The Effect of Lean Operations on Financial Distress: A Dynamic Perspective

Abstract

Financial risk of public firms has significant impacts on shareholder wealth and the economy at large. Firms adopt various strategies to sustain their competitiveness and reduce the likelihood of financial distress. Operating lean is one of these strategies to achieve sustainable efficiency and success. However, there is little empirical evidence on whether lean is an effective strategy for reducing future financial risks. In this study, we establish the causal effect of lean on financial distress through dynamic panel models. We show that a firm’s inventory and supply chain leanness reduce the probability of future financial distress and the effects from these two dimensions are not substitutable. Our model overcomes endogeneity issues including the unobserved variables and reverse causality. We also propose a new definition of firms’ external environment that captures the evolving nature of competition. Using the new definition, we test the moderating effect of environmental dynamism and complexity. Environmental complexity moderates the effects of lean operations while dynamism does not. Overall, our results highlight the importance of taking a dynamic perspective to study the link between operational strategy and firm outcomes.

Keywords: financial distress, lean, inventory, supply chain, econometrics, competitive environment, strategy

JEL Classification: M00