implementation and local searching (e.g., Beckman, 2006; March, 1991). It is necessary to extract rents from existing capabilities through economies of scale, coordination and cost reduction. Exploitation is necessary to achieve or reinforce the fit between strategy, structure, people and processes (Tushman & O Reilly, 1996: 18), and is realized through incremental and continuous improvements. 5

6 The simultaneous execution of exploration and exploitation is crucial for organizational survival and prosperity (March, 1991; Tushman & O Reilly, 1996). While exploitation positively affects short-term performance, exploration is a must for organizational survival and prosperity in the long-run (Gibson & Birkinshaw, 2004; March, 1991). 'An organization that engages exclusively in exploration will ordinarily suffer from the fact that it never gains the returns of its knowledge', while 'an organization that engages exclusively in exploitation will ordinarily suffer from obsolescence' (Levinthal & March, 1993: 105). At the same time, purely explorative organizations are vulnerable to efficiencyoriented competitors; those that are merely exploitative gain returns that could be unsustainable in the long run (Lubatkin et al., 2006). The attainment of the ability to simultaneously explore and exploit has remained rather illusory for organizations as well as for organizational scholars. While some authors cast doubt on the performance benefits of ambidexterity (e.g., Van Looy et al., 2005), others extend initial cross-sectional empirical support to take in the benefits of ambidexterity (e.g., Gibson & Birkinshaw, 2004; He & Wong, 2004). Nonetheless, a causal relationship between ambidexterity and performance has not yet been empirically established or fully grounded theoretically (Lubatkin et al., 2006). Exploration and exploitation activities require contradictory knowledge-processing capabilities (Floyd & Lane, 2000), routines, structures (Tushman & O Reilly, 1996) and context (Gibson & Birkinshaw, 2004). Exploitation routines may crowd out exploration routines (Benner & Tushman, 2003; Gilbert, 2006). While the combination of exploitation and exploration is imperative (Levinthal & March, 1993), their simultaneous execution remains a major challenge for organizations (Levinthal & March, 1993; Tushman & O Reilly, 1997). 6

7 Hence, organization scholars have suggested that organizations need to become ambidextrous, i.e., to develop the ability to execute both exploration and exploitation activities simultaneously, in order to remain successful over long periods (e.g., Gibson & Birkinshaw, 2004; Tushman & O Reilly, 1996). Early conceptualizations of ambidexterity have emphasized the configuration of activities that exhibit tradeoffs in executing cost leadership and differentiation strategies (Porter, 1980), global integration and local responsiveness (Barlett & Ghoshal, 1989), or flexibility and efficiency in manufacturing (Alder et al., 1999). Current literature re-emphasizes the focus on activities by highlighting the ability to execute explorative and exploitative activities simultaneously. Lubatkin et al. (2006) succinctly argued that organizational ambidexterity involves those activities that underpin the exploitation of existing competencies as well as the exploration of new opportunities. Similarly, while arguing for the importance of attaining ambidexterity, Benner and Tushman (2003), He and Wong (2004) and Jansen et al. (2006) all maintained that organizations must learn how to conduct exploration and exploitation activities concurrently. Hence, we define organizational ambidexterity as the simultaneous execution of both explorative activities and exploitative activities. The phenomenon whereby the achievement of advantages inherent in the simultaneous pursuit of exploration and exploitation is also coupled with organizational paradoxes is receiving increasing levels of attention from organizational scholars. Scholars have argued that organizations should develop autonomous businesses in order to reap the benefits of ambidexterity (Duncan, 1976; Tushman & O Reilly, 1996). Organizational ambidexterity can also be achieved through structural separation, by locating new business development in a separate unit or by creating autonomous business units (Tushman & O Reilly, 1996), so that innovation and exploration needs are not undermined by inertial and conservative logics. Another perspective advances the notion that, while structural separation is not a necessity, 7

8 task partitioning or temporal separations are required (see further: Gibson & Birkinshaw, 2004). Finally, contemporary theory argues that ambidexterity is best achieved through the empowerment of employees to make their own judgments on how best to divide their time between conflicting demands (Gibson & Birkinshaw, 2004). The benefits of implementing the systems and processes needed to achieve ambidexterity seem to outweigh the costs, in general so long as ambidexterity takes a contextual rather than a structural form, which entails lower costs in the controlling and supervision of employees (Gibson & Birkinshaw, 2004). Demand-side ambidexterity and performance The literature on ambidextrous organizations has primarily focused on supply-side, technological and product innovations as the context in which organizations can become ambidextrous (He & Wong, 2004; Katila & Ahuja, 2002; Lubatkin et al., 2006; Tushman & O Reilly, 1996). Exploration and exploitation are, however, conceptualized as having both supply-side technology/product and demand-side market/customer dimensions (Benner & Tushman, 2003). An organization can 'resist the threat of obsolescence of its competences not only by developing new products and services but also by entering new markets and finding new customers' (Jansen et al., 2006: 1670). The marketing literature has drawn on the concept of demand-side exploration and exploitation for many years (e.g., Kohli & Jaworski, 1990; Levitt, 1960). Demand-side exploration includes the identification and targeting of new customer groups, innovative segmentation, improved product use and substitution patterns (see further: Sidhu et al., 2007). Innovations that emerge from customers or markets are exploratory, since they require new knowledge or departures from existing skills (Benner & Tushman, 2003). The recruitment and management of new-to-the-market customers entail organizational engagement in explorative activities. First, specific structures and routines are 8

9 often needed to identify, analyze and finally capture significant and stable flows of new customers. The newness of these customers to the economy often makes them unknown and unexplored within an industry environment, which leads organizations to adopt specific organizational arrangements to deal with them. Second, these customers are a source of growth and profits for companies that learn how to serve them, since they can be lead-users of emerging technologies and new and fast-growing market segments (Lilien et al., 2002). Third, they encourage product, distribution and organizational innovation that may spill over to existing customers. Finally, they can help an organization to understand and anticipate future market and demand trends. At the same time, organizations gain significant returns from exploiting old demandside certainties. Serving retained customers avoids search and recruitment costs, capitalizes on trust-driven relationships (Uzzi & Lancaster, 2003) and takes advantage of lower information asymmetry (Petersen & Rajan, 1994). This is not to say, however, that innovation can be overlooked. Rather, it is incremental innovation, consisting of continuous improvements and refinements of existing services, that is required to both retain customers and increase the margins that can be extracted from them through cross-selling and by exploiting opportunities to enlarge the gap between the value delivered to them and the production costs (Besanko et al., 1999). By simultaneously managing explorative and exploitative strategies, an organization avoids the risk of sustaining experimentation costs and investments without gaining adequate returns which would occur if there were an imbalance in favor of exploration and the risk of losing its adaptability to environmental changes which arises when exploration is overlooked (March, 1991). Hence, organizations that manage simultaneously to explore and exploit crucial demand-side factors obtain returns from the pursuit of old certainties while 9

10 also exploring new opportunities that infuse the necessary level of variation to ensure organizational survival. Hypothesis 1. The higher the level of demand-side organizational ambidexterity, the higher the level of organizational performance. Volatility and ambidexterity How does an organization become ambidextrous? Previous research has established that the underlying ability to engage simultaneously in explorative and exploitative activities develops over a long period of time (Alder et al., 1999; Ghoshal & Bartlett, 1994; Gibson & Birkinshaw, 2004). Nevertheless, a theory that explicates the emergence of ambidexterity has yet to be developed (Alder et al., 1999). Scholars have argued that structural separation tied with a common culture and vision (Tushman & O Reilly, 1996), shared vision tied with clear managerial career paths (Barlett & Ghoshal, 1989), or, more generally, the organizational context, systems, processes and beliefs that shape individual-level behavior in an organization (Gibson & Birkinshaw, 2004), as well as top-management integration (Lubatkin et al., 2006) create the conditions under which ambidexterity may materialize. Further insights on how organizations attain ambidexterity can stem from examining how their engagement in exploitation and exploration evolves over time. Regardless of the level of ambidexterity an organization has achieved at a given point in time, its engagement in explorative and exploitative activities may continuously change. An organization can increase both its exploration and its exploitation, decrease both, or increase its involvement in exploration while reducing exploitation or vice versa. We argue that volatility in organizational behavior with respect to exploration and exploitation affects the attainment of ambidexterity. Volatility refers to the instability of a firm s utilization of 10

11 exploration and exploitation (Carson et al., 2006). Low levels of volatility imply that an organization has the required time to develop routines that manage internal paradoxes through experiencing the emerging levels of exploration and exploitation, and enough time to encode inferences with which to guide its future behavior. The process is gradual and incremental (Feldman, 2000). High levels of volatility entail the continuous modification of organizational routines, roles, positions, control and so on. This continuous change renders inadequate the time needed for an organization to experience, observe, reflect and learn how to cope with the conflicting demands imposed upon it. This lack of time to encode inferences from history into routines that would guide its behavior thus negatively affects skill building (Argote, 1999; Zollo & Winter, 2002). High volatility may also signal that an organization is trying to exploit short-term opportunities to exploit/explore rather than to choose a strategy and craft organizational context accordingly. This shows a reactive rather than proactive approach, while the attainment of ambidexterity would require the development of specific routines, incentives as well as specific functions for the process to be learned (Zollo & Winter, 2002). High volatility may also signal inconsistent management (Gibson & Birkinshaw, 2004). This includes using the practices only for a short while, which generates confusion, reduces the motivation to learn and triggers an internal struggle and resistance to change in the workforce (Barley, 1986). Rapid and continuous change in terms of organizational exploration and exploitation requires corresponding changes in existing routines and structures in order to align organizational resource allocation, remuneration, incentive systems, hiring, training and budgeting routines with the new organizational objectives. For example, an organization that substantially alters the intensity of its engagement in explorative activities from one period to another will need to build specialized networks or other structures specifically aimed at 11

12 recruiting new-to-the-market customers or exploring new technologies. Nonetheless, once built, these structures will either be dismantled or remain unexploited in the next time period through a rapid reduction in the firm s engagement in exploration. Furthermore, the organization must adopt new, more search-oriented routines in times of organizational focus on exploration. This entails the adoption of corresponding performance evaluation systems that provide incentives for activities relating to innovation, technological breakthroughs and new customer recruitment, including new, less standardized criteria and procedures for customer evaluation. The focus on rewarding innovations and risktaking will be short lived as the organizations will in the next period substantially amend their exploration focus. Similar effects occur in relation to resource allocation and especially hiring. Opposing organizational requirements happen when large changes take place from one period to another in terms of organizational focus on exploitation. The adoption and subsequent abandonment of organizational resource allocation, remuneration, incentive systems, hiring focus, training and budgeting routines entails the loss of learning investments (Zollo & Winter, 2002), costs (Ocasio, 1997) and risks, that lead to not being skillful at the simultaneous execution of exploration and exploitation activities. Non-tradable assets such as ambidexterity need to be built up over a long period of time (Dierickx & Cool, 1989: 1506). Dierickx and Cool argue that a strategic asset is the cumulative result of adhering to a set of consistent policies over a period of time. Strategic assets are accumulated through a time path of flows. Supporting our arguments for a consistent pattern of investment in exploration and exploitation, Dierickx and Cool (1989: 1506) argue that a consistent pattern of resource flows is required in order to achieve a desired change in strategic asset stocks. Taking into consideration the temporal nature of the development of capacities for action, we argue that ambidexterity is dependent on variability in the demands imposed on an 12

13 organization. Capacities for successful exploration and exploitation and their ultimate combination are developed through a gradual introduction of complexities to an organization. Hence, high variability in terms of exploration and exploitation is expected to hinder the development of the underlying ability to explore and exploit simultaneously. Hypothesis 2. The higher the volatility in engaging in exploration and exploitation, the lower the organizational ambidexterity. The mediation effect of ambidexterity As a final point in our framework of volatility, ambidexterity and organizational performance, we propose that ambidexterity acts as a vehicle through which volatility affects organizational performance. We concur with previous research in viewing ambidexterity as a meta-capacity for action (Gibson & Birkinshaw, 2004), which is developed gradually over time (Alder et al., 1999; Ghoshal & Bartlett, 1994). The pattern of evolution of exploration and exploitation over time impacts performance by affecting the learning process through which an organization builds its ambidextrous capacity. The organizational learning gained from a gradual experimentation with exploration and exploitation activities influences the firm s performance positively. As argued above, rapid and drastic changes in the organizational utilization of exploration and exploitation hinder the attainment of ambidexterity. The process by which an organization becomes ambidextrous tends to be conceptualized as being lengthy, bumpy, partially obstructed, complex, uncertain and hazardous (e.g., Benner & Tushman, 2003; Gibson & Birkinshaw, 2004; Tushman & O Reilly, 1996). Managers may be tempted to leapfrog the learning and gradual adaptation process that an organization is required to go through in order to become ambidextrous. They 13

14 may dramatically and frequently change the organization s objectives, structures and processes in order to explore and exploit simultaneously and become ambidextrous instantaneously. Furthermore, they may exploit profit-making opportunities arising from environmental evolution without focusing on building any specific capacity. We have argued above, however, that time-compression diseconomies (Dierickx & Cool, 1989) prevent managerial leapfrogging over the accumulative learning process. Such a leap will negatively affect ambidexterity and hence also negatively affects organizational performance. Similarly, the initiation of incremental changes in the organizational configuration of exploration and exploitation cannot be expected to lead automatically to improved performance. Volatility influences performance only through the lengthy and uncertain development of ambidexterity. The cumulative nature of ambidexterity as a non-tradable strategic asset requires an adherence to a set of consistent organizational policies over a period of time. The flow or input of organizational policies by themselves is unlikely to directly produce performance effects (Dierickx & Cool, 1989). It is the gradual accumulation of these policies that is required in order to achieve a desired change in the organizational capacity to explore and exploit simultaneously and hence also in organizational performance. One method by which an organization can smooth the transition from one level of exploration and exploitation to another is to gradual introduce initiatives that address the new challenges. The abrupt change in organizational routines is likely to create struggle and resistance, which will hinder the learning that underpins ambidexterity and, in turn, negatively affecting organizational performance. Hypothesis 3. Ambidexterity mediates the relationship between volatility and organizational performance. 14

15 DATA AND METHODS This research employs a longitudinal design to explicate the relationship between ambidexterity, volatility and performance. Such a design has four clear advantages over previous studies. First, the incorporation of longitudinal elements augments existing literature on organizational ambidexterity. Somewhat surprisingly, the available empirical work that directly addresses the viability of the ambidexterity hypothesis discounts the time dimension when considering underlying exploration and exploitation activities. The time dimension, however, is pivotal for the materialization of the effects of exploration and exploitation. As March (1991) has argued, exploration focuses on current actions that may yield future returns, while exploitation encompasses current behavior pertaining to limited search and risk-taking that improves present returns. Cross-sectional designs are not optimal to test exploration- and exploitation-based hypotheses. The second advantage is that longitudinal construct measurement coupled with objective measures avoid common methods, retrospective recall and manager bias as well as concerns about respondents actual knowledge (Venkatraman & Grant, 1986). Third, longitudinal research incorporates into the analysis change in organizational behavior. Fourth, longitudinal research improves the understanding of causal inferences by directly addressing the time-order criteria for the identification of causal relationships. The dataset employed in this study is truly unique in its continuity over time and of the actors, as well as in its comprehensiveness and richness. The data were collected from multiple longitudinal sources. The dataset encompasses firm bank relationships for 98% of organizations operating in Norway over the period from 1995 to The dataset provides detailed information at the firm level regarding the type and strength of firms relationships with banks. It averages over half a million entries per year, and is not limited to listed firms, but encompasses nearly all firms in the economy irrespective of their size, age, etc. On annual 15

16 bases, all financial institutions are required to disclose data encompassing the existence and nature of their relationships with firms. We tested our hypotheses on a sample of 467 bank-year observations. We focused on banks that have built commercial customer portfolios, and hence we excluded small savings banks that primarily serve consumers. The banking industry is especially conducive for the longitudinal empirical examination of demand-side ambidexterity. Customers, which are distributed in time and space, are the main source of uncertainty, thus constituting the largest impediment to the operation of organizational technology in banking (Thompson, 1967). Exploration is attained by experimenting with new customers, which represent banks entry into new geographical locations, new industries, new technologies and new markets. Exploitation entails committing to existing customers embedded in already-explored locations and industries. For a bank, exploitation involves developing and consolidating relationships with existing customers, since long-term credit relationships with affiliated customers help banks solve problems of informational asymmetry when compiling information about organizations for use in credit decisions (Boot, 2000). Long-term credit relationships may also enhance banks profits through more aligned financial services to customer needs and a better distribution of search and information acquisition costs over time. Not surprisingly, then, customer loyalty is a major challenge for banks (e.g., Sharpe, 1990). Furthermore, mandatory disclosure of standardized banking data allows the comparisons made across banks to be reliable and complete, which circumvents any issue around missing or imputed values. The banking industry provides a rich empirical context for the examination of multiple organizational phenomena, including knowledge transfer and embeddedness (Uzzi & Gillespie, 2002), director interlocks (Davis & Mizruchi, 1999) and so on. Extensive organizational research into banking has resulted in consistent and robust measures. 16

17 Measures Bank performance. Bank returns on assets is a widely used measure of bank performance. It is utilized by both bank regulators and numerous organizational researchers (e.g., Barnett et al., 1994; Deephouse, 1999). Previous empirical research on ambidexterity has focused on self-reported performance (Gibson & Birkinshaw, 2004; He & Wong, 2004; Lubatkin et al., 2006). Gibson and Birkinshaw (2004) relied upon how senior and middlemanagement perceived a business unit s performance over five years. Testing the ambidexterity hypothesis using objective performance data eliminates the biases inherent in the use of self-reported performance, including common-method bias, respondents actual knowledge, retrospective recall and manager biases. Exploration and exploitation. To verify whether bank ambidexterity is associated with bank performance, we first constructed detailed measures of exploration and exploitation for each calendar year between 1995 and Previous research has suggested a wide range of operationalizations primarily based on supply-side technological exploration and exploitation, including patent search scope and depth (Katila & Ahuja, 2002), attention division and resource allocation in innovation projects (He & Wong, 2004), technical innovation (Beckman, 2006), project newness (McGrath, 2001) and product innovation (Jansen et al., 2006). Our focus on demand-side uncertainties and on actual organizational behavior, as opposed to perceived self-behavior, calls for novel operationalizations of those activities on the customer side. Exploration in a given year was operationalized as the number of new customers divided by the total size of the customer base in the previous year. In other words, exploration is the percentage of new customers (new in the economy and for the bank, not merely for the bank) that each bank acquired in a given year out of the total number of customers that the 17

18 bank had immediately prior to the acquisition of the new customers. The acquisition of such customers is explorative since it entails bank-wide searches, increased internal variation, discovery and risk-taking (March, 1991). Learning occurs within the bank firm relationship (Uzzi & Gillespie, 2002) because newly established organizations have neither a track record nor audited accounts. Furthermore, newly established organizations are often agents of change in the economy, experimenting with new technologies, new markets and new distribution channels. Hence, the information asymmetry between banks and these customers is the most severe (Berger & Udell, 1998). Such customers are conducive for exploratory learning for banks, since they are a source of information about new markets, new industries, new technologies and new demand trends and hence can foster bank product innovation. As the percentage of new customers relative to the number of customers increases, banks enhance the variation in their customer sets, are involved in wide organizational search behavior, have to invest in reducing information asymmetry and are exposed to a larger amount of new information about technologies and markets. Exploitation involves the pursuit of old certainties involving refinement, efficiency, selection, implementation and execution activities (March, 1991). Banks utilize existing knowledge of markets, technologies, distribution channels as well as organization-specific knowledge in refining their offerings. The banking literature emphasizes that returns to bank firm relationships are increasing but at a decreasing rate (e.g., Petersen & Rajan, 1994). The persistence of bank firm relationships allows banks to be more efficient in providing financial services. Banks provide firms with already-developed financial services or further refine them. Continuous relationships therefore involve refinement of the knowledge acquired and the implementation and execution of services based on the initial investment in learning. In our research, exploitation in a given year was thus operationalized as the number of retained 18

19 customers divided by the total customer base. Exploitation is the percentage of a bank s current customers that were also customers of that bank in the previous year. This directly controls for variations associated solely with bank size. Ambidexterity. Our measure of ambidexterity uses the multiplicative method of exploration and exploitation (e.g., Gibson & Birkinshaw, 2004). This measure addresses two fundamental issues in empirically testing the ambidexterity hypothesis. First, in line with the literature that emphasizes that ambidexterity manifests itself in an organization s actual behavior (He & Wong, 2004; Lubatkin et al., 2006; Smith & Tushman, 2005; Tushman & O Reilly, 1996), we examine actual observed ambidextrous behavior. Previous studies of the ambidexterity hypothesis (Gibson & Birkinshaw, 2004; He & Wong, 2004; Lubatkin et al., 2006) have relied solely upon participants perceptions of what their organizations were doing as opposed to measuring what the organizations actually do. The second issue is that previous research that has used the multiplicative method has assumed an equality of importance between exploration and exploitation activities across a large number of industries, which were examined jointly. We focus on one relatively homogeneous industry and hence do not need to assume that the balance between exploration and exploitation is the same across industries. Volatility. Volatility refers to the instability of a firm s utilization of exploration and exploitation (Carson et al., 2006). When the utilization of exploration and exploitation varies rapidly and abruptly, an organization will continuously change its demands. Building on previous research (Carson et al., 2006), we operationalized volatility by measuring for each bank the average of the standard deviations of exploration and exploitation. The standard deviations are calculated from the first year for which data are available up until the year in question. The lower the standard deviations, the more the organization maintains its levels of investment in exploration and exploitation. The change in organizational activities and the 19

20 corresponding demands on the organization are gradual and incremental. By contrast, high levels indicate that an organization changes its modus operandi frequently, i.e., it modifies frequently and/or intensively its emphasis on exploration and exploitation. We controlled for a number of alternative explanations for bank performance: Bank size. An increasing number of findings suggest that bank size is negatively related to bank performance (e.g., Barnett et al., 1994; Deephouse, 1999). Hence, we measured bank size as the lagged natural logarithm of bank assets. Bank loss. We also controlled for the lagged loan loss per bank measured in terms of the percentage of actual loss of a bank s total assets. The nature of the customer set serviced can be argued to affect bank performance. Customer-set performance. The average returns on assets of all customers affiliated with each bank controls for the current quality of the customer set. When bank customers perform well, their higher average returns on assets are expected to negatively impact bank loss. Customer-set performance variability. Similarly, the level of variability in customers return on assets measured by its standard deviation indicates the risk associated with serving particular groups of customers. Riskier customer sets will make it harder to predict returns. Customerset intangible assets. Banks find it more difficult to evaluate organizations that have a high percentage of intangible assets on their balance sheets. For example, organizations that invest heavily in R&D are riskier than manufacturing organizations that can pledge collaterals with high resalable values. The value of intangible assets is not only uncertain but also subject to low market value owing to its specificity. We measured customer-set intangible assets as the percentage of intangible assets of total assets averaged across each bank s customers. RESULTS To analyze the relationships between exploration, exploitation, ambidexterity, volatility and bank performance, we used random-effects time-series regression analysis. 20

21 Similar results were found when we utilized Prais Winsten regression models. Two preliminary tests establish the appropriateness of random effect modeling and the inclusion of year dummies. A Hausman test indicated that a random-effect model is more suitable than a fixed-effect model (χ = 10.22, d.f. = 12, p = 0.59). We also examined whether year dummies should be included in the model. Taking into consideration the macro-economic effects on firms financial behavior, bank earnings are expected to be sensitive to macro-economic conditions. A specific test indicated that it is clearly more appropriate to include year dummies in the models (χ = , d.f. = 6, p < 0.001). Means, standard deviations and correlations among the variables are shown in Table 1. << Tables 1 and 2 here>> Model 1 of Table 2 presents the base model including only control variables of factors affecting bank performance. As expected from the sensitivity of bank performance to macro economic conditions, a number of the year dummies are significant. Furthermore, bank size and bank loss are negatively and significantly related to bank performance. Models 2 and 3 of Table 2 respectively examine the impact of exploitation and exploration on bank performance. Consistent with March s (1991) predictions, bank exploitation is positively and significantly associated with current bank performance (Model 2 of Table 2) and current exploration activities have a negative but insignificant effect on current bank performance (Model 3 of Table 2). To evaluate hypothesis 1, which states that bank ambidexterity is positively associated with performance, we mean-centered the underlying factors before calculating their multiplicative term (Cohen et al., 2003). Thereafter, we inputted the multiplicative variable, ambidexterity, into Model 4 of Table 2. The coefficient for ambidexterity in Model 4 of Table 21

22 2 is positive and significant (β = 26.90, s. e. = 5.36, p < 0.01), hence supporting hypothesis 1. The Wald statistic reported at the bottom of model 4 establishes the significant improvement of Model 4 in comparison to Model 3 hence providing further support for the significant effect of organizational ambidexterity on performance. Table 1 reports that ambidexterity is correlated with exploitation and exploration (0.22 and 0.50 respectively). In order to ensure that multicollinearity between exploitation, exploration and ambidexterity does not affect our findings, we omitted both exploration and exploitation variables from the analysis. The results were unchanged. Ambidexterity remained a highly significant predictor of bank performance (t = 6.12, p < 0.001). Hypothesis 2 predicts that volatility is negatively associated with organizational ambidexterity. As reported in Model 5 of Table 2, which has ambidexterity as its dependent variable, volatility negatively and significantly affects ambidexterity (β = 0.29, p < 0.01), thus supporting hypothesis 2. Hypothesis 3 predicts that ambidexterity mediates the relationship between volatility and bank performance. The analysis of mediation effects involved four steps (Baron & Kenny, 1986), the first of which was to establish that volatility significantly affects the mediating variables, namely ambidexterity. We found support for this association in Model 5 of Table 2, discussed above in relation to hypothesis 2. The second step required the establishment of an association between volatility the independent variable and bank performance the dependent variable. Model 6 of Table 2 examines the effects of volatility on bank performance. It provides strong support for the argument that, as organizations increase their pace in changing their modus operandi, their performance deteriorates (β = 0.10, s. e. = 0.03, p < 0.01), thus supporting the second step. The third step of mediation requires a demonstration that the mediator variable (ambidexterity) significantly impacts the dependent variable (performance) when the independent variable (volatility) is controlled for, 22

23 and that the latter, volatility, is no longer significant in the model that contains the mediating variable. Model 4 of Table 2, as reported above in discussing hypothesis 1, establishes that ambidexterity positively and significantly affects bank performance. As reported in Model 7 of Table 2, ambidexterity positively and significantly affects bank performance also when volatility is controlled for. Furthermore, with the presence of ambidexterity in the model, the coefficient of volatility is no longer significant (β = 0.02, n.s.). The fourth step requires the establishment of the significance of the mediated effect. We calculated the significance of the mediated effect by dividing it by the computed standard errors of the coefficient responsible for the effect. The obtained z score is highly significant (z = 4.42). Thus, the above tests provide support for hypothesis 3, which states that ambidexterity mediates the relationship between volatility and performance. DISCUSSION The objectives of this paper were to enhance our understanding of the antecedents and consequences of ambidexterity with the specific emphasis on the effects of volatility of organizational behavior with respect to ambidexterity and organizational performance. We examined the impact of exploration, exploitation, volatility and ambidexterity on organizational performance in the context of the banking industry. In doing so, we found support for the argument that ambidexterity positively and significantly impacts organizational performance. We then incorporated the concept of volatility and found that the degree of volatility in the organizational utilization of exploration and exploitation over time negatively impacts organizational ambidexterity. We also established that ambidexterity acts as a mediator between volatility and organizational performance as the effects of volatility on organizational performance are transmitted through ambidexterity. 23

24 This paper contributes to the literature on organizational ambidexterity in a number of ways. First, it provides a conceptual model that sheds light on the factors that impact the achievement of ambidexterity involved in becoming ambidextrous as well as on the value of ambidexterity to organizations. We provided a longitudinal test of the effects that volatility has on ambidexterity and organizational performance. We addressed the call for the development of a theory regarding the attainment of ambidexterity over time (Alder et al., 1999; Gibson & Birkinshaw, 2004) by introducing, elucidating and testing the effects of volatility. The lack of a consistent strategy regarding exploration and exploitation creates organizational unrest and uncertainty, which hinder the development of ambidexterity. Our findings also suggest that ambidexterity needs to be built through a gradual and systematic process of learning. A relatively stable pattern of explorative and exploitative activities over time seems to be required both for an organization to learn how to manage them simultaneously and to internally communicate a consistent set of signals. Explorative and exploitative activities per se are conducive for learning through experience accumulation. A gradual and controlled process of evolution along the two dimensions of organizational learning makes it viable for an organization to build and capitalize on specific sets of structures and routines aimed at developing ambidexterity. The effective use of such structures and routines, in turn, requires a process of learning. Future research should explore the processes underlying the achievement of ambidexterity. Many questions fall into this research stream: what conditions can lead an organization unbalanced toward either exploration or exploitation to change its pattern of activities in search of ambidexterity? Which kinds of inertial forces can hamper organizational efforts toward a consistent and gradual attainment of ambidexterity? Which intra-organizational mechanisms and processes (e.g. reward systems) are the most effective for the attainment of ambidexterity? Furthermore, 24

25 how environmental variables like stability vs. dynamism can affect the process leading to ambidexterity? The second contribution made by this paper is that it augments the existing crosssectional empirical literature. First, we provided a longitudinal design that is more in line with the underlying time-dependent effects of exploration and exploitation postulated by March (1991). Second, we employed objective measures of exploration, exploitation, ambidexterity and organizational performance. Third, we did not combine various industries in one study and hence did not assume that the balance between exploration and exploitation is equal across industries. We tested our hypothesis in the context of the banking industry that may represent a case similar to traditional manufacturing industries whereby organizations are engaged in exploitative activities and only to a lesser extent in explorative activities. Future research should extend this work to other industries with different features. The biotechnology industry, for example, may represent a rather different case in which organizations are much more concerned with exploration than with exploitation activities. Building on the argument advanced in this paper that the desired level of exploration and exploitation activities is industry-dependent, future research should therefore examine whether the ambidexterity hypothesis applies equally across industries that require a rather different distribution of exploration and exploitation activities. We are aware that our operationalization of exploration and exploitation, and hence ambidexterity, presents some limitations, that could be addressed through further research. In particular, relying upon the importance of information asymmetry as established by the economics of banking literature, we focused on customer newness for a bank and for the economy to capture a bank s exploration and exploitation. Hence, we provided a dichotomous assignment of organizational activities. Valuable extensions to the operationalization of exploration/exploitation may explore refinements of the measure that include a number of 25