- Email: [email protected]
Determinants of board directors' strategic involvement
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EMJ VOL. 8 NO. 2: June 7990
Shaker A. Zahra Associate
Professor
of Strategic
Management
John A. Pearce II Chairman of the Management Department George Mason University, Fairfax, Virginia,
T he role of boards
of directors in shaping corporate strategy has increased in importance in recent years. However, evidence suggests that boards differ significantly in their involvement in the strategic arena. In this study of 139 Fortune manufacturing and service corporations we identify sources of variations in level of board strategic involvement. Boards that have a majority of insiders, whose directors possess significant expertise in the firm’s major industry, and whose internal operations are efficient are more involved in the strategic process.
The past few years have witnessed a dramatic rise in interest in Europe and the USA in enhancing the effectiveness of boards of directors (Zahra & Pearce, 1989). Rubber stamp boards that prevailed for nearly three decades are undergoing significant changes to increase directors’ contribution to company performance (Molz, 1988). Towards this end, director responsibilities are being revised to reflect today’s competitive environment (Henke, 1986; Pinnel, 1986). Accordingly, directors are expected to participate in shaping the strategic direction of their firms and monitoring progress in implementing chosen strategy. These rising expectations of active involvement by boards in strategic issues reflects a strong, growing sentiment that boards should become an instrument of corporate strategic change (Zahra, in press).
USA Research suggests that boards still differ considerably in their level of involvement in strategic issues facing their companies (Rosenstein, 1987). Some boards define their role narrowly as discussing and approving the chief executive officers’ (CEOs’) strategic initiatives. Others view their task as one of active participation in conceiving, formulating, selecting and implementing strategies. These boards may, in fact, mandate that CEOs and their associates undertake major redirections of strategies to better achieve corporate goals. Why do boards vary so markedly in their strategic involvement? Unfortunately, the literature lacks credible evidence on variables that may account for such fundamental differences among boards in their strategic involvement. In this study, we propose that variations in the level of boards’ involvement in strategic issues may stem from differences in the composition, internal processes, and characteristics of the boards themselves. We propose also that past company financial performance may affect boards’ involvement when the firm is doing poorly, directors will feel pressured to be more actively involved in shaping the strategy of the firm. We test our hypotheses using data from 139 Fortune companies.
Board Strategic
Involvement
For decades, the role of the board was widely understood as governing the corporation without interfering
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in the actual managerial or policy-making processes (Brown, 1976). But, over the years, boards have become dominated by CEOs who had considerable influence in selecting, retaining and remunerating directors (Molz, 1988). As a result, boards were widely perceived as passive, functioning only as rubber stamps of managerial choices (Bavly, 1985). These rubber stamp boards led Drucker (1973) to decry the decline of the boards as a serious worldwide problem of corporate governance. Boards that functioned as rubber stamps failed to provide the necessary control function within the governance structure.
opportunities, and in establishing long-term objectives. Concerning strategy formulation, the board’s involvement includes reviewing executive analyses of corporate strengths and weaknesses, discussing various forecasts, examining CEO assumptions about the firm’s environment, assisting in developing new strategic options, and aiding in the selection of company strategy. The involvement of the board in strategy implementation may include setting milestones to evaluate progress towards institutionalizing the strategy and evaluating company performance.
Following a series of corporate bankruptcies in the mid197Os, and intensifying international competition, the importance of the strategic contribution of boards was reasserted. Recognizing the need to reactivate boards, Juran and Louden noted that “corporate policy formation is potentially one of the most valuable activities of the board” (1975: 48). Pinnel (1986) also suggested that conceiving and initiating the strategic plan was a joint responsibility for the CEO and the board. Thus, the board’s role was being broadened to include attention to strategic concerns facing the corporations.
Variations of Board Strategic Involvement
As the decade of the 1970s came to a close, Andrews reflected a rapidly growing sentiment - in Europe and the USA - by observing that “strategic management comes to its culmination in the chairmanship of effective boards” (1980: 175). Later, he delineated potential areas of board strategy (Andrews, 1981). Accordingly, directors were encouraged to pay special attention to “corporate strategy for top management” where the major task was to ascertain whether or not senior executives were in agreement on the assumptions underlying the strategy and the general direction of the ;irm. Similarly, Lauenstein (1982) identified five key areas of board strategic responsibilities: (a) determining strategic concepts that differentiate the company from its competition; i.e., company mission and competitive advantage, (b) ensuring effective organizational planning to achieve a substainable competitive advantage, (c) designing programs leading to successful managerial succession, (d) examining the company’s overall investment policies, and (e) making decisions on liquidating the firm. This study builds on the above suggestions about board strategic involvement. To us, board strategic involvement refers to the level of attention given by directors to the various elements of the strategic process. Therefore, board strategic involvement covers corporate mission development, strategy conception and r’ormulation, and strategy implementation. Regarding mission, the board may assist in the definition of the business concept, in identification of new business
How can we explain variations in board strategic involvement? To answer this question, we examine three crucial factors: board characteristics, perceived criticality of board role, and the organizational performance gap. These variable sets are summarized in Figure 1. Board characteristics encompass four variables: the proportion of outside directors among membership, level of board expertise, efficiency of internal board proceedings, directors’ independence from the CEO, and the perceived criticality of the board in relation to company performance. Our emphasis on board characteristics is consistent with the thrust of proposals for reforming the board to put it on equal footing with the CEO. These proposals suggest careful attention to the above five variables as a prerequisite for an effective, powerful board (Zahra & Pearce, 1989). Thus, by examining how these variables may explain to variations in board strategic involvement, we hope to contribute to the debate on appropriate reform efforts. The second set in Figure 1 centers on the perceived criticality (importance) of boards in relation to company performance. By including this variable in the model we are recognizing a persistent irony in corporate practices in Europe and the USA: CEOs still have considerable power in shaping boards and in doing so they determine their usefulness to their companies. Consequently, we need to examine how CEOs’ perceptions of their boards importance to company performance may influence directors’ level of strategic involvement. Performance gap refers to the difference between company performance and its established goals. Alternately, this gap can be defined as the difference between a firm’s level of performance and its industry group (Jauch & Glueck, 1988). We will propose that when such a gap develops, directors become more actively involved in reviewing and revising the firm’s strategy.
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Board Characteristics* l
outsiders
(HI)
expertise 0 efficiency
(W
l
l
(H3) (H4)
independence
9
Level of Board l
Criticality of Board Role (H5)
Strategic 4
i i i i
7
I
1 l
Company Performance
Gap 0-W
7
Involvement
i L _---
----
* Industry Type
(‘) Hl to H6 refer to the study’s hypotheses. Figure 1 Predictors
of variations
In the level of board
strategic
Figure 1 suggests that the association between board characteristics, criticality and performance gap and the level of board strategic involvement depends on the type of industry in which companies compete. Two factors suggested that industry type may moderate the effect of board variables on strategic involvement. First, industries have their unique strategic challenges and demands of success (Dess, Ireland & Hitt, 1988). These differences in industry contexts may result in unique patterns of influence of board variables in its strategic involvement. Second, the literature hints at possible differences in board variables based on industry conditions (Vance, 1983). Thus, board composition, characteristics and processes may differ by industry type. These two factors call for an examination of the varying impact of board variables on its strategic involvement, taking into account a firm’s industry. Having presented the major variables in the research model (Figure l), discussion will now center on developing hypotheses on their potential association with the level of strategic involvement. Board characteristics AS Figure 1 shows, four board characteristics are of potential importance explaining their level of strategic involvement: representation of outsiders, expertise, efficiency of operations, and independence.
involvement
Representation of outside directors. Directors who serve on boards are classified as insiders or outsiders. Outside directors are not members of the firm’s (or its subsidiaries’) top management group, their associates or their relatives; are not consultants to the firm; and are not members of former executives of the firm (or its subsidiaries). The past decade witnessed a sharp increase in the number of outsiders on corporate boards in Europe and the USA (Mills, 1985; Zahra & Pearce, 1989). Increased representation of outsiders is believed to broaden the base of expertise represented on the board and to improve the quality of counsel provided to the CEO. In addition, outsiders are presumed to be objective in making decisions, and as a result are better able to represent diverse stakeholders. Because of their expertise and objectivity, boards that are dominated by outside directors will be more involved in strategic issues. Hl:
Increased representation of outside directors on a board is positively associated with the level of board strategic involvement.
Board expertise. Relevant expertise has been emphasized in the literature on board reform as an important board attribute (Boulton, 1984), and as a crucial
ZAHRA AND PEARCE: predictor of the boards’ strategic contribution (Kreiken, 1985). Indicators of expertise are directors’ familiarity with the competitive forces in the industry, their understanding of the key factors of success that underlie strategic changes, and their familiarity with the history and operations of the company (Vance, 1983). Thus, increased expertise will make it possible for directors to initiate, review and monitor the development and implementation of strategies. These observations provide the rationale for the following hypothesis: 142:
Directors’ expertise is positively related to the level of board strategic involvement.
Efficiency of internal board operations. Internal board operations embody those variables that influence a board’s decision-making process (Zahra & Pearce, 1989). These variables include the way the board is organized into specialized committees, the flow of information among committees, the quality and frequency of board meetings, and other administrative arrangements essential to board maintenance (e.g., leadership). As a result, efficient internal board operations are likely to enhance the board’s power base, and improve the quality of deliberations and the decisions made by the boards (Ross, 1988). Strategic issues are complex in nature and require considerable thought and analysis. Hence, an efficient internal board process provides directors with the infrastructure necessary for such detailed examinations. Strategic concerns can be thus evaluated regularly as a part of the board’s regular agenda (Zahra, in press). Alternatively, the board may develop specialized committees to study the issues at hand and report to the full board (Rosenstein, 1987). Overall, the board will be in a position to influence the strategic posture of the firm. These observations lead to the following hypothesis: H3:
Efficient internal operations of a board are associated positively with its level of board strategic involvement.
Effective boards are often Board independence. described as “independent” from their CEO and key members of the top management team (Chitayat, 1984). In fact, a major proposal to reform the board is to separate its chairmanship from the position of CEO, thereby helping to equalize power relationships between the two parties (Dalton, 1989; Kesner, 1989; Rechner & Dalton, 1989). Geneen condemned the large majority of Fortune 500 boards as ineffective and incapable of “fully doing what they are legally, morally, and ethically supposed to do” because they lacked a necessary level of
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independence from management (1984, p. 28). Geneen attributed this problem to three causes. First, the board chair is often the CEO. Second, several insiders usually serve on the board, making it easier for the CEO to achieve the required majority votes on most issues. Third, as mentioned earlier, the CEO plays an important role in choosing inside and outside directors. The above observations suggest that increased independence is likely to enhance a board’s strategic involvement because directors will feel responsible for the outcome of their decision making. These directors will work closely with the firm’s executives to determine its competitive position and strategic direction. This leads to the following hypothesis: H4:
Board independence from the CEO will be associated positively with its level of board strategic involvement.
Criticality of board conffibution An important insight from past research on the determinants of organizational power is that the perceived criticality of the contributions of an entity is positively related to its power (Pfeffer, 1981). Specifically, if the contribution of a unit to organizational goal achievement is considerable, this unit will extract and wield a great deal of formal and informal power (Pfeffer & Salancik, 1978). An extrapolation of this finding to board research would suggest that the more valuable the role of the board is viewed as being, the more discretion the board will possess. For example, if executives tend to see boards as a “legal necessity,“ they may learn to “do without” their boards’ involvement in strategic issues. On the other hand, if CEOs judge board contributions to company performance to be important, directors’ input into the strategic process will be sought frequently. CEOs may involve directors in develooing strategies useful in shielding the firm from the adverse impact of unfavorable environmental trends, in identifying new business areas, in shaping a particular strategy (e.g., international expansion), and in offering advice concerning operational improvements. This line of thought suggests the following hypothesis: H5:
The perceived criticality of board impact on company effectiveness will be associated positively with the level of board strategic involvement.
Organizational performance gap Boards are likely to become more involved in the strategic process at times of major corporate crises (Mintzberg, 1983). For example, if the firm performs poorly over an extended period of time, the board will impose additional controls over managerial actions. Indeed, if this gap between company performance and
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industry norms continues to persist, directors may re-examine the chosen corporate strategy or review the implementation process. These steps are usually taken before the more drastic measures of replacing the CEO is considered (Dalton & Kesner, 1985). Under these circumstances, the level of board strategic involvement will rise owing to a genuine concern for the well-being of the corporation or because of the directors’ desire to protect themselves against potential shareholders’ legal suits. In either case, the board will exercise its control function before becoming deeply involved in strategy reformulation. A more active role by the board is probable if a persistent or widening gap is perceived to exist. This reasoning leads to the following hypothesis: H6:
Poor past company performance will be associated positively with the level of board strategic involvement.
In brief, the above six hypotheses summarized the expected associations between board composition, perceived criticality of its role and corporate performance gap and board strategic involvement. We tested these hypotheses empirically, as presented below.
Method Data collection and sample A questionnaire was mailed to 695 - 400 industrial and 295 service - chosen corporations from the Forturrc industrial and service population. This group of firms was studied because of its critical importance to the US economy and because these corporations have been the major target of board reform over the past 20 years. A total of 139 firms (70 service and 69 manufacturing) responded, for an overall response rate of 20 percent. This rate was considered encouraging because of the widely acknowledged low response rate associated with the Fortune population. In fact, some have characterized these firms as “endangered species” for data collection for academic purposes (Tootalian & Gaedeke, 1987). In addition, companies are reluctant to discuss the operations or effectiveness of their boards because of concern over potential director liability. Respondents The questionnaire was directed to the CEO or the highest ranking officer of the corporation. This person was chosen because over 80 percent of Fortulle firms have boards whose chairs are also the CEOs, and because the CEO appears to play a major role in determining the extent to which the board can contribute to strategy. We analyzed the titles of respondents and found that they were among these firms’ most senior executives.
Measures 1. The strategic involvement of the board was measured using 16 items (see Table 1) that were derived from the literature. The items were worded to correspond directly to the various dimensions of strategic management. The items were subjected to factor analysis using varimax orthogonal rotation which resulted in four significant dimensions, but the fourth factor had one item. It was decided, therefore, to ignore the fourth factor because it was not meaningful. Therefore, only the three major factors and associated items were included in Table 1. The three significant factors revolved around board involvement (in order of importance) in: mission development ( a = 0.86), strategy formulation (a = 0.91), and strategy implementation (a = 0.79). 2. Outsiders representation. Number of outside directors serving on each board was obtained from the CEOs in response to the following item, “What is the number of outside directors that serve on your board; that is, those directors not connected to the company or its subsidiaries?” Furthermore, CEOs were instructed to exclude “company officers who have retired within the past 3 years” from their figures. This definition is consistent with the tradition in this area (Kesner, 1987). Figures provided by respondents for manufacturing corporations were then correlated with data collected from Mood!y’s Industrial Manuals to ensure the accuracy of responses. The correlation was high (r = 0.97, p < 0.001). 3. Board expertise was measured by response to four items on a 5-point scale (1 = poor to 5 = excellent). The items were: familiarity with industry conditions, familiarity with company operations, overall level of board professionalism, and overall directors’ expertise. The items were added to produce an overall index (a = 0.78). 4. Efficiency of internal board operations was measured using five items, following a 5-point scale (1 = poor to 5 = excellent). Executive ratings were added to produce an overall index (a = 0.87). The items were: frequency of board meetings, quality of counsel provided by the board, board organization, quality of board deliberations, and quality of communication among directors. 5. Board independence was measured using two 7-point semantic differential scales: dependentindependent, and leader-follower (reverse scored). Responses were summed to produce an overall scale (a = 0.80).
ZAHRA Table 1
AND PEARCE:
DIRECTORS’
Establishing long-term objectives Definition of company mission and direction Identification of new business areas Analysis of company strengths and weaknesses Review of economic forecasts Review of social forecasts Review of technological forecasts Review of political forecasts Identification of new strategic options Review of managerial assumptions about Selection of company strategy Evaluating chosen strategy implementation Monitoring progress in evaluating long-range plans Evaluating company performance Evaluating success of strategy
I:; (5) (6) (71 (81 (9) (10) (11) (12) (13) (14) (15)
INVOLVEMENT
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Board Strategic Involvement: Results of Factor Analysis
Items ’
(1) (2)
STRATEGIC
Eigenvalue = O/oof variance = O/ocumulative variance
=
Formul
Factor* lmple
0.23 0.27 0.28 0.76 0.67 0.79 0.54 0.65 0.73 0.54 0.65 0.22 0.21 0.27 0.19
0.20 0.27 -0.27 0.21 -0.23 -0.24 -0.24 0.26 0.21 0.16 0.24 0.72 0.69 0.55 0.40
-0.13 0.12
3.99 40.10 40.10
2.09 22.10 62.20
12.60 74.80
’ Item responses followed a 5point response format: “Not Involved” (coded 1); “Slightly (coded 2); “Moderately Involved” (coded 3); “Very fnvolved” (coded 4); and “Extremely (coded 5). * Facror Labels: (1) Formulation, (2) Implementation & (3) Mission
6. Criticality of board input. Executives were asked to rate two items by assigning a score ranging from zero (poor) to 100 (outstanding}. An index was developed (a = 0.83) using responses to the following items: (a) “board contribution to company performance,” and (b) “the extent to which you feel you must consult the board before making major longrange related decisions.” 7. Company performance gap was evaluated subjective and objective criteria as follows:
using
(a) Perceived Performance Gap. Executives evaluated their companies using performance to three items: company overall performance, company profitability, and company competitive position. Executives were asked to allocate a number ranging from zero (poor) to 100 (outstanding) to indicate their perception of company performance. Scores on the three items were then used to develop an overall performance index (0: = 0.92). For each industry group, an average performance measure was developed. The perceived (subjective) performance gap was then measured as the difference between the mean industry group and an individual firm’s scores. (b) Objective Performance. Two criteria were used: (1) stability of corporate stock prices, and (2) earnings per share (El%). Both criteria covered the preceding three years. Again, average performance scores were
Mission 0.61 0.56 0.45 0.07 0.14 0.11 0.09 0.13 0.12 0.21 -0.15 -0.11 -0.12
1.23
involved” involved“
developed for each industry subgroup, using each of the two criteria. Objec~i~?~performance gap was then measured by subtracting company scores from the industry group average.
Analysis Multiple regression was used to test the study‘s hypotheses. Table 2 shows regression results for the overall strategic involvement index al~d the three subscales: mission, strategy formulation, and strategy implementation. The four modeb were significant at p < 0.~1. The first hypothesis (Hl) suggested a positive association between the representation of outside directors and board strategic involvement. As Table 2 shows, the first hypothesis was not supported (8 = -0.19, p < 0.05). Table 2 also shows that the associations between outsiders and the mission development, and outsiders and strategy formulation were significant and negative. The second hypothesis (H2) suggested that board expertise was related positively to its strategic involvement. This hypothesis was supported for the overall scale (P = 0.40, p < 0.001) and all three subscales. In all cases, the associations were positive and significant, as predicted.
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EMJ VOL. 8 NO. 2: June 7990 Table 2
Results of Regression Analysis: Determinants of Board Strategic involvement
Independent 1. 2. 3. 4. 5. 6.
Variables
Outsiders Expertise Efficiency of Internal Operations Independence Role Criticality Performance Gap (a) Perceived (b) Stock Price (c) Earnings Predictability Multiple
R R2 F P
4 = Strategy l
“p “‘p
-0.19* 0.40’ * 0.43”’ 0.05 0.29* *
= = = =
a I = Overall Strategic
Involvement; lmpl~mentation
Overall 2
1
0.01 0.07 0.07
l
-0.23’ 0.27’ 0.24’ 0.04 0.41 ** l
-0.24” 0.37* * * 0.21 0.07 0.36’+
0.01 0.03 - 0.01
0.76 0.57 14.30 0.0000 2 = Mission;
l
Sample a 3
0.04 0.02 0.09
0.62 0.38 6.61 0.0000
3 = Strategy
l
0.68 0.46 9.24 0.0000
4 - 0.04 0.33** * 0.27’ = 0.15 0.27’ l
0.07 0.08 0.06 0.71 0.50 10.70 0.0000
Formulation;
p < 0.05 < 0.01 < 0.001
The third hypothesis (H3) posited a positive relationship between the efficiency of internal board operations and board strategic involvement. As Table 2 shows, the third hypothesis was supported. The results for the overall scale and the three strategic involvement indices were positive and significant, as hypothesized. The fourth hypothesis (H4) asserted that a positive relationship existed between the level of directors’ independence from management and board strategic involvement. As Table 2 showrs, the results did not support the fourth hypothesis.
regression Table 3.
analysis.
The
results
are
presented
in
In general, the results were consistent with those found in the overall sample. Although impact of board expertise and earnings predictability appeared to vary between the service and manufacturing sectors, industry type did not affect the hypothesized associations significantly. Therefore, we concluded that industry type did not moderate the relationships depicted in Figure 1.
Discussion The fifth hypothesis (H5) suggested a positive association between the perceived criticality of board input and board strategic involvement. The results supported this hypothesis for the overall strategic involvement scale and its subscales. The sixth hypothesis (H6) suggested that a larger organizational performance gap was associated with a higher level of board strategic involvement. As Table 2 shows, neither subjective nor objective performance measures were associated with board strategic involvement or its subscales. Therefore, the sixth hypothesis was not supported.
The results lead to four observations. First, board strategic involvement is a multidimensional concept. As Table 1 shows, CEOs responses show that board strategic involvement covers mission development, strategy formulation and strategy implementation. Boards are thought to be most active in mission development and least in implementation. This finding is consistent with the current theory. Implementation is widely considered the purview of CEOs. And, extensive interference by directors in implementation may cause ambiguity about lines of command, thereby creating conflict.
The moderating effect of industry We looked into possible differences between manufacturing and service subgroups. Our goal was to examine if the results were stable across different industry groups. To test this possibility we used multiple
Finding that board strategic involvement is important from a practical viewpoint. It offers companies and board reform activists a basis to delineate the sphere of directors’ potential role in strategy. Companies and activists may use this finding to clearly state what
ZAHRA Table 3
Determinarhs
of Board Strategic
AND PEARCE:
involvement
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by Industry Type
SUBSAMPLEa
Independent 1.
2. 3. 4. 5. 6.
Manufacturing 3 2
1
-0.24’
-0.17
Outsiders
- 0.03
0.24’
-0.25*
0.31
0.31
0.26’ 0.03 0.38*
0.28’ 0.12 0.38’
0.25 0.02 0.35’
0.04 0.06
0.11 0.14
0.04 0.19
0.07 0.10
0.13 0.19
0.02 0.08
0.16
0.18
0.02
0.12
0.18
0.08
0.17
0.72 0.52 5.23 0.0002
0.74 0.55 6.04 0.0000
0.69 0.49 4.67 0.0005
0.74 0.54 5.23 0.002
0.61 0.36 2.61 0.0232
0.68 0.46 3.84 0.0023
0.74 0.56 5.74 0.0001
0.29’ 0.15 0.31
(a) Perceived (b) Stock Price (c) Earnings
0.04 0.03
0.05 0.01
Predictability
0.17
=
-0.16
0.20’ 0.16 0.18
0.23* 0.07 0.32*
0.82 0.68 10.49 0.0000
-0.12
4
3
2
0.21
0.22’ 0.16 0.44’
= = = =
1
0.36’
0.47’
R R2 F P
4
0.43’
0.46**’
l
Service
-0.22*
Expertise Efficiency of Internal Operations Independence Role Criticality Performance Gap
Multiple
a1
Variables
l
0.47’
l
l
Overall Strategic Involvement; 2 = Mission; 3 = Strategy Formulation;
4 =
l
l
l
l
0.32’ 0.17 0.29’
Strategy Implementation
* p < 0.05 '* p < 0.01 "'D < 0.001
boards are expected to do regarding mission development, strategy formulation and implementation. Second, board characteristics centering on directors expertise (H2) and efficiency of internal operations (H3) are significant predictors of variations in board strategic involvement. This finding reaffirms the importance of the intangible portion of board characteristics. For a long time, researchers have emphasized the role of composition variables, with contradictory findings. For instance, contrary to expectations, Table 2 shows that outsiders’ representation (H2) was negatively associated \vith board strategic involvement. In combination, these results urge examination of expertise and efficiency as vitally important correlates of board strategic involvement. From a practical perspective, the positive association betlveen board expertise and strategic involvement (H21 suggests that thoughtful selection of directors who have significant familiarity with the industry and company operations is important. Directors need a specialized focus to contribute positively to their strategic function. This way directors can become true gatekeepers of crucial information emanating from the firm’s external environment. The finding that the efficiency of the internal process (H3; has a strong positive association with the strategic involvement of the board is also encouraging. Over the past decade, many steps have been recommended to
reform the board such as separating its chairmanship from the CEO (Rechner & Dalton, 1989), establishing specialized committees, restructuring the flow of information (Rechner, 1989), and increasing the frequency of board meetings. The results of the present study reinforces the value of these recommendations. Together, they may prepare the board for its expanded strategic involvement. On the other hand, increasing representation of outside directors on the board may hinder its strategic involvement. This finding contradicts our hypothesis (Hl) and much of the popular literature. However, upon reflection six practical considerations limit the potential strategic involvement of these directors: (1) demands of their other professional responsibilities may make it difficult for outside directors to devote the necessary time for board activities (Andrews, 1981). In fact, Chitayat (1984) found that lack of time is a major impediment of outside directors’ involvement in initiating or approving strategic issues; (2) as outsiders’ representation increases, the possibility of interlocking directorates rises. This may cause outside directors to limit their own contribution to the development of strategies in order to protect the different interests that they represent and to avoid conflicts of interest; (3) since the CEO still plays a major role in selecting outside directors, their independent from management is often questionable. In reality, this means that outsiders may not delve deeply into managerial views or strategic proposals; (4) it has been observed that
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when outside directors doubt managerial abilities or directions they often resign instead of confronting the CEO; (5) having outside directors is not a guarantee that the many concerns expressed in a firm’s external environment will be stressed in mapping strategic decisions (Pearce, 1983). In fact, many outside directors seem disposed to focus on issues pertaining to efficiency, rather than long-term effectiveness; (6) outside directors often lack familiarity with industry conditions and company operations (Vance, 1983), and function largely based on information provided by the CEO. Third, the results highlight a persistent paradox in attempting to stimulate directors’ involvement in the strategic process. Clearly, characteristics of boards are of paramount importance in explaining variations in boards‘ involvement. But, the current results show that without CEOs’ belief in and acceptance of directors’ crucial strategic contribution, directors’ strategic involvement will be limited (H5). This seemingly paradoxical finding urges collaboration between the board and CEO. CEOs working in consort with - but not dominating - their boards can gain considerably from directors’ experience and insight. Fourth, the corporate performance gap (H6) does not appear to be associated with variations of board But, caution is necesSary in strategic involvement. interpreting this finding. Mintzberg’s (1983) synthesis of the literature suggests that boards become especially active at times of crises, including declining performance. Hence, it would be premature to abandon research on this variable before validating this study’s results by using alternative measures of performance gap.
Conclusion Boards are increasingly active in shaping the strategies their firms pursue. This study shows that boards will be actively involved in the strategic arena if directors have the requisite expertise, have structured their boards’ decision-making processes well, and are viewed by CEOs as important contributors to the effective performance of their companies. REFERENCES Andrews, K.R. (1980) The Concept of Corporate Strategy, rev. edn, Homewood, IL: Richard D. Irwin. Andrews, K.R. (1981) Corporate Strategy as a Vital Function of the Board, Hatward Business Review, 39: 6, 174-184. Bavly, D. (1985) What is the Board Good For?, Long Range
Planning,
19: 3, 20-26.
Boulton, W. (1984) The Board of Directors: Beware of Those Triggers that Cause Board Change, Journal of Business Strategy, 5: 1, 84-92. Brown, C.C. (1976) Putting the Corporate Board to Work, New York, NY: Macmillan. Chitayat, G. (1984) The Role of Board of Directors in Practical Terms, Management International Review, 24: 1, 71-77. Dalton, D.R. (1989) Corporate Governance: Who Is In Control Here?, Business Horizons, 32: 4, 2-10. Dalton, D.R. & Kesner, I.F. (1985) Organizational Performance as an Antecedent of Inside/Outside Chief Executive Succession: An Empirical Assessment, Academy of Management Journal, 28, 749-776. Dess, G.G., Ireland, R.D. & Hitt, M.A. (1988) Industry Effects and Strategic Management Research. Paper presented at the Academy of Management, Anaheim, CA. Drucker, P.F. (1973) Management: Tasks, Responsibilities & Practices, New York: Harper & Row. Geneen, H. (1984) Managing, New York: Doubleday. Henke, J.W., Jr. (1986) Involving the Board of Directors in Strategic Planning, Journal of Business Strategy, 7: 2, 87-95. Jauch, L.R. & Glueck, W.F. (1988) Strategic Marmgemcnt and Business Policy, 3rd edn, New York, NY: McGraw-Hill. Juran, J.M. & Louden, J. (1975) The Corporate Director, New York, NY: AMACOM. Kesner, I.F. (1987) Directors’ Stock Ownership and Organizational Performance: An Investigation of Fortune 500 Companies, ]oumal of Management, 13, 499-508. Kesner, I.F. (1989) Shareholders and the Issue of Corporate Governance: The Silenced Partner, Business Horizons, 32: 4, 16-21. Kreiken, J. (1985) The Board’s Role in Strategic Planning and Resource Allocation. In Handbook for Corporate Directors, E.P. Mattar & M. Ball (eds), New York: McGraw-Hill. Lahenstein, M. (1982) Your Board of Directors - A New Strategy for the Eighties, journal of Busirless Strategy, 2, 110-114. Mills, G. (1985) On the Board, London: Allen & Unwin. Mintzberg, H. (1983) PozOer In and Around Organizatiorls, Englewood Cliffs, NJ: Prentice-Hall, Inc. Molz, R. (1988) Managerial Domination of Boards of Directors and Financial Performance, ]ournal qf Busirless Research, 16, 235-250. Pearce, J.A., II (1983) The Relationship of Internal Versus External Orientation to Financial Measures of Strategic Performance, Strategic Management Journal, 4, 297-306. Pfeffer, J. (1981) Poztler In Organizations, Boston, MA: Pitman. Pfeffer, J. & Salancik, G. (1978) The External Control of Orguni&ions: A Resource Dependence Perspective, New York: Harper & Row. Pinnel, B. (1986) The Role of the Board of Directors in Corporate Planning, Long Range Planning, 19: 10, 27-32. Rechner, P.L. (1989) Corporate Governance: Fact or Fiction?, Business Horizons, 32: 4, 11-15. Rechner, P.L. & Dalton, D.R. (1989) The Impact of CEO as Board Chairperson on Corporate Performance: Evidence vs Rhetoric, The Academy of Management Executive, 3, 141-143.
ZAHRA
AND PEARCE:
Rosenstein, J. (1987) Why Don’t US Boards Get More Involved in Strategy?, Long Range Planning, 20: 3,20-34. Ross, R.S. (1988) Small Groups in Organizational Settings, Englewood Cliffs, NJ: Prentice Hall. Tootelian, D.H. & Gaedeke, R.M. (1987) Fortune 500 List Revisited 12 Years Later: Still an Endangered Species for Academic Research?, journal of Business Research, 15, 359-363.
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Vance, S.C. (1983) Corporate Leadership: Boards, Directors and Strategy, New York: McGraw-Hill. Zahra, S.A. (1990) Role of Boards of Directors in Strategic Planning, Long Range Planning, in press. Zahra, S.A. & Pearce, J.A. II (1989) Boards of Directors and Corporate Financial Performance: A Review and Integrative Model, journal of Management, 15: 2,291-334.
EMJ VOL. 8 NO. 2: June 7990
Shaker A. Zahra Associate
Professor
of Strategic
Management
John A. Pearce II Chairman of the Management Department George Mason University, Fairfax, Virginia,
T he role of boards
of directors in shaping corporate strategy has increased in importance in recent years. However, evidence suggests that boards differ significantly in their involvement in the strategic arena. In this study of 139 Fortune manufacturing and service corporations we identify sources of variations in level of board strategic involvement. Boards that have a majority of insiders, whose directors possess significant expertise in the firm’s major industry, and whose internal operations are efficient are more involved in the strategic process.
The past few years have witnessed a dramatic rise in interest in Europe and the USA in enhancing the effectiveness of boards of directors (Zahra & Pearce, 1989). Rubber stamp boards that prevailed for nearly three decades are undergoing significant changes to increase directors’ contribution to company performance (Molz, 1988). Towards this end, director responsibilities are being revised to reflect today’s competitive environment (Henke, 1986; Pinnel, 1986). Accordingly, directors are expected to participate in shaping the strategic direction of their firms and monitoring progress in implementing chosen strategy. These rising expectations of active involvement by boards in strategic issues reflects a strong, growing sentiment that boards should become an instrument of corporate strategic change (Zahra, in press).
USA Research suggests that boards still differ considerably in their level of involvement in strategic issues facing their companies (Rosenstein, 1987). Some boards define their role narrowly as discussing and approving the chief executive officers’ (CEOs’) strategic initiatives. Others view their task as one of active participation in conceiving, formulating, selecting and implementing strategies. These boards may, in fact, mandate that CEOs and their associates undertake major redirections of strategies to better achieve corporate goals. Why do boards vary so markedly in their strategic involvement? Unfortunately, the literature lacks credible evidence on variables that may account for such fundamental differences among boards in their strategic involvement. In this study, we propose that variations in the level of boards’ involvement in strategic issues may stem from differences in the composition, internal processes, and characteristics of the boards themselves. We propose also that past company financial performance may affect boards’ involvement when the firm is doing poorly, directors will feel pressured to be more actively involved in shaping the strategy of the firm. We test our hypotheses using data from 139 Fortune companies.
Board Strategic
Involvement
For decades, the role of the board was widely understood as governing the corporation without interfering
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in the actual managerial or policy-making processes (Brown, 1976). But, over the years, boards have become dominated by CEOs who had considerable influence in selecting, retaining and remunerating directors (Molz, 1988). As a result, boards were widely perceived as passive, functioning only as rubber stamps of managerial choices (Bavly, 1985). These rubber stamp boards led Drucker (1973) to decry the decline of the boards as a serious worldwide problem of corporate governance. Boards that functioned as rubber stamps failed to provide the necessary control function within the governance structure.
opportunities, and in establishing long-term objectives. Concerning strategy formulation, the board’s involvement includes reviewing executive analyses of corporate strengths and weaknesses, discussing various forecasts, examining CEO assumptions about the firm’s environment, assisting in developing new strategic options, and aiding in the selection of company strategy. The involvement of the board in strategy implementation may include setting milestones to evaluate progress towards institutionalizing the strategy and evaluating company performance.
Following a series of corporate bankruptcies in the mid197Os, and intensifying international competition, the importance of the strategic contribution of boards was reasserted. Recognizing the need to reactivate boards, Juran and Louden noted that “corporate policy formation is potentially one of the most valuable activities of the board” (1975: 48). Pinnel (1986) also suggested that conceiving and initiating the strategic plan was a joint responsibility for the CEO and the board. Thus, the board’s role was being broadened to include attention to strategic concerns facing the corporations.
Variations of Board Strategic Involvement
As the decade of the 1970s came to a close, Andrews reflected a rapidly growing sentiment - in Europe and the USA - by observing that “strategic management comes to its culmination in the chairmanship of effective boards” (1980: 175). Later, he delineated potential areas of board strategy (Andrews, 1981). Accordingly, directors were encouraged to pay special attention to “corporate strategy for top management” where the major task was to ascertain whether or not senior executives were in agreement on the assumptions underlying the strategy and the general direction of the ;irm. Similarly, Lauenstein (1982) identified five key areas of board strategic responsibilities: (a) determining strategic concepts that differentiate the company from its competition; i.e., company mission and competitive advantage, (b) ensuring effective organizational planning to achieve a substainable competitive advantage, (c) designing programs leading to successful managerial succession, (d) examining the company’s overall investment policies, and (e) making decisions on liquidating the firm. This study builds on the above suggestions about board strategic involvement. To us, board strategic involvement refers to the level of attention given by directors to the various elements of the strategic process. Therefore, board strategic involvement covers corporate mission development, strategy conception and r’ormulation, and strategy implementation. Regarding mission, the board may assist in the definition of the business concept, in identification of new business
How can we explain variations in board strategic involvement? To answer this question, we examine three crucial factors: board characteristics, perceived criticality of board role, and the organizational performance gap. These variable sets are summarized in Figure 1. Board characteristics encompass four variables: the proportion of outside directors among membership, level of board expertise, efficiency of internal board proceedings, directors’ independence from the CEO, and the perceived criticality of the board in relation to company performance. Our emphasis on board characteristics is consistent with the thrust of proposals for reforming the board to put it on equal footing with the CEO. These proposals suggest careful attention to the above five variables as a prerequisite for an effective, powerful board (Zahra & Pearce, 1989). Thus, by examining how these variables may explain to variations in board strategic involvement, we hope to contribute to the debate on appropriate reform efforts. The second set in Figure 1 centers on the perceived criticality (importance) of boards in relation to company performance. By including this variable in the model we are recognizing a persistent irony in corporate practices in Europe and the USA: CEOs still have considerable power in shaping boards and in doing so they determine their usefulness to their companies. Consequently, we need to examine how CEOs’ perceptions of their boards importance to company performance may influence directors’ level of strategic involvement. Performance gap refers to the difference between company performance and its established goals. Alternately, this gap can be defined as the difference between a firm’s level of performance and its industry group (Jauch & Glueck, 1988). We will propose that when such a gap develops, directors become more actively involved in reviewing and revising the firm’s strategy.
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EMJ VOL. 8 NO. 2; June 7990
Board Characteristics* l
outsiders
(HI)
expertise 0 efficiency
(W
l
l
(H3) (H4)
independence
9
Level of Board l
Criticality of Board Role (H5)
Strategic 4
i i i i
7
I
1 l
Company Performance
Gap 0-W
7
Involvement
i L _---
----
* Industry Type
(‘) Hl to H6 refer to the study’s hypotheses. Figure 1 Predictors
of variations
In the level of board
strategic
Figure 1 suggests that the association between board characteristics, criticality and performance gap and the level of board strategic involvement depends on the type of industry in which companies compete. Two factors suggested that industry type may moderate the effect of board variables on strategic involvement. First, industries have their unique strategic challenges and demands of success (Dess, Ireland & Hitt, 1988). These differences in industry contexts may result in unique patterns of influence of board variables in its strategic involvement. Second, the literature hints at possible differences in board variables based on industry conditions (Vance, 1983). Thus, board composition, characteristics and processes may differ by industry type. These two factors call for an examination of the varying impact of board variables on its strategic involvement, taking into account a firm’s industry. Having presented the major variables in the research model (Figure l), discussion will now center on developing hypotheses on their potential association with the level of strategic involvement. Board characteristics AS Figure 1 shows, four board characteristics are of potential importance explaining their level of strategic involvement: representation of outsiders, expertise, efficiency of operations, and independence.
involvement
Representation of outside directors. Directors who serve on boards are classified as insiders or outsiders. Outside directors are not members of the firm’s (or its subsidiaries’) top management group, their associates or their relatives; are not consultants to the firm; and are not members of former executives of the firm (or its subsidiaries). The past decade witnessed a sharp increase in the number of outsiders on corporate boards in Europe and the USA (Mills, 1985; Zahra & Pearce, 1989). Increased representation of outsiders is believed to broaden the base of expertise represented on the board and to improve the quality of counsel provided to the CEO. In addition, outsiders are presumed to be objective in making decisions, and as a result are better able to represent diverse stakeholders. Because of their expertise and objectivity, boards that are dominated by outside directors will be more involved in strategic issues. Hl:
Increased representation of outside directors on a board is positively associated with the level of board strategic involvement.
Board expertise. Relevant expertise has been emphasized in the literature on board reform as an important board attribute (Boulton, 1984), and as a crucial
ZAHRA AND PEARCE: predictor of the boards’ strategic contribution (Kreiken, 1985). Indicators of expertise are directors’ familiarity with the competitive forces in the industry, their understanding of the key factors of success that underlie strategic changes, and their familiarity with the history and operations of the company (Vance, 1983). Thus, increased expertise will make it possible for directors to initiate, review and monitor the development and implementation of strategies. These observations provide the rationale for the following hypothesis: 142:
Directors’ expertise is positively related to the level of board strategic involvement.
Efficiency of internal board operations. Internal board operations embody those variables that influence a board’s decision-making process (Zahra & Pearce, 1989). These variables include the way the board is organized into specialized committees, the flow of information among committees, the quality and frequency of board meetings, and other administrative arrangements essential to board maintenance (e.g., leadership). As a result, efficient internal board operations are likely to enhance the board’s power base, and improve the quality of deliberations and the decisions made by the boards (Ross, 1988). Strategic issues are complex in nature and require considerable thought and analysis. Hence, an efficient internal board process provides directors with the infrastructure necessary for such detailed examinations. Strategic concerns can be thus evaluated regularly as a part of the board’s regular agenda (Zahra, in press). Alternatively, the board may develop specialized committees to study the issues at hand and report to the full board (Rosenstein, 1987). Overall, the board will be in a position to influence the strategic posture of the firm. These observations lead to the following hypothesis: H3:
Efficient internal operations of a board are associated positively with its level of board strategic involvement.
Effective boards are often Board independence. described as “independent” from their CEO and key members of the top management team (Chitayat, 1984). In fact, a major proposal to reform the board is to separate its chairmanship from the position of CEO, thereby helping to equalize power relationships between the two parties (Dalton, 1989; Kesner, 1989; Rechner & Dalton, 1989). Geneen condemned the large majority of Fortune 500 boards as ineffective and incapable of “fully doing what they are legally, morally, and ethically supposed to do” because they lacked a necessary level of
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independence from management (1984, p. 28). Geneen attributed this problem to three causes. First, the board chair is often the CEO. Second, several insiders usually serve on the board, making it easier for the CEO to achieve the required majority votes on most issues. Third, as mentioned earlier, the CEO plays an important role in choosing inside and outside directors. The above observations suggest that increased independence is likely to enhance a board’s strategic involvement because directors will feel responsible for the outcome of their decision making. These directors will work closely with the firm’s executives to determine its competitive position and strategic direction. This leads to the following hypothesis: H4:
Board independence from the CEO will be associated positively with its level of board strategic involvement.
Criticality of board conffibution An important insight from past research on the determinants of organizational power is that the perceived criticality of the contributions of an entity is positively related to its power (Pfeffer, 1981). Specifically, if the contribution of a unit to organizational goal achievement is considerable, this unit will extract and wield a great deal of formal and informal power (Pfeffer & Salancik, 1978). An extrapolation of this finding to board research would suggest that the more valuable the role of the board is viewed as being, the more discretion the board will possess. For example, if executives tend to see boards as a “legal necessity,“ they may learn to “do without” their boards’ involvement in strategic issues. On the other hand, if CEOs judge board contributions to company performance to be important, directors’ input into the strategic process will be sought frequently. CEOs may involve directors in develooing strategies useful in shielding the firm from the adverse impact of unfavorable environmental trends, in identifying new business areas, in shaping a particular strategy (e.g., international expansion), and in offering advice concerning operational improvements. This line of thought suggests the following hypothesis: H5:
The perceived criticality of board impact on company effectiveness will be associated positively with the level of board strategic involvement.
Organizational performance gap Boards are likely to become more involved in the strategic process at times of major corporate crises (Mintzberg, 1983). For example, if the firm performs poorly over an extended period of time, the board will impose additional controls over managerial actions. Indeed, if this gap between company performance and
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7990
industry norms continues to persist, directors may re-examine the chosen corporate strategy or review the implementation process. These steps are usually taken before the more drastic measures of replacing the CEO is considered (Dalton & Kesner, 1985). Under these circumstances, the level of board strategic involvement will rise owing to a genuine concern for the well-being of the corporation or because of the directors’ desire to protect themselves against potential shareholders’ legal suits. In either case, the board will exercise its control function before becoming deeply involved in strategy reformulation. A more active role by the board is probable if a persistent or widening gap is perceived to exist. This reasoning leads to the following hypothesis: H6:
Poor past company performance will be associated positively with the level of board strategic involvement.
In brief, the above six hypotheses summarized the expected associations between board composition, perceived criticality of its role and corporate performance gap and board strategic involvement. We tested these hypotheses empirically, as presented below.
Method Data collection and sample A questionnaire was mailed to 695 - 400 industrial and 295 service - chosen corporations from the Forturrc industrial and service population. This group of firms was studied because of its critical importance to the US economy and because these corporations have been the major target of board reform over the past 20 years. A total of 139 firms (70 service and 69 manufacturing) responded, for an overall response rate of 20 percent. This rate was considered encouraging because of the widely acknowledged low response rate associated with the Fortune population. In fact, some have characterized these firms as “endangered species” for data collection for academic purposes (Tootalian & Gaedeke, 1987). In addition, companies are reluctant to discuss the operations or effectiveness of their boards because of concern over potential director liability. Respondents The questionnaire was directed to the CEO or the highest ranking officer of the corporation. This person was chosen because over 80 percent of Fortulle firms have boards whose chairs are also the CEOs, and because the CEO appears to play a major role in determining the extent to which the board can contribute to strategy. We analyzed the titles of respondents and found that they were among these firms’ most senior executives.
Measures 1. The strategic involvement of the board was measured using 16 items (see Table 1) that were derived from the literature. The items were worded to correspond directly to the various dimensions of strategic management. The items were subjected to factor analysis using varimax orthogonal rotation which resulted in four significant dimensions, but the fourth factor had one item. It was decided, therefore, to ignore the fourth factor because it was not meaningful. Therefore, only the three major factors and associated items were included in Table 1. The three significant factors revolved around board involvement (in order of importance) in: mission development ( a = 0.86), strategy formulation (a = 0.91), and strategy implementation (a = 0.79). 2. Outsiders representation. Number of outside directors serving on each board was obtained from the CEOs in response to the following item, “What is the number of outside directors that serve on your board; that is, those directors not connected to the company or its subsidiaries?” Furthermore, CEOs were instructed to exclude “company officers who have retired within the past 3 years” from their figures. This definition is consistent with the tradition in this area (Kesner, 1987). Figures provided by respondents for manufacturing corporations were then correlated with data collected from Mood!y’s Industrial Manuals to ensure the accuracy of responses. The correlation was high (r = 0.97, p < 0.001). 3. Board expertise was measured by response to four items on a 5-point scale (1 = poor to 5 = excellent). The items were: familiarity with industry conditions, familiarity with company operations, overall level of board professionalism, and overall directors’ expertise. The items were added to produce an overall index (a = 0.78). 4. Efficiency of internal board operations was measured using five items, following a 5-point scale (1 = poor to 5 = excellent). Executive ratings were added to produce an overall index (a = 0.87). The items were: frequency of board meetings, quality of counsel provided by the board, board organization, quality of board deliberations, and quality of communication among directors. 5. Board independence was measured using two 7-point semantic differential scales: dependentindependent, and leader-follower (reverse scored). Responses were summed to produce an overall scale (a = 0.80).
ZAHRA Table 1
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DIRECTORS’
Establishing long-term objectives Definition of company mission and direction Identification of new business areas Analysis of company strengths and weaknesses Review of economic forecasts Review of social forecasts Review of technological forecasts Review of political forecasts Identification of new strategic options Review of managerial assumptions about Selection of company strategy Evaluating chosen strategy implementation Monitoring progress in evaluating long-range plans Evaluating company performance Evaluating success of strategy
I:; (5) (6) (71 (81 (9) (10) (11) (12) (13) (14) (15)
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169
Board Strategic Involvement: Results of Factor Analysis
Items ’
(1) (2)
STRATEGIC
Eigenvalue = O/oof variance = O/ocumulative variance
=
Formul
Factor* lmple
0.23 0.27 0.28 0.76 0.67 0.79 0.54 0.65 0.73 0.54 0.65 0.22 0.21 0.27 0.19
0.20 0.27 -0.27 0.21 -0.23 -0.24 -0.24 0.26 0.21 0.16 0.24 0.72 0.69 0.55 0.40
-0.13 0.12
3.99 40.10 40.10
2.09 22.10 62.20
12.60 74.80
’ Item responses followed a 5point response format: “Not Involved” (coded 1); “Slightly (coded 2); “Moderately Involved” (coded 3); “Very fnvolved” (coded 4); and “Extremely (coded 5). * Facror Labels: (1) Formulation, (2) Implementation & (3) Mission
6. Criticality of board input. Executives were asked to rate two items by assigning a score ranging from zero (poor) to 100 (outstanding}. An index was developed (a = 0.83) using responses to the following items: (a) “board contribution to company performance,” and (b) “the extent to which you feel you must consult the board before making major longrange related decisions.” 7. Company performance gap was evaluated subjective and objective criteria as follows:
using
(a) Perceived Performance Gap. Executives evaluated their companies using performance to three items: company overall performance, company profitability, and company competitive position. Executives were asked to allocate a number ranging from zero (poor) to 100 (outstanding) to indicate their perception of company performance. Scores on the three items were then used to develop an overall performance index (0: = 0.92). For each industry group, an average performance measure was developed. The perceived (subjective) performance gap was then measured as the difference between the mean industry group and an individual firm’s scores. (b) Objective Performance. Two criteria were used: (1) stability of corporate stock prices, and (2) earnings per share (El%). Both criteria covered the preceding three years. Again, average performance scores were
Mission 0.61 0.56 0.45 0.07 0.14 0.11 0.09 0.13 0.12 0.21 -0.15 -0.11 -0.12
1.23
involved” involved“
developed for each industry subgroup, using each of the two criteria. Objec~i~?~performance gap was then measured by subtracting company scores from the industry group average.
Analysis Multiple regression was used to test the study‘s hypotheses. Table 2 shows regression results for the overall strategic involvement index al~d the three subscales: mission, strategy formulation, and strategy implementation. The four modeb were significant at p < 0.~1. The first hypothesis (Hl) suggested a positive association between the representation of outside directors and board strategic involvement. As Table 2 shows, the first hypothesis was not supported (8 = -0.19, p < 0.05). Table 2 also shows that the associations between outsiders and the mission development, and outsiders and strategy formulation were significant and negative. The second hypothesis (H2) suggested that board expertise was related positively to its strategic involvement. This hypothesis was supported for the overall scale (P = 0.40, p < 0.001) and all three subscales. In all cases, the associations were positive and significant, as predicted.
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EMJ VOL. 8 NO. 2: June 7990 Table 2
Results of Regression Analysis: Determinants of Board Strategic involvement
Independent 1. 2. 3. 4. 5. 6.
Variables
Outsiders Expertise Efficiency of Internal Operations Independence Role Criticality Performance Gap (a) Perceived (b) Stock Price (c) Earnings Predictability Multiple
R R2 F P
4 = Strategy l
“p “‘p
-0.19* 0.40’ * 0.43”’ 0.05 0.29* *
= = = =
a I = Overall Strategic
Involvement; lmpl~mentation
Overall 2
1
0.01 0.07 0.07
l
-0.23’ 0.27’ 0.24’ 0.04 0.41 ** l
-0.24” 0.37* * * 0.21 0.07 0.36’+
0.01 0.03 - 0.01
0.76 0.57 14.30 0.0000 2 = Mission;
l
Sample a 3
0.04 0.02 0.09
0.62 0.38 6.61 0.0000
3 = Strategy
l
0.68 0.46 9.24 0.0000
4 - 0.04 0.33** * 0.27’ = 0.15 0.27’ l
0.07 0.08 0.06 0.71 0.50 10.70 0.0000
Formulation;
p < 0.05 < 0.01 < 0.001
The third hypothesis (H3) posited a positive relationship between the efficiency of internal board operations and board strategic involvement. As Table 2 shows, the third hypothesis was supported. The results for the overall scale and the three strategic involvement indices were positive and significant, as hypothesized. The fourth hypothesis (H4) asserted that a positive relationship existed between the level of directors’ independence from management and board strategic involvement. As Table 2 showrs, the results did not support the fourth hypothesis.
regression Table 3.
analysis.
The
results
are
presented
in
In general, the results were consistent with those found in the overall sample. Although impact of board expertise and earnings predictability appeared to vary between the service and manufacturing sectors, industry type did not affect the hypothesized associations significantly. Therefore, we concluded that industry type did not moderate the relationships depicted in Figure 1.
Discussion The fifth hypothesis (H5) suggested a positive association between the perceived criticality of board input and board strategic involvement. The results supported this hypothesis for the overall strategic involvement scale and its subscales. The sixth hypothesis (H6) suggested that a larger organizational performance gap was associated with a higher level of board strategic involvement. As Table 2 shows, neither subjective nor objective performance measures were associated with board strategic involvement or its subscales. Therefore, the sixth hypothesis was not supported.
The results lead to four observations. First, board strategic involvement is a multidimensional concept. As Table 1 shows, CEOs responses show that board strategic involvement covers mission development, strategy formulation and strategy implementation. Boards are thought to be most active in mission development and least in implementation. This finding is consistent with the current theory. Implementation is widely considered the purview of CEOs. And, extensive interference by directors in implementation may cause ambiguity about lines of command, thereby creating conflict.
The moderating effect of industry We looked into possible differences between manufacturing and service subgroups. Our goal was to examine if the results were stable across different industry groups. To test this possibility we used multiple
Finding that board strategic involvement is important from a practical viewpoint. It offers companies and board reform activists a basis to delineate the sphere of directors’ potential role in strategy. Companies and activists may use this finding to clearly state what
ZAHRA Table 3
Determinarhs
of Board Strategic
AND PEARCE:
involvement
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by Industry Type
SUBSAMPLEa
Independent 1.
2. 3. 4. 5. 6.
Manufacturing 3 2
1
-0.24’
-0.17
Outsiders
- 0.03
0.24’
-0.25*
0.31
0.31
0.26’ 0.03 0.38*
0.28’ 0.12 0.38’
0.25 0.02 0.35’
0.04 0.06
0.11 0.14
0.04 0.19
0.07 0.10
0.13 0.19
0.02 0.08
0.16
0.18
0.02
0.12
0.18
0.08
0.17
0.72 0.52 5.23 0.0002
0.74 0.55 6.04 0.0000
0.69 0.49 4.67 0.0005
0.74 0.54 5.23 0.002
0.61 0.36 2.61 0.0232
0.68 0.46 3.84 0.0023
0.74 0.56 5.74 0.0001
0.29’ 0.15 0.31
(a) Perceived (b) Stock Price (c) Earnings
0.04 0.03
0.05 0.01
Predictability
0.17
=
-0.16
0.20’ 0.16 0.18
0.23* 0.07 0.32*
0.82 0.68 10.49 0.0000
-0.12
4
3
2
0.21
0.22’ 0.16 0.44’
= = = =
1
0.36’
0.47’
R R2 F P
4
0.43’
0.46**’
l
Service
-0.22*
Expertise Efficiency of Internal Operations Independence Role Criticality Performance Gap
Multiple
a1
Variables
l
0.47’
l
l
Overall Strategic Involvement; 2 = Mission; 3 = Strategy Formulation;
4 =
l
l
l
l
0.32’ 0.17 0.29’
Strategy Implementation
* p < 0.05 '* p < 0.01 "'D < 0.001
boards are expected to do regarding mission development, strategy formulation and implementation. Second, board characteristics centering on directors expertise (H2) and efficiency of internal operations (H3) are significant predictors of variations in board strategic involvement. This finding reaffirms the importance of the intangible portion of board characteristics. For a long time, researchers have emphasized the role of composition variables, with contradictory findings. For instance, contrary to expectations, Table 2 shows that outsiders’ representation (H2) was negatively associated \vith board strategic involvement. In combination, these results urge examination of expertise and efficiency as vitally important correlates of board strategic involvement. From a practical perspective, the positive association betlveen board expertise and strategic involvement (H21 suggests that thoughtful selection of directors who have significant familiarity with the industry and company operations is important. Directors need a specialized focus to contribute positively to their strategic function. This way directors can become true gatekeepers of crucial information emanating from the firm’s external environment. The finding that the efficiency of the internal process (H3; has a strong positive association with the strategic involvement of the board is also encouraging. Over the past decade, many steps have been recommended to
reform the board such as separating its chairmanship from the CEO (Rechner & Dalton, 1989), establishing specialized committees, restructuring the flow of information (Rechner, 1989), and increasing the frequency of board meetings. The results of the present study reinforces the value of these recommendations. Together, they may prepare the board for its expanded strategic involvement. On the other hand, increasing representation of outside directors on the board may hinder its strategic involvement. This finding contradicts our hypothesis (Hl) and much of the popular literature. However, upon reflection six practical considerations limit the potential strategic involvement of these directors: (1) demands of their other professional responsibilities may make it difficult for outside directors to devote the necessary time for board activities (Andrews, 1981). In fact, Chitayat (1984) found that lack of time is a major impediment of outside directors’ involvement in initiating or approving strategic issues; (2) as outsiders’ representation increases, the possibility of interlocking directorates rises. This may cause outside directors to limit their own contribution to the development of strategies in order to protect the different interests that they represent and to avoid conflicts of interest; (3) since the CEO still plays a major role in selecting outside directors, their independent from management is often questionable. In reality, this means that outsiders may not delve deeply into managerial views or strategic proposals; (4) it has been observed that
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when outside directors doubt managerial abilities or directions they often resign instead of confronting the CEO; (5) having outside directors is not a guarantee that the many concerns expressed in a firm’s external environment will be stressed in mapping strategic decisions (Pearce, 1983). In fact, many outside directors seem disposed to focus on issues pertaining to efficiency, rather than long-term effectiveness; (6) outside directors often lack familiarity with industry conditions and company operations (Vance, 1983), and function largely based on information provided by the CEO. Third, the results highlight a persistent paradox in attempting to stimulate directors’ involvement in the strategic process. Clearly, characteristics of boards are of paramount importance in explaining variations in boards‘ involvement. But, the current results show that without CEOs’ belief in and acceptance of directors’ crucial strategic contribution, directors’ strategic involvement will be limited (H5). This seemingly paradoxical finding urges collaboration between the board and CEO. CEOs working in consort with - but not dominating - their boards can gain considerably from directors’ experience and insight. Fourth, the corporate performance gap (H6) does not appear to be associated with variations of board But, caution is necesSary in strategic involvement. interpreting this finding. Mintzberg’s (1983) synthesis of the literature suggests that boards become especially active at times of crises, including declining performance. Hence, it would be premature to abandon research on this variable before validating this study’s results by using alternative measures of performance gap.
Conclusion Boards are increasingly active in shaping the strategies their firms pursue. This study shows that boards will be actively involved in the strategic arena if directors have the requisite expertise, have structured their boards’ decision-making processes well, and are viewed by CEOs as important contributors to the effective performance of their companies. REFERENCES Andrews, K.R. (1980) The Concept of Corporate Strategy, rev. edn, Homewood, IL: Richard D. Irwin. Andrews, K.R. (1981) Corporate Strategy as a Vital Function of the Board, Hatward Business Review, 39: 6, 174-184. Bavly, D. (1985) What is the Board Good For?, Long Range
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Vance, S.C. (1983) Corporate Leadership: Boards, Directors and Strategy, New York: McGraw-Hill. Zahra, S.A. (1990) Role of Boards of Directors in Strategic Planning, Long Range Planning, in press. Zahra, S.A. & Pearce, J.A. II (1989) Boards of Directors and Corporate Financial Performance: A Review and Integrative Model, journal of Management, 15: 2,291-334.