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Board Diversity and Innovation
The mediating role of Social Capital
Name: Nuka Machviladze
Student number: 10713034
Final Thesis Date: 31 January, 2015
Master of Science, Business Administration
Track: International Management
University of Amsterdam
Supervisor: Dr. Ilir Haxhi
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Statement of originality
This document is written by Student Nuka Machviladze who declares to take full responsibility for the contents of this document.
I declare that the text and the work presented in this document is original
and that no sources other than those mentioned in the text and its references
have been used in creating it.
The Faculty of Economics and Business is responsible solely for the
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Table of contents
Abstract………...5
1. Introduction……….……....6
2. Literature Review………..12
2.1 Board of directors: Agency theory and resource dependence theory………..12
2.2 Board Diversity………...…14
2.3 Social Capital………..16
2.4. Innovation………...………...19
3. Linking Diversity, Social Capital and Innovation………...……….24
3.1 Diversity and Innovation………....……….24
3.1.1 Gender and Innovation……….24
3.1.2 Age and Innovation………..26
3.1.3 Ethnicity and Innovation………..27
3.2 Board diversity and social capital………...………....29
3.3 Social Capital and Innovation……….32
3.4 Social capital as mediator………33
4. Methodology………...36
4.1 Sample and data collection………..36
4.2 Variables………..36 4.2.1 Dependent Variables………36 4.2.2 Independent Variables………..37 4.2.3 Mediating Variables……….37 4.2.4 Control variables………..38 4.3 Data analysis……….………..39 4.4 Method of analysis………..39 5. Results………...40 5.1 Descriptive Statistics………...40
5.1.1 Means and Standard Deviations………...40
5.1.2 Correlation………41
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5.2 Regression Analysis………44
5.3 Mediation………52
6. Discussion……….55
6.1 Board diversity and firm innovation………...55
6.2 Board diversity and social capital………...57
6.3 Social Capital and Innovation……….58
6.4 Social Capital as a mediator………60
6.5 Firm size, board size and industry complexity………61
7. Limitations………63
8. Future Research……….65
9. Conclusion………66
10. References………...70
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Abstract
A current issue regarding corporate governance is related to whether diversity can influence shareholders value and how it can influence firm performance and firm innovation. The effects of board diversity on firm outcomes has been studied extensively in the literature. However, the results show contradicting findings. Building upon resource dependence theory this study explores insights about whether and how board diversity can influence firm
outcomes. Therefore we hypothesize that board diversity will have a positive effect on firm innovation and that this relationship will be mediated by social capital. By bringing in social capital as a mediator, this study brings a social contribution to existing literature and extends the understanding of social perspective of resource dependence theory in corporate
governance. The sample in this study consists of 80 US firms selected from Fortune 500. The results show significant findings for the effect of age diversity on firm innovation. However, in contrast to the expectation, the relationship is found to be negative. No support is found for gender and ethnicity diversity affecting firm innovation, and social capital mediating the relationship. Furthermore the research has found that firm size, board size and industry complexity are significant factors explaining the relationship between board diversity, social capital and firm innovation.
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1. Introduction
One of the central questions for the corporate governance agenda is the understanding of how board of directors can impact corporate performance. Even though there is a distinction of boards structure between countries (US and UK have unitary system using single board of directors including inside and outside directors versus most of Europe’s two-tier system using two board roles including management board and supervisory board) (Krivogorsky, 2006) , the board of directors have two general functions in an organization: Monitoring the
management and providing resources (Hillman and Dalziel, 2003). The monitoring function of boards is to protect shareholders value and make sure that managers will not act in their own interests. This goal is supported by the agency theory where the board fulfils a very important role in resolving agency problems between management and shareholders, by monitoring and controlling the management. Second important function of boards is to
provide resources. This theory is derived from the resource dependence theory. Thus from the resource dependence perspective the board is seen as an important strategic resource for the organization (Hillman & Dalziel, 2003; Haynes & Hillman, 2010).
A current issue regarding corporate governance is related to whether diversity can influence shareholders value and finally firm’s performance. There are two types of diversity. One is the observable diversity such as race, ethnic background, age or gender. The other type of diversity is less visible and observable, such as education, technical abilities, functional background, socioeconomic background, personality characteristics and values (Milliken and Martins, 1996). This study focuses on observable types of diversity by investigating whether diversity in gender, ethnicity and age could make an impact on firm outcomes. The overall fraction of women and minorities in boards remains small, however diversity in boards has been growing over the last thirty years. While in 1973 only seven per cent of Fortune 1000 boards had minority directors, in 2010, 78 per cent have at least one minority director (Rhode
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& Packel, 2010). By minority we mean a group that differs in culture, ethnical background or race from the majority/dominant group.
Several studies argue that board diversity is an important goal in an organization (Milliken & Martins, 1996, Carter et al., 2003, Rhode & Packel, 2010). There are several reasons to have diversity in a company. First, diversity is seen as the right thing to do because everybody with appropriate skills deserves a chance to work at higher levels. But besides this, diversity is also found to influence decision-making process and firm performance (Rhode & Packel, 2010). Diverse boards can provide new insights and perspectives which can improve organizational value and firm performance. Another advantage of board diversity is that because
stakeholders (employees, customers, clients, shareholders) become increasingly diverse, and because the goal of boards is to protect their stakeholders, it is important that the
representatives of these stakeholders are diverse as well (Kang et al., 2007). However, diversity could also have negative effects on firm outcomes. Because diverse board members come from different backgrounds and have different perspectives on aspects, this can increase conflicts, create poor team integration and lack of cohesion among board members (Miller & Triana; 2009; Knight et al., 1999; Hambrick et al., 1996). Therefore, diverse individuals can also have negative impact on team performance (Milliken & Martins, 1996).
Overall, the effects of board diversity on firm performance has been studied extensively in the literature, but the results show contradicting findings. While research has shown that board diversity affects firm’s outcome (i.e. financial performance), its effect on innovation, as one of the important factors of organizations success, is still underdeveloped. This research tries to fill in the gap by investigating the effects of board diversity on firm innovation. In this way, this study contributes to the literature on the influence of diversity on alternative outcomes of the firm. Prior research shows that innovation is an important predictor of firm performance (Miller & Triana, 2009).
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Innovation is also broadly seen as an important element of competiveness, implemented in the organizational structures, processes, products, and services within an organization (Gunday et al., 2011). One of the keys to global success is innovation, and firms can achieve competitive advantage through innovation which in turn creates growth and wealth for the company (Brown & Eisenhardt, 1998). The purpose of this research is to explore how board diversity can add to firm innovation by answering the Research Question:
Research Question 1: What is the relationship between board diversity and firm innovation? It is believed that diverse board members could contribute to firm innovation by providing resources derived from being diverse. Diverse board members are seen to monitor in a more effective way because boards with different backgrounds are more able to consider issues in other ways. This means that diverse board members acquire resources that directors with traditional backgrounds do not have (Carter et al., 2003). Existing literature has found evidence that diversity can influence firm performance (Milliken & Martins, 1996;Carter et al., 2003; Kang et al., 2007; Rhode & Packel, 2010). Because many studies suggest that board diversity has positive effect on firm performance, it is believed that the effects will also hold for firm innovation, since innovation is another type of a firm outcome.
However, the relation between board diversity and firm outcomes is found to be complex and indirect (Forbes & Milliken, 1999). In line with the literature, the relationship is believed to be indirect and influenced by some other factors such as interaction and communication (Østergaard et al., 2011) and strategic decision making (Hambrick and Mason, 1984; Balta et al., 2013). In order to explore the effect of alternative factors that may influence firm
outcomes such as innovation, we focus on social capital. Thus next to the investigation of direct relationship between board diversity and firm innovation, this study will also focus on the social factor acquired from the external environment and will investigate whether
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diversity and innovation can be mediated by social capital. Therefore, the second Research Question will be:
Research Question 2: How can social capital mediate the relationship between board
diversity and firm innovation?
Literature suggests that the ability for board members to acquire strategic resources can be affected by links and contacts in the external environment (Carter et al.,2003; Pfeffer & Salancik, 1978; Pye, 2005). These linkages can create great advantages for boards and for their organization, such as provision of resources (information, expertise etc.), channel and communication networks, and support and legitimacy from organizations in the external environment (Pfeffer & Salancik, 1978). Social capital plays an important role in providing resources form the external environment, and these increasing resources of board directors, provided through ties with external and social environment, are found to impact
organizational performance (Hillman & Dalziel,2003; Haynes & Hillman. 2010). Social capital is a part of board capital (the other part is human capital). Board capital refers to the sum of human capital (i.e. boards experience, expertise and reputation) and social capital (i.e. resources linked with external and social environment such as network of ties to other firms and external contingencies) (Hillman & Dalziel;2003,Walt & Ingley,2003).
Several studies in the resource dependence theory find that diversity not only creates internal resources, but also external resources (Carter et al.,2003; Walt & Ingley, 2003; Pfeffer & Salancik, 1978; Pye, 2005). Diverse directors can create links and contacts with the external environment which can create channel and communication networks, and support and legitimacy from organizations in the external environment (Pfeffer & Salancik, 1978). The social ties of directors with the external environment are considered to be important and are seem to affect what is happening outside the board room, inside as well as outside the organization (Pye, 2005). In line with the literature, it is believed that social capital acquired
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from the external environment can impact the relationship between board diversity and firm innovation. In other words it is expected that, the higher the degree of diversity within the boards, the higher the chance is that they have ties with the external environment (social capital), the higher the impact on firm innovation will be. Thus the gap in the literature that this study tries to fill is the relationship of board diversity and innovation through the mediating factor of social capital.
Overall, this research has the purpose to answer two research questions.
I) What is the relationship between board diversity and firm innovation?
II) How can social capital mediate the relationship between board diversity and firm innovation?
The sample frame for this study consists of 80 firms of Fortune 500 U.S. companies from 2007 until 2012. The data to test the relationship between board diversity, social capital and innovation will be collected from Orbis database and Wharton Research Data Services (WRDS). The used method to analyse the data and to test the hypothesis is hierarchical ordinary least squares (OLS) regression through SPSS. To test for mediation, PROCESS developed by Hayes, will be used.
We argue that gender, age and ethnicity will have a direct effect on firm innovation, but we also argue that the relationship will be mediated by social capital.
This study adds to the literature by investigating social capital as a mediator of the
relationship between board diversity and firm innovation. By focusing on social capital, the study brings a social contribution to existing literature and argues that diversity and firm innovation relationship is indirect and can be influenced by social factors. In sum, the study extends the understanding of social perspective of resource dependence theory in corporate governance.
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The study will also make a practical contribution for directors in businesses by providing them practical information about the effects of diversity in boards and how it may help them to acquire resources that can have a positive impact on firm innovation.
The rest of the study is organized as follows: First, theoretical framework will describe diversity, social capital and innovation, and the hypothesis formulation will be presented. Second, methods of the study are introduced which will include sample information, study measures, data analysis and test results. Finally we will close up with discussion, future research, limitations and conclusion.
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2. Literature Review
2.1 Board of directors: Agency theory and resource dependence theory
One of the most important distinction of board structures in corporate governance is the unitary versus two-tier board system. While the US, UK and some European countries (Belgium, France, Italy, Portugal and Spain) are using a unitary board structure, most of the Continental European Union Members (CEUM) use a two-tier board structure (Krivogorsky, 2006). Unitary board system is characterized by a single board of directors. In this one-tier board system only one single board exists. All board members are normally elected by the shareholders and it can include inside directors as well as outside directors. Inside directors are usually current or former managers of the organization. Outside directors are usually active or retired executives in other organizations (Ayuso & Argandoña, 2009) and have little or no financial links with the company (Conyon & Peck, 1998). The shareholders have also the power to remove the board members, however this will only happen in extreme cases such as serious misconduct or extreme underperformance (Jungmann, 2006). A two-tier board system characterizes the German model of corporate governance. According to this model, corporations have to have two boards, the management board and the supervisory board ( who either represent shareholders or employees). The main goal of supervisory board is to monitor management and replace them if necessary. Among other tasks, supervisory boards represent the corporation, approve annual accounts and intervene in cases where the company’s
interests are seriously affected (Jungmann, 2006). This study will investigate the unitary board system of top 500 companies in the United States of America.
Generally, the board of directors have two essential functions in an organization: monitoring the management and providing resources. The monitoring function of boards is to protect shareholders value and make sure that managers will not act in their own favourites. This goal is supported by the agency theory. Agency theorists argue that the key activity for boards is to
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monitor management on behalf of shareholders. The board fulfils a very important role in agency theory, to resolve agency problems between management and shareholders, by monitoring and controlling the management. If necessary, boards are able to replace management if they are not creating value for their shareholders but rather act in their own interest. The key issue related to the agency theory is proportions of inside and outside or independent directors. From an agency perspective, it is suggested that the greater the
proportion of outside directors (directors with no commitment to the organization), the greater the ability to monitor self-interested actions of management which will minimise agency costs (Walt & Ingley, 2003), and will finally improve firm performance (Hillman & Dalziel, 2003). Outside or independent directors will not group with inside directors in order to undermine the interests of shareholders because of their incentive to build reputation as expert monitors (Carter et al., 2003).
Second important function of boards is to provide resources. This theory is derived from the resource dependence theory. From the resource dependence perspective the board is seen as an important strategic resource for the organization. Many studies show that the role of boards as strategic resources is affected by the external environment. Boards seem to develop
strategic resources by having links and contacts with the external environment. These linkages create great advantages for boards and for their organization, such as provision of resources (information, expertise etc.), creating channel and communication networks, and creating support and legitimacy from organizations in the external environment (Pfeffer & Salancik, 1978). From the resource dependence theory, boards as resources seem to develop board capital. The board capital refers to the sum of human capital and relational capital of boards. Human capital includes boards experience, expertise and reputation, hence the knowledge of boards. Relational capital, also referred to as social capital, includes resources linked with external and social environment such as network of ties to other firms and external
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contingencies (Hillman & Dalziel;2003,Walt & Ingley,2003). Hillman and Dalziel (2003) introduce the concept of board capital and they integrate two perspectives:
1) The agency theory where effective monitoring is a function of boards incentives. 2) The resource dependence theory where provision of resources is a function of board capital.
External contacts, ties and interactions (social capital) is able to provide information that complements human capital, and these capitals combined, helps to shape the organizational outcomes. Overall, studies show that in the resource dependence theory, board capital plays an important role in providing recourses to the firm, which finally impacts the organizational performance (Hillman & Dalziel, 2003; Haynes & Hillman, 2010). This paper will pursue the study of how certain board characteristics can impact certain organizational outcomes. As previous study show, the social capital plays an important role in providing resources for board members, and boards are seem to influence firm performance. So there is a significant evidence that board member characteristics (such as their social capital) can influence organizational outcomes. However, we believe that other characteristics of boards can influence organizational outcomes and social capital can play a mediating role in this relationship. That is why this study will investigate diversity as the influencing board
characteristic and the effect of it on the organizational outcome of innovation. We argue that board diversity affects firm innovation, but we also argue that social capital mediates this relationship. Next we will explain why the study is using diversity as a driver of innovation and then why social capital can mediate the diversity-innovation relationship.
2.2 Board Diversity
Board diversity relates to board alignment and diverse combination of attributes,
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process and decision-making (Walt & Ingley, 2003). According to Milliken and Martins (1996) there are two types of diversity. One is the observable diversity such as race, ethnic background, age or gender. Other diversity type is the one that is less visible, non-observable diversion, such as education, technical abilities, functional background, socioeconomic background, personality characteristics or values (Milliken & Martins, 1996). Unobservable diversities show diversities in knowledge, technical skills and expertise and experience. The reason for the distinction between observable and unobservable diversity is that when differences between people are visible, they are more likely to raise responses due to biases, prejudices and stereotypes (Milliken & Martins, 1996). Diversity is found to have a positive impact on creativity and innovation, and effective problems solving in organizations. Also, diversity promotes better understanding of market place (Milliken & Martins, 1996, Carter et al., 2003), it can raise discussions, ideas exchange and group performance. It can also provide new insights and perspectives which can improve organizational value and firm performance (Kang et al., 2007). Another advantage of board diversity is that because stakeholders
(employees, customers, clients, shareholders) become increasingly diverse, and because the goal of boards is to protect their stakeholders, it is important that the representatives of these stakeholders are diverse as well (Kang et al., 2007). Importance of diversity is found not just to be the right thing to do, but also influences decision-making process and firm performance (Rhode & Packel, 2010).
Motivation for board diversity underlies in the agency theory and resource dependence theory (Walt & Ingley, 2003). Regarding to the agency theory, diverse boards can monitor
management in a more effective way due to its ability of having directors with other gender, cultural, and ethnical backgrounds to consider issues in other ways than directors with traditional backgrounds (Carter et al., 2003).
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Board diversity is also promoted from the resource dependence theory. Diversity in boards seems to increase the resources that are inserted by individuals in boards and the access to external resources. (Carter et al.,2003; Walt & Ingley, 2003).
Overall, studies confirm that diversity in boards can improve monitoring, problems solving, better understanding of market place and it can provide resources which can increase
creativity and innovation in an organization. These empirical findings argue to see a positive relationship between board diversity and firm outcomes. That is why this study uses diversity as a board characteristic and examines how diversity can affect one of the organizational outcomes, in this case, the firm innovation. However, it is also found that due to different perspectives on issues, diversity in teams can lead to more disagreements, conflicts and communication problems (Knight et al., 1999, Hambrick et al., 1996). Therefore, diverse individuals can have integration problems and can have negative impact on team performance (Milliken & Martins, 1996).
2.3 Social Capital
Relational capital or social capital is defined as ´the sum of actual and potential resources embedded within, available through, and derived from the network of relationships possessed by an individual or social unit’ (Nahapiet & Ghoshal, 1998). Hillman & Dalziel (2003) introduce the concept of board capital as the sum of human and social capital of boards of directors. Board capital determines boards ability to provide resources to the firm and thus is built upon the resource dependence theory. This paper will focus on board’s social capital which explains boards resources obtained through network of ties and connections (Hillman & Dalziel, 2003; Walt & Ingley, 2003). Many studies confirm that social ties with board members inside the organization (internal ties) and/or outside the organization (external ties) affect board features and their influences on the board. Social capital can be distinguished into two types: internal social capital (i.e. director’s co-working experience on the focal board) and
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external social capital (i.e. board’s external directorship ties to other corporate boards) (Tian et al.,2010).
Regarding to internal social capital, Stevenson and Radin (2009) support a social capital perspective on influence that addresses the relationships with others on the board as important factors in the social dynamics of board decision making. They focus on the ties within the board of directors and discuss that ties to others in a network of strong ties among those who meet outside board meetings are more important predictors of social influence than human capital or ties across boards. Ties within the board represent the social capital of members in the form of prior relationships with other directors, ties to others on the board, and
membership in cliques within the board’s network of ties. This social perspective focusing on network ties clarifies the social dynamics of the boardroom. Boards are seem as social
institutions in the social network model that enables boards to interact and reach agreements. Regarding to external social capital, Pye (2005) draws attention to the importance of social capital to board behaviour. He concludes that social capital expands the understanding of the impacts of external relations on the internal working of boards. Board behaviour is influenced by a complex network of relationships between executive (insider) directors, nonexecutive (outsider) directors and multiple external and internal stakeholders. The social ties of board members to the external environment allows firms to access more or better information which lessens the impact of uncertainty of its industry environment (Haynes & Hillman, 2010). Firms that have board members with multiple ties to the firm’s main industry are better able to survive and succeed because it can more easily understand industry events and trends due to better information (Haynes & Hillman, 2010). An important method of controlling and accessing resources from the external environment is through director interlocks. Director interlocks occur when a director on a focus firm sits on the board of a different firm. Directors that sit on more than one board are creating ties where information and resources can flow
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into and out of firms and can impact firm’s outcomes (Johnson et al., 2012). Director
interlocks can provide experience, and they can influence decisions and acquisitions (Johnson et al., 2012). However, director interlocks can also have negative effects on shareholders. Interlocked directors may not be sufficiently independent, and their decisions in one firm may affect their expectations in other firms. For instance, CEO-director can vote to increase salary of the focal firm’s CEO in the hope of getting reciprocal treatment (Ruigrok et al., 2006). Thus while interlocking boards can be considered as important vehicle of controlling and accessing resources from the external environment, when directors independence is compromised, which is the case in interlocked directors, it has the potential to favor management interests rather than shareholders interest (Johnson et al., 2012).
The social ties with the outside world of directors have been recognized as important for a long time. What happens in the boardroom is also influenced by what happens outside the board room, both inside and outside the organization (Pye, 2005). The aphorism that “it’s not what you do, it’s who you know” becomes even more relevant. Relationships can constitute an important asset, and these assets can be called upon and leveraged to one’s advantage. Thus relationships are a significant resource for social action (Pye, 2005). Social capital is a great relevance to governance researchers and invites them to integrate different levels of analysis. It includes ‘working from an individual and his or her relationships through to social unit (group or board) and to the network and assets that may be mobilized through that
network that have potentially huge impact at board level.’ (Pye, 2005). However, Pye argues that the evaluation of the process and outcomes of social capital can become problematic. Social capital is not tradable like financial capital is. This addresses the importance of person and context for making sense of the interrelationships between board directors. The valuation and recognition of this capital is unclear especially because it can change in time and
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event, through the action of others. It takes two to build a relationship in social capital, it takes more to recognize and validate it, but it takes only one to destroy the value of the capital if he or she decides not to play his or her part in enacting the resource requested by the other party (Pye, 2005). It can also be destroyed by others who fail to recognize or validate the value of the relationship. Thus external relationship appear to have significant value on board
behaviour, but the actual impact and outcome of external relationship (social capital) can only be known with hindsight (Pye, 2005).
Overall, social capital explains boards resources obtained through network of ties and
connections and these ties can influence board’s decision making, interaction and consensus, and allows firms to access more or better information and easily understand industry events and trends. This study is mainly focusing on external social capital due to the importance of social capital to board behaviour and the impacts of external relations on the internal working of boards. Board members with multiple ties in the external environment are found to be better able to obtain information, survive and succeed in their industry. Social ties can develop social capital for board members and this board resource is found to impact
organizational success. Because diversity can also create resources for board members which may also impact organizational success, this study investigates what the relationship between diversity and innovation (a form of organizational success) is and how this relationship is mediated by social capital.
2.4. Innovation
Innovation is ‘the generation, acceptance, and implementation of new ideas, processes, products or services. Innovation therefore implies the capacity to change or adapt’ (Thompson, 1965). Schramm et al. (2008) established a definition of innovation as ‘the
design, invention, development and/or implementation of new or altered products, services, processes, systems, organizational structures, or business models for the purpose of creating
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new value for customers and financial returns for the firm’. The typology of innovations
differs among literatures, but this paper will describe the typology using OECD Oslo manual (2005). In the manual, four types of innovation are distinguished. i.e. product innovation, process innovation, marketing innovation and organizational innovation (OECD Oslo Manual, 2005). A product innovation means introducing new or improved good or service with respect to its characteristics or intended uses (e.g. improvements in technical specifications, software, user friendliness, components and materials). A process innovation means implementing new or improved production or delivery method. A marketing innovation means implementing new marketing method which involves changes in product design or packaging, product placement, product promotion or pricing. An organizational innovation means implementing new organizational method in the business practices of the organization, workplace
organization or external relations (OECD Oslo Manual, 2005). Another important types of innovation in the literature is incremental and radical innovation. Incremental innovations refers to refining and reinforcing the potential of existing products or technologies (innovation in existing products/services or technologies). The goal is to improve existing products, services or processes by making small changes (West & Farr, 1990; Wincent et al., 2010). Radical innovation refers to significant transformation or renewal of products or technologies (innovation in new products/services or technologies) (Wincent et al., 2010). This type of innovation creates large changes in the organization. Innovation is broadly seen as an
important element of competiveness, implemented in the organizational structures, processes, products, and services within an organization (Gunday et al., 2011).
Innovation is not only seen as something new, but it also has to add value to customers and firms. To be able to manage innovation, it is required to have a set of best practises and a good firm and industry level measures. The academics have given many attention to innovation. However, the reviews and meta analyses are rare and narrowly focused, either
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around the level of analysis (individual, group, firm, industry, consumer group, nation) or the type of innovation (product, process, business model). Even though the narrow focus helps us to understand specific facets of innovation on a deeper level, it prevents us to see the relations between these facets and eventually obstructs the consolidation of the field (Crossan and Apayding, 2010).
Crossan and Apayding (2010) conducted a systematic analysis of innovation research and developed a comprehensive multi-dimensional framework of organizational innovation, linking leadership, innovation as a process and innovation as an outcome. There is a wide range of meanings of innovation, Crossan and Apayding (2010) composed a comprehensive definition of innovation as: ‘production or adoption, assimilation, and exploitation of a
value-added novelty in economic and social spheres; renewal and enlargement of products,
services, and markets; development of new methods of production; and establishment of new management systems. It is both a process and an outcome’. Their definition records important
aspects of innovation: ‘Production or adoption’ means that it includes both internally
conceived and externally adopted innovation. ‘Exploitation’ emphasizes innovation as a more than a creative process by including application. ‘Value-added’ highlights intended benefits at one or more levels of analysis. It shows that innovation can either refer to relative as to absolute, novelty of an innovation. ‘Process and outcome’ emphasizes the two roles of innovation. Their study is focused on organizational innovation (firms, group, and individual levels of analysis) because these elements are arguably within individuals firm’s control. By focusing on the firm level, they provide a practical basis for managers where they can build structures and systems that would enable innovation within a firm.
The multi-dimensional framework (figure 1) shows determinants and dimensions of
innovation. The determinants of innovation are combined from the existing literature and are divided into three distinct meta-theoretical construct: innovation leadership (supported by
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upper echelon theory), managerial levers (supported by the dynamic capabilities theory) and business processes (supported by process theory).The Upper Echelon Theory (Hamrbick & Mason, 1984) proposes that leaders behaviour are a function of their values, experiences and personalities. It suggests that composition and characteristics of the Top Management Team yield a stronger explanation of organizational outcomes than a leader’s characteristics alone (including amount of education, age, tenure, diversity of background and experience and extra-industry ties). The dynamic capabilities theory (Eisenhardt & Martin, 2000) supports the managerial levers construct, which is a dynamic strain of the resource-based view of Barney (2001), where different resource bases among firms provide the source of variation for innovations. The new products are then selected by the marketplace and the firms mission is to combine exploitation of the existing resources and at the same time searching for new opportunities (exploration).
Figure 1: Multi-dimensional framework of organizational innovation (Crossan & Apaydin,
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However, to not ‘creative destruct’ the currently valuable resources, next to exploiting existing resources a firm should also develop new and valuable resources and capabilities (Crossan & Apaydin, 2010). The process theory holds that similar inputs transformed by similar processes will lead to similar outcomes. There are certain constant conditions that are necessary for the outcome to be reached. A process level explanation recognizes the
generative mechanisms that cause observed events to happen in the real world, and the particular circumstances or contingencies when the causal mechanisms are operated (Harré and Madden, 1975; Tsoukas, 1989 in Crossan & Apaydin, 2010). A process has also a wide range of meanings, and Crossan & Apaydin (2010) use the definition of process as the category of concepts of firm actions (like rates of communication, work flows, decision making techniques or methods for strategy creation). The dimensions of innovation include innovation as a process and innovation as an outcome which explains the two roles of innovation.
According to OECD manual, the following factors seem to be influential on innovation and on firm performance. First, competition and opportunities for entering new markets can drive innovation activities in an organization (OECD Oslo Manual, 2005). Other factors that can impact innovation include economic factors (e.g. high costs or lack of demand),
organizational factors (e.g. skilled personnel or knowledge) and legal factors (e.g. regulations or tax rules) (OECD Oslo Manual, 2005). These factors influence organizational factors by creating human capital, knowledge, education and expertise, which in turn, influences
innovative activities and performance. Innovation impact on firm performance can range from effects on sales and market shares to changes in productivity and efficiency (OECD Oslo Manual, 2005).
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3 Linking Diversity, Social Capital and Innovation
3.1 Diversity and Innovation
Diverse board members are monitoring in a more effective way because boards with different backgrounds are more able to consider issues in other ways. This means that diverse board members acquire resources that directors with traditional backgrounds do not have (Carter et al., 2003). Existing literature has found evidence that diversity can influence firm
performance (Milliken & Martins, 1996;Carter et al., 2003; Kang et al., 2007; Rhode & Packel, 2010). The ability of organizations to attract and retain people from diverse cultural backgrounds can lead to competitive advantages in cost structures and through maintaining human resources with the highest quality (Cox, 1991). Cultural diversity in workgroups can also create great advantages such as creativity, innovation, problem solving and flexible adaptation to change (Cox, 1991). Research is mainly focused on diversity at the workplace, but studies of diversity at the top level (board of directors) of an organization and its impact on firms innovativeness is limited. This study will investigate how board diversity can contribute to the level of innovation which will in turn can contribute to the growth and wealth of an organization.
3.1.1 Gender and Innovation
Existing literature finds generally a positive effect of gender diversity on firm outcomes. Women directors are able to bring unique features and skills to the board that can impact firm outcomes (Green and Cassel, 1996). More woman in boards could also lead to more
understanding of its customers and other stakeholders (Carter et al., 2003). Board members that have higher gender diversity may represent wider society and it can indicate that the company is able to understand different customer preferences in a better way. Female
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(Rosener, 1990). Overall, the impact of female directors on firm outcomes are generally found to be positive.
In line with existing literature, it is expected that gender diversity will have a positive effect on firm innovation. The ability of women to see things differently, their involvement and understanding of broader public is believed to impact innovativeness of a company in a positive way. The more women a board has, the more variety of information is expected to be available. Also, different values and perspectives of woman in boards will help to understand issues in a different way. This may help solving problems in a better way and reach a broader public. These benefits are expected to improve firms ability to create innovation.
Østergaard et al., 2011 argue that diversity can affect the way knowledge is generated and applied in the innovation process. They find a positive relationship between diversity in terms of education and gender on the likelihood of introducing innovation in an organization. However, the study of Østergaard et al. (2011) is focused on employee level. This study will focus on the directors level and will contribute to the literature on diversity and innovation moving beyond the much more studied diversity at employee and management level. There is also found to be a positive relationship between open culture in diversity and innovative performance. Torchia et al. (2011) find that increased number of women in corporate boards (going from one or two women to at least three women) makes it possible to improve the level of firm innovation. They investigate the contribution of women to the level of organizational innovation though their involvement in board strategic tasks. Board strategic tasks refers to the degree of board members involvement in the initiation and implementation phases of the strategic process. Carter et al. (2003) also find a significant positive relationship between the fraction of women and firm’s financial value. Overall, a positive relationship is found
between gender diversity and firm outcomes. Therefore we hypothesize:
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3.1.2 Age and Innovation
Generally, diversity in age is also found to have positive impact on firm outcomes. The explanation of why diversity in age can have a positive impact on firm outcomes is similar to the explanation of diversity in gender. Different generations in boards can provide different values, insights and perspectives on certain issues. This can promote better understanding of the market place, the customers, and other stakeholders. Board members that consist different generations are found to be better in problem solving and decision making processes (Cox, 1994). Diverse board members in terms of age are also more able to understand the values and preferences of customers and stakeholders of different generations (Cox & Blake, 1991). However, diversity in age can also increase conflicts and disagreements because of different perspectives and values different generations have. Therefore, board members with diverse age could also have negative effects on firm outcomes (Milliken & Martins, 1996).
Because diverse board members in terms of age are better able to understand broader range of stakeholders, and are able to bring new insights and perspectives, it is expected that diverse board members in terms of age will positively impact firm innovation. Although there is also found that age diversity could have negative effect, it is expected that age diversity will positively impact firm innovation. The ability of different generations bringing in different ideas and perspectives, is expected to outweigh the negative effects of age diversity. Including younger board members and their perspectives on certain issues is believed to be important in creating innovation. Young generations are better able to provide information about what is new in the market and how customer and other stakeholder preferences are changed over time. We argue that combining young directors with older ones that are more experienced can create great advantages for the firm and for firms innovativeness.
Nakano & Nguyen (2011) investigate the relationship between age of board members and firm performance for large sample of firms in Japan. They find that higher board age has a
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negative effect on firm performance. Another finding was that board age is more sensitive for younger and growing firms. They explain that board members with higher age are more risk averse and especially in undertaking acquisitions. McClelland and Barker (2012) also argue that CEOs that have left short career time in the board are adopting more risk-averse strategies which will have impact on future firm performance. Dechow and Sloan (1991) studied
whether CEOs in their final year invested discretionary to achieve short-term earnings. They find that CEOs in their final years in office spend less on research and development (R&D). Generally, a negative relationship is found between high age board members and firm performance. Therefore we hypothesize:
H2: Age diversity has a positive effect on firm’s innovation
3.1.3 Ethnicity and Innovation
One of the important diversities in society and in firms nowadays is ethnical diversity. In line with gender diversity and age diversity, ethnicity diversity is generally found to have positive impact on firm outcomes. Board members with diverse ethnic backgrounds can offer different experiences and can contribute to board decision making process by providing unique
perspectives and strategic issues (Walt & Ingley, 2003). Ethnicity in diversity may also
improve cross-cultural communication problems and interpersonal conflicts (Darmadi, 2011). Similar, to age diversity and gender diversity, we expect that ethnicity diversity will have a positive impact on firm innovation. Diverse ethnic board members can bring new insights, have unique perspectives and experiences which can all impact firm’s innovativeness in a positive way. Also, ethnic backgrounds could help international firms deal with foreign issues. In the current globalized world, diversity in ethnicity becomes even more important. Firms do not only have diverse workforce at national level, but firms also tend to globalize and operate internationally. This means that firms have to deal with international stakeholders
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from different ethnical backgrounds. The increasing globalization process has changed our customers and stakeholders and firms have to deal with different nationalities from different regions. Having diverse ethnical board members can help taking a step forward into the globalized world which in turn can contribute to firm’s innovation. Ethnicity diversity can help board members to better understand national ethnic diverse stakeholders, but also to understand firm’s international stakeholders.
Oxelheim and Randøy (2003) investigated the effect of foreign Anglo-American board members on firm performance on 253 Swedish and Norwegian firms. They find that firms with non-Anglo-American members of the board had higher firm values. They conclude that including foreign board members signals that firms not only introduce acquaintances to the board, but it also shows that firms are taking a step forward to globalization process. It also gives a positive signal to stakeholders which can improve organizational growth and performance. However, ethnicity diversity can also create conflicts and communication problems due to different cultural values and perspectives. Some studies find no significant relationship between ethnicity and firm outcomes (Randøy et al., 2006; Rose, 2007).
Generally, a positive relationship is found between ethnicity diversity and firm outcomes. In line with the literature, we expect that ethnicity diversity will have a positive outcome on firm innovation. Therefore we hypothesize:
H3: Ethnicity diversity has a positive effect on firm’s innovation
The effects of gender, age and ethnicity diversity are been established in the literature, but the findings are mixed. Therefore we developed the above hypotheses to test what the direct relationship between board diversity and firm innovation is. In addition, we will investigate the mediating effect of social capital on the relationship between board diversity and firm innovation. In order to measure the mediating effect, it is essential to test the direct effect as well. So even though the direct relationship between board diversity and firm innovation
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research is not novel, it is necessary to test the hypotheses because of two reasons. First, the literature shows mixed results and mostly the effect is tested on firm performance rather than on firm innovation. Second, because the next step will be to test a mediating effect of social capital, we would also like to see what the direct effect will be between board diversity and firm innovation.
3.2 Board diversity and social capital
Literature supports the idea that social capital can be provided by racial and gender diversity (Miller & Triana, 2009). Demographic diversity is found to be associated with differences in social capital and network resources. It is believed that demographic diversity can provide broader information by having links and ties outside the immediate network (Miller & Triana, 2009). Social capital can be provided by creating ties and receiving broader information. It is also found that females tend to have more diverse social networks than white males do (Ibarra, 1992). To obtain a career and social resources, woman and minorities were found to be more motivated to maintain multiple networks (Ibarra,1992;1993). Overall, diversity is found to increase resources that are inserted by individuals and the access to external
resources (Carter et al., 2003; Walt & Ingley, 2003). Diversity is also found to promote better understanding of market place (Milliken & Martins, 1996, Carter et al., 2003), by providing new insights from different point of views, raise discussions, ideas exchange and enhance communication with internal and external environment. Diversity within board members can create variety of knowledge, expertise and skills. By being diverse, board members can create resources through connections and ties with the external environment. Diversity in races and gender of directors widens the expertise and the number of linkages to external contingencies the firm is facing. In this way board members with diverse race and gender can contribute to firm’s resources (Hillman et al., 2002).
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In line with the literature, it is expected that diversity in all cases (age, gender and ethnicity) will have a positive effect on acquiring social capital. Because diversity in boards creates internal and external resources, it is expected that diverse board members in terms of age, gender and ethnicity will be more likely to acquire social capital than traditional board members. Because females are believed to have more social skills than males, it is expected that more females in boards will help to acquire more social capital. Same reason applies to boards with more age diversity and ethnicity diversity. We argue that directors with different ages and ethnic backgrounds are more able to create ties with a broader environment. Due to higher network heterogeneity, connections and ties with broader environment will provide more social capital for board members.
Hillman et al. (2002) examined how female and racial minority directors differ from those of white males for directors who serve on Fortune 1000 boards. They find that most female and African-American directors come from a non-business career, hold more advanced degrees than white male directors and join multiple boards at a faster rate than white male directors. This demographic characteristics of directors are bringing different human and social capital into the firm. Regarding non-business careers, female and minority races are found more likely to be support specialist and community influential than business experts. Through these non-business careers, females and minority races can provide social capital to firms. Support specialist provide specialized expertise in law, banking, public relations etc. Community influential provide non-business perspectives on issues and are influential with powerful groups in the community (Hillman et al., 2002). Regarding education, woman and racial minorities are found to establish advantages and provide the firm valuable skills and
connections as a result of their education. Thus also through advanced education, females and racial minorities are providing social capital to the firm. Regarding patterns of board
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the first board. Saliency refers to characteristics that are noticeable and judged to be relevant (Hillman et al., 2002). By being already a board member, it proves that you are qualified for being a member of another board which will reduce the risk of an unknown. After women and racial minorities join their first board, it reduces the perceived lack of fit on boards. Once female and minority races overcomes this lack of fit, the effect of stereotyping is weakened because they have proven to fit in. This makes them more attractive for subsequent
directorships and demonstrates a level of community with other directors. The anxiety of being different and unknown to existing directors is reduced. Ibarra (1992) investigated gender inequalities in the organizational distribution of power by testing how gender
differences had the tendency to form same-sex network relationships and how the individual attributes and positional resources were converted into network advantages. The study finds that women are seem to have more differentiated network pattern in which they obtained social support and friendship from women and instrumental access through network ties of men. On the other hand, men were more likely to form same-sex network relationships across multiple networks and these ties were found to be stronger (Ibarra, 1992). In line with
previous study, this research will investigate whether diversity in age, gender and ethnicity at the board level will contribute to directors’ social capital. Therefore we hypothesize:
H4: Gender diversity of boards has a positive effect on social capital H5: Age diversity of boards has a positive effect on social capital H6: Ethnicity diversity of boards has a positive effect on social capital
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3.3 Social Capital and Innovation
Studies show that board capital plays an important role in providing recourses to the firm, which finally impacts organizational performance (Hillman & Dalziel, 2003; Haynes & Hillman, 2010). The literature argues that board capital can create great advantages for boards and for organizations. Firms can profit from diverse human and social capital of diverse board members which in turn supports an innovation strategy (Miller & Triana, 2009). The human and social capital which is provided from knowledge can create competitive advantages by identifying opportunities for innovation (Miller & Triana, 2009).
In line with existing literature, it is expected that social capital will also contribute to firm innovation due to its ability to provide resources (information, expertise etc.), create channel networks and communication (Pfeffer & Salancik, 1978). By communicating and interacting with the external environment, boards can increase their resources and influence firm
outcomes such as innovation.
Rass et al (2013) argue that implementation of open innovation instruments strengthens the social capital of an organization. Open innovation is the exploration of external knowledge and ideas and the exploitation of internal knowledge outside the organization. Open
innovation is found to increase interaction, establish social relationships and thus create a social network, which in turn, is positively related to firm performance (Rass et al., 2013). Network board capital (human capital and relational/social capital) is also found to impact innovation (Wincent et al., 2010). Network board diversity of expertise and educational level are important to improve innovative performance in SME networks. SME networks are often characterized by governmental and institutional involvement and are pooling resources and taking research and development activities to provide the individual small firms with
resources that they would not be able to get it on their own (Wincent et al., 2010). While they find that network board capital (human capital and relational/social capital) influences
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innovation of an organization, this study will focus on the social perspective of the board capital (social capital) rather than human and social capital in sum. Also, while Wincent et al. (2010) find support for human capital affecting innovation for SMEs, this study will focus on large firms, since the sampled firms are from top 500 US firms. Since board capital is found to influence firm performance, we believe that social capital (as a part of board capital) will impact firm innovation (as a part of firm’s success). Therefore, we hypothesize:
H7: Social capital has a positive effect on firm’s innovation 3.4 Social capital as mediator
Finally, the mediating relationship will be tested. While extensive literature investigates the relationship between diversity and firm outcomes, there is a need to focus on mediating variables when such relationships are analysed. Because the relationship between diversity and firm outcomes, are complex and indirect (Forbes & Milliken, 1999), we argue that mediating factors can clarify the relationship between board diversity and firm innovation. Literature confirms that diversity has a positive influence on firm outcomes as well as on firm innovation. Literature also supports the link between diversity and social capital. Diverse individuals are found to provide social capital which in turn are found to impact firm outcomes. Overall, we argue that social capital can play a mediating role in the relationship between board diversity and firm innovation because of two main reasons. First, the
relationship between diversity and firm outcomes are not always direct and clear. Second, social capital seems to be influenced by diversity and seems to impact firm outcomes in a positive way.
To our knowledge, there are no studies about the mediating role of social capital between board diversity and firm innovation relationship. However, previous studies did investigate other mediating factors. For instance, Miller and Triana (2009) investigate mediators that
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explain how board diversity (in terms of gender and ethnicity) is related to firm performance. They suggest that the relationship operates through two mediators: firm reputation and
innovation. They find that both partially mediate the relationship between board diversity and firm innovation. In this study they assume that board diversity provides strategic human and social capital recourses to firms which influence these efforts, and increases innovation and firm reputation. They have a ‘value to diversity’ perspective which maintains that the important advantage of diverse groups is that they should provide a broader range of
knowledge, information and perspectives compared to homogeneous groups. Other examples of mediating factors, that influence diversity-firm outcome relationship, that have been discussed in the literature are interaction process (Østergaard et al., 2011), and strategic decision making (Hambrick & Mason, 1984).
To our knowledge there are no studies about the mediating effect of social capital on
diversity-innovation relationship. However, there are studies about other factors that have an impact on the relationship between diversity and firm outcomes. Because previous literature has found other influencing factors, we expect that social capital could also have an
influencing role in the diversity-innovation relationship. This study will look at the board level of organization, and investigate whether social capital can positively mediate the relationship between board diversity and firm innovation. Therefore we hypothesize:
H8: Social capital is positively mediating the relationship between board diversity and firm’s innovation
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Figure 2: Conceptual Model Board Diversity Gender Age Ethnicity Social Capital Interlocks Innovation R&D Patents H4 H5 H6 H7 H1 H2 H3 H8
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4. Methodology
4.1 Sample and data collection
The sample frame for this study consists of 80 Fortune 500 U.S. companies. We started by collecting data for Fortune 500. However, because of missing data about the variables, the sample was finally reduced to 80 firms. The data to test the relationship between board diversity, social capital and innovation was collected from two databases. The data about diversity (gender, age and ethnicity) and R&D expenses are collected from Wharton Research Data Services (WRDS). The data about interlocks and the number of patents are collected from Orbis database. These two databases are available through the library of the University of Amsterdam and provide various of economic and business information. The data is used for the year 2007 until 2012.
4.2 Variables
4.2.1 Dependent Variables
The dependent variable in this study is firm innovation. Firm innovation will be measured with two variables:
I) R&D expenses
II) Number of Patents.
While generally R&D expenses are used to determine firm’s innovation, this study will also use the number of patents to measure innovation. The reason for also using patents is that R&D intensity determines the input stage (decision to innovate and innovation intensity) and the innovation process. However, the actual output stage of innovation can be better
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4.2.2 Independent Variables
The independent variables in this study include board diversity. Building up with the previous studies, board diversity will be divided into following 3 variables:
I) Gender diversity: The gender diversity will be tested by taking the average of the proportion of women over the sample years.
II) Age diversity: The age diversity will be tested by calculating the average standard deviation of the ages of board members over the sampled years. The standard deviation is chosen to calculate the spread of ages within boards.
III) Ethnicity diversity: The ethnicity diversity will be tested by calculating the average proportion of non-Caucasians over the sampled years. The non-Caucasian
ethnicities included Asian, African American, Latin American, Native American and Middle East.
All the variables will be will be expressed as the proportion of the total board size. 4.2.3 Mediating Variables
The mediating variable in this study is social capital. The social capital will be measured with director interlocks (i.e. the number of companies in which the boards position is held). The reason for choosing director interlocks as a measure for social capital is because it is an important method of controlling and accessing resources from outside the board. Director interlocks occur when a director on a focus firm sits on the board of a different firm. Directors that sit on more than one board are creating ties where information and resources can flow into and out of firms and can impact firm’s outcomes (Johnson et al., 2012). The data about the interlocks will be calculated as the proportion of directors who sit in more than:
I) Three companies (>3 interlocks), II) Four companies (>4 interlocks)
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III) Five companies (>5 interlocks).
Thus three variables are tested for social capital. The reason for this is to see whether higher number of interlocks could have higher impact on the outcomes.
4.2.4 Control variables
This study uses three control variables.
I) Firm size: Because larger firms and larger boards may have greater chance to have diversity and innovation in firms, this study will use firm size as control variable. Firm size will be measured with the number of employees. The use of firm size is in line with previous literature ( Carter et al., 2003, 2010; Talke et al, 2010, Østergaard et al., 2011).
II) Board size: Board size is controlled by taking the average number of directors in boards within the sampled years. Controlling for board size is also in line with previous literature and it is explained that larger boards are more able to bring better information because there is greater knowledge from more directors to firm decision making (Carter et al., 2010).
III) Industry complexity: Controlling for industry is also in line with previous literature (Carter et al, 2010, Østergaard et al., 2011). This study will control for industry complexity by measuring whether the industries the firms are operating in are complex or not. Firms that operating in a more complex industry is argued to have less chance to be innovative. Thus a negative relationship is expected between industry complexity and firm innovation.
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4.3 Data analysis
First, the normality of the dataset was tested to fulfil the assumption of parametric testing. The descriptive statistics of the data showed that the data was positively skewed. To resolve the positively skewed distribution, all variables were transformed into log values using Lg10 function in SPSS. This provides the base ten logarithm of the variable in parentheses. To account for zero values in the data, the log transformations were performed with a+1 in the equation. After the log transformations, the values were approximately normal distributed which could be used for testing. Second, multicollinearity was tested using VIF in SPSS. All VIF levels were acceptable which provided variables that could be used to analyse.
4.4 Method of analysis
The used method to analyse the data and to test the hypothesis was hierarchical ordinary least squares (OLS) regression using SPSS. OLS regression is one of the major techniques that is used to analyse data and it forms the basis of many other techniques such as ANOVA and generalized linear models (Hutcheson, 2011). The hierarchical regression model is used to test the relationship between various independent variables and dependent variables after
controlling for firm size, board size and industry complexity. The first model consists only the control variables. In the following models, board diversity characteristics and social capital characteristics were added. The regression is made for the following two measures of
innovation, R&DLog and PatentsLog (logs to account for skewed distributions) and for three measures of social capital ( log values of >3interlocks, > 4 interlocks and >5 interlocks). To test for mediation, PROCESS, developed by Hayes, will be used for variables that showed significant effects in the regression analysis.
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5. Results
In this chapter, the results of the analyses will be reported which were described in the previous chapter. The results will be given separately for the two dependent variables R&D and Patents. With the results, hypotheses will be tested and discussed.
5.1 Descriptive Statistics
5.1.1 Means and Standard Deviations
To give a clear overview of the firms in the sample, some general firm characteristics will be discussed. Table 1 consists means and standard deviations of each variable in the study. The tested sample are 80 US firms randomly chosen from Fortune 500. The Fortune 500 consists top 500 US firms. The data is gathered for a time period of six years (2007-2012). The control variable firm size was tested with the number of employees, which varied from 5800 to 646000. The firms chosen are all large firms, but there is a large variance between them (Standard deviation of 106468,74). The average number of employees was 93341. The control variable board size was tested as the average number of board members over the sample years. The average board consisted 12 board members. The industry complexity was tested by looking at the industry’s the firms operate in and whether these industries are complex or not, hence complex industries are less innovative than noncomplex ones (1=high complex
industry, 2=low complex industry). The average industry complexity was 1,46 with a standard deviation of 0,502, meaning that high and low complex industries, the sampled firms are operating in, are nearly equal spread. The gender diversity was tested by taking the average of the proportion of women over the sample years. The highest percentage female board
members was 46% and the average was 18%. The age diversity was tested by calculating the average standard deviation of the ages of board members over the sampled years. The highest standard deviation of age was 11,19 and the mean was 6,227. The ethnicity diversity was
