Governance Institutions and Adaptation Costs: Evidence from the Fall of the Berlin Wall

This paper investigates how institutions governing the employment relationship influence firms' adaptation to environmental changes. After the Berlin Wall fell, migration from East Germany accounted for an abrupt increase in the supply of a key resource—labor—in the West. I study responses to this disruption among firms in the economically important machinery and equipment industry. I find that western firms adapted to migration by increasing employment unless they were affiliated with a works council, an institution that limits the firm's autonomy in managing its workforce. I also find evidence of institution-contingent responses to migration in two areas of firm strategy: vertical boundaries and the focus on exploration versus exploitation. The results suggest that “hybrid” (i.e., less hierarchical) governance institutions increase adaptation costs. The results also indicate that such adaptation costs have implications for multiple aspects of firm decision making that are nominally beyond the scope of those governance institutions.

This paper was accepted by Bruno Cassiman, business strategy.