BOARD INTERLOCKS IN STRATEGIC DECISION MAKING
AN EMERGING MARKET PERSPECTIVE
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MASTER DISSERTATION
BOARD INTERLOCKS IN STRATEGIC DECISION MAKING:
AN EMERGING MARKET PERSPECTIVE
By Leonora de Raad
MSc. International Business and Management University of Groningen, Sathyajit Gubbi
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Abstract
This dissertation examines the relevance of board interlocks as learning mechanisms on the strategic decisions of emerging market firms. Due to market liberalizations and high growth in emerging markets, market-seeking developed market firms rush in and become competitors, emerging markets need to overcome the competitive weaknesses. To get swift access to tacit assets (i.e. technological know-how, human capital) emerging market firms make risky acquisitions into the developed market in which they are unexperienced. I predicted that board interlocks would substitute for the lack of experiential knowledge regarding cross-border acquisitions. For business group affiliated firms the substitution effect of board interlocks is assumed to be less, as the group provide them with many ways to attain knowledge vicariously. Both hypothesis where not supported by the statistical analysis. The research focused on 45 firms from the Indian software industry and showed no effect of the extent of board interlocks on knowledge gaining, operationalized as future acquisitions. There appears to be no substitution effect of vicarious learning for missing experiential learning through board interlocks in the emerging market context.
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Content
Abstract…………...………...………...2
Introduction………...………4
Literature Review………...…7
Data and Method………...……16
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Introduction
Research regarding board interlocks has blossomed for over four decades. Davis (1996:12) even called board interlocks “the most studied social structure in organization theory”. Board interlocks exist when an individual affiliated with one firm also serves on the board of
another firm (Fennema & Schijf, 1978). By studying the relevant literature it becomes apparent that there are roughly two functions that board interlocks have: they can facilitate asserting control over other firms and they can be used to obtain knowledge and experience from others. Based on the latter, board interlocks are a generally accepted asset for a firm to upgrade its knowledge to improve corporate strategy (Haunschild & Beckman, 1998;
Carpenter & Westphal, 2001; O’Hagan & Green, 2004).
Although large amounts of research regarding board interlocks as information and knowledge providing mechanisms in a developed market context exist (i.e. Carpenter & Westphal, 2001; Barkema & Schijven, 2008), scholarly knowledge regarding this in the emerging market context is almost non-existent. Due to institutional differences that have a large impact on the strategic behaviour of a firm blindly assuming that board interlocks serve the same purpose in different institutional contexts is wrong (Peng, Wang & Jiang, 2008).
This paper intends to investigate if the conditions under which board interlocks facilitate strategic-decision making in the developed market context are also applicable to the emerging market context. The main research question is: “What is the relevance of board
interlocks in strategic decisions of emerging markets firms?”
Based on the work of Mizruchi (1996), Beckman & Haunschild (1998), Barkema & Schijven (2008), Tuschke, Hernandez & Sanders (2013) the conditions under which board interlocks are expected to provide knowledge to the focal firm for making better strategic decisions are defined. These conditions are that the focal firm needs to make a new and specific strategic decision in an uncertain environment in which it has no experiential knowledge.
5 weaknesses that emerging market firms have. They do not have the managerial competence and professional expertise to be able to compete head on with developed market firms due to institutional voids (Luo & Tung, 2007; Gubbi, Aulakh, Ray, Sarkar & Chittoor, 2009).
BothLuo & Tung (2007) and Gubbi, Aulakh, Ray, Sarkar & Chittoor (2009) describe how emerging market firms use high risk taking cross-border acquisitions to get access to certain advanced and tacit assets from developed market firms like technological know-how, R&D facilities, human capital, brands and distribution channels (Luo & Tung, 2007; Gubbi, Aulakh, Ray, Sarkar & Chittoor, 2009). However emerging market firms have little previous
experience in international markets (Figure 1 and 2)(Luo & Tung, 2007). This together with their lack of managerial competence and professional expertise creates a situation in which experiential knowledge is lacking although a new and specific strategic decision regarding who to acquire arises. Therefore creating the perfect situation in which according to the literature board interlocks could provide the focal firm with the knowledge needed to make the right acquisition.
In the context of emerging markets it is important to take notice of the fact that board interlocks are not the only way in which firms can learn from others. Vicarious learning includes all the learning and knowledge that can be attained by observing others and retaining and imitating their behaviour (Barkema & Schijven, 2008). Some firms in the emerging market context are part of a bigger structure called a business group. Business group affiliated firms are characterized by the large number of ties they have amongst each other. They are connected by formal ties: equity, buyer-supplier and directorate ties and informal ties: family, friendship, religion, language and ethnicity (Khanna and Rivkin, 2000).
Affiliated firms benefit from the ties they have amongst each other as providing resource sharing, mutual loan guarantees, cross-border-subsidization, creating economies of scale and scope and facilitating organizational learning through pooling and coordinating resources without facing high levels of risk (Hoskisson et al., 2000; Guillen, 2010).
6 ways in which these firms are provided with the knowledge they need regarding issues in which they lack experiential knowledge (Lamin, 2006). Therefore interlocks might be less important for generating knowledge vicariously when a firm is affiliated to a business group. This would indicate that the relevance of board interlocks on the strategic decision of making an acquisition is assumed to be less strong when the firm is affiliated to a business group.
The empirical context of this study is the Indian software industry. This industry offers an environment with a global scope in which competition from developed market firms is high and innovativeness is important due to short product life cycles. This creates an
environment in which competitive weaknesses that emerging market firms have due to their institutional context come forward. Therefore emerging market firms are pressured to quickly gain strategic assets through risk taking acquisitions in order to minimize their competitive lag with developed market competitors (Marketline, 2011).
This research found that when the extent of board interlocks is larger the emerging market firm is not more inclined to make an acquisition. Consequently, group affiliation or not had no impact on the non-existent effect between interlocks and acquisitions. Since no
significance was found it becomes apparent that the conditions under which board
interlocks are relevant for strategic decision making in the the developed market context is not transferable to the emerging market context. Therefore institutional differences should be taken into account and further research is needed to be able to discover if and under which conditions board interlocks are relevant for strategic decision making of the emerging market firm.
This dissertation contributes to the research field of international business strategy by expanding the horizon of knowledge regarding the role of board interlocks as learning
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Literature review
A board interlock exists when an individual affiliated with one firm also serves on the board of another firm (Fennema and Schijf, 1978). Already in the early twentieth century, board interlocks were a topic of debate in the United States, and even identified as a problem. The congressional concern of the influence of board interlocks on the workings of the market lead in 1914 to a law that prohibited board interlocks between companies competing in the same industry (Mizruchi, 1996). Nowadays, interlocks have become the primary indicator for inter-firm network ties (Mizruchi, 1996; Barkema and Schijven, 2008). Interlocks can have a significant impact on strategic decision making (Heracleous and Murray, 2001; Mizruchi, 1996). However, the exact function of board interlocks, other than providing ties, has been under debate since the 1970s (Mizruchi, 1996).
There are different theories and perspectives that have had significant impact on explaining for what kind of purpose board interlocks are exactly created. These can be divided into two groups proclaiming a different role for board interlocks. The management control theory, class hegemony and corporate governance on the one side and the resource dependence and transaction cost theory on the other. The first group of theories are reflecting the goal to control other firms, the second group are reflecting the goal to get knowledge and experience from other firms (Kiel and Nicholson, 2003; O’Haggen and Green, 2008).
The management control theory and the class hegemony theory contend that interlocks emphasize upper-class participation in business (Mace, 1971; Sonquist & Koenig, 1975). Board interlocks are integrative ties that give a firm regular insight into the decision-making apparatus of other firms. The main purpose is to support control, class cohesion, assert power and access capital (Stearns and Mizruchi, 1993). This view focusses on board interlocks as being a consequence of decisions made for reasons that serve the interest of the individual creating them rather than the firm. Examples are career advancement and financial remuneration (Zajac, 1988). These theories view board interlocks as an end in themselves, rather than a means to an end (Useem, 1984).This control function of board interlocks relates closely to corporate governance. Corporate governance is: “The system of
8 (Lin, 2011: 212). Board interlocks could be positioned in here as a structure of control (Peng, Au & Wang, 2001).
In addition to the control perspective, the resource dependency theory among others claims that board interlocks serve as a mechanism established to reduce environmental uncertainty (Pfeffer & Salancik, 1978), and to ensure access to a resource not available internally (Burt, 1980; Boyd, 1990; Lang & Lockhart, 1990). As a board interlock provides certain knowledge and experience about strategic decisions it reduces uncertainty. It enables firms to co-opt sources of environmental uncertainty and stabilize transaction relationships (Mizruchi, 1996). Board interlocks are a generally accepted asset for a firm to upgrade its knowledge in order to improve corporate strategy (Haunschild & Beckman, 1998; Carpenter & Westphal, 2001; O’Hagan & Green, 2004).
The transaction cost theory explains that a board interlock is a hybrid structure, just as strategic alliances. The strategic asset that a board interlock can provide is not created within the boundaries of the firm -- what would be called a hierarchy structure -- nor externally bought in the market -- what would be called an arm’s length structure of asset transfer (Oliver, 1990; Buckley & Dunning 1994). Interlocking partners can provide an exchange of information between firms and bring their experience to bear on strategic problems (Peng, Au & Wang, 2001; Hillman, Cannella & Paetzold, 2000).
It is clear that board interlocks are definitely used to access certain experience and
9 Many researchers have discussed the positive effect of board interlocks on strategic
decisions in the developed market context (Beckman & Haunschild, 2002; Nadolska & Barkema, 2013; Levitt & March, 1988; Barkema & Schijven, 2008; Mizruchi, 1996; Oliver, 1990; Carpenter & Westphal, 2001; Pfeffer & Salancik, 1978) the influence of board interlocks on strategic decision making in an emerging market context is almost non-existent. Only Tuschke, Hernandez & Sanders (2013) and Sarkar & Sarkar (2005) recognise that interlocks are also in the emerging market context used as knowledge and experience conduits. Tuschke et al (2013) found that board interlocks affect the focal firms’ entry strategies into the unknown emerging market, although from a developed market firm perspective. The research by Sarkar & Sarkar (2005) was about if the performance of large Indian firms is higher when the extent of board interlocks is higher, therefore only indirectly assuming board interlocks affect strategic decision making positively.
This lack of research regarding the relevance of board interlocks as learning conduits to improve strategic decision making in the emerging market context is rather peculiar. As it provides exactly the conditions of uncertainty described in the literature review in which board interlocks are expected to facilitate and improve the strategic decisions of a firm.
Emerging markets used to be solely characterized by their institutional voids, however times are changing as market liberalization measures are introduced, protectionist barriers are crumbling and the government is placed more on the side lines. Due to these changes certain assets and resources that emerging market firms possess and that created competitive advantages under their former institutional regime become less valuable as more market oriented institutions are introduced (Wright, Filatotchev, Hoskisson & Peng, 2005). As protectionist barriers are disappearing many developed market firms rush in to find new opportunities for growth (Dawar & Frost, 1998; Arnold & Quelch, 1998). These developed market firms with their strategic advantages regarding substantial financial resources, advanced technology, superior products, powerful brands, and seasoned
10 Emerging market firms might be able to benefit from their low cost advantages due to cheap labour and plentiful natural resources (Dawar & Frost, 1998), however they need to
overcome their large competitive weaknesses, which are: poor governance and accountability, managerial competence, professional expertise and the lack of global presence and weak technological and innovation capabilities (Luo & Tung, 2007; Gubbi, Aulakh, Ray, Sarkar & Chittoor, 2009).Developed market firms do not share these problems as in their institutional context ownership rights and the rule of law are well-guarded and corporate governance is based on solid and well-enforced laws (Peng, Wang & Jiang, 2008). Developed market firms take the critical role of “soft” infrastructure for granted. This
infrastructure is often underdeveloped in emerging markets (e.g. there are no reliable skilled market research firms that are able to inform about customer preferences, no head-hunter agencies to recruit employees from and no consultancy firms to tell you what the best strategic options are (Khanna, Palepu & Sinha, 2005).
The institutional context has a large impact on the strategic behaviour of a firm as it provides the rules of the game (Wright et al, 2005; Scott, 2008). Therefore the differences in the institutional contexts between developed and emerging markets are important to take into consideration. Theories based on the developed institutional context might not apply in an emerging market context (Hoskisson, Eden, Lau and Wright, 2000). This paper intends to find out if the conditions under which board interlocks can facilitate strategic decision-making in the developed market context is also applicable to the emerging market context. In doing so this paper intends to achieve a better understanding of board interlocks as learning
mechanisms and if institutional differences influence the role of board interlocks as learning conduits for strategic decision-making.
11 recent research, board interlocks are described as the most influential and important way of vicarious learning (Tuschke, Sanders & Hernandez, 2013; Barkema & Schijven, 2013). Next to vicarious learning a firm also learns and creates knowledge from its own experiences of dealing with strategic issues in the past, this is called experiential learning (Tuschke et al., 2013).
Experiential learning and vicarious learning interact with each other, although it is unclear whether they are substitutes or are complementary (Tuschke et.al., 2013; Barkema & Schijven, 2008; Bresman, 2010; Haas & Hansen, 2005). An important context in which both kind of learning intersect is within the boardroom (Tuschke et al., 2013).
Once a firm has learned from experience and implemented some routines and mechanisms about handling certain issues a firm becomes less reluctant in taking on the advice of others, due to imprinting, inertia and the so called not-invented-here syndrome. Therefore, they are substitutes: the more experiential knowledge a firm has with certain strategic issues the less critical and influential interlocks become due to knowledge redundancy (Barkema &
Schijven, 2008; Tuschke, et al. 2013).
On the other hand, experiential knowledge and interlocks could be complementary. When a firm has gained some experience in a particular domain absorptive capacity is created (Bapuji & Crossan, 2004), and this puts managers in a better position to judge the relevance of an interlock partner’s ability regarding the strategic issue (Barkema & Schijven, 2008; Hauschild & Beckman, 1998).
12 make new and uncertain decisions, board interlocks are particularly useful as a substitute of experiential knowledge.
Thus, based on these conditions which are shaped in the developed market context, board interlocks are assumed to serve a role in the strategic decision making of a firm when uncertainty is high and experiential knowledge is low and the decisions that need to be made are new and focused on a particular issue. In the emerging markets uncertainty is high due to institutional voids and market liberalization as this creates an influx of new developed market competitors that expose the competitive weaknesses of the emerging market firms. Experiential knowledge is low as these firms do not have the managerial competence and professional expertise to be able to compete head on with developed market firms.
Luo & Tung (2007) and Gubbi et al. (2009) bring forward that even though having limited knowledge regarding overseas markets, emerging market firms use aggressive and risk taking investments in the form of acquisitions and mergers to be able to get fast access to assets from foreign firms or their subunits to compensate for the competitive weaknesses (Luo & Tung, 2007). Emerging market firms seek advanced and tacit assets in technological know-how, R&D facilities, human capital, brands, consumer bases, distribution channels, managerial expertise and natural resources (Luo & Tung, 2007).
Emerging market firms lack experiential knowledge concerning cross-border acquisitions, therefore creatinghigh levels of uncertainty regarding entering these markets. As mentioned before the influence from others (outsiders) is greater under conditions of uncertainty (Cyert & March, 1963; DiMaggio & Powell, 1983; Beckman & Haunschild, 2002) and especially if it concerns knowledge needed about a specific and pointed issue (Tuschke et al, 2013). As both are true for acquisitions it is assumed that board interlocks would be created as a substitute for missing experiential knowledge. Therefore it is expected that the larger the extent of board interlocks, the less uncertainty exists regarding acquiring a firm. Based on these arguments the following hypothesis will be tested:
13 Within emerging markets there is an alternative dominant organizational form called
business groups in which vicarious learning in general seems to occur more often. Group affiliated firms, in contrast to non-affiliated firms, have an extended network of ties amongst each other, and thus many different ways to learn vicariously. Therefore board interlocks might be created less often when there are many other ways to learn vicariously as well. Mahmood, Zhu & Zajac (2011: 4) explain this difference clearly: “One important difference
between intra-group networks and general inter-firm networks is the likelihood of multiplex ties between group affiliates. For instance, it is not uncommon for two group affiliates to be connected through buyer-supplier ties, equity ties, and director ties simultaneously, whereas two firms in more general networks are more typically (but not necessarily) linked to each other via a uniplex tie”.
In many emerging market economies, business groups are a common type of network structure and of great economic importance as they frequently dominate parts of a
country’s productive assets (e.g. Indian business group affiliated firms owned80 percent of total assets of the top fifty corporate‐sector firms in 2006 (Sarkar, 2010)), therefore strongly influence the economic development of the country and making them important to discuss (Mahmood, Zhu and Zajac, 2011).
A business group is an agglomeration of firms, which are separate legal entities that can be active in different kind of businesses, yet they operate collectively under the
entrepreneurial, financial, and strategic control of a common authority, typically a family (Guillen, 2010). The difference between conglomerates existing in the developed world and business groups is that the latter is both managed and controlled by a family (Lamin, 2006).
Business groups are characterized by the large amount of different ties amongst the
affiliated firms (Guillen, 2010). The definition for business groups by Encamation (1989: 45) reflects this clearly: “In each of these groups, strong social ties of family, caste, religion,
language, ethnicity and region reinforced financial and organizational linkages among affiliated enterprises”. Business groups are the most embedded network amongst firms that
exist in the world (Heracleous and Murray, 2001). Business group affiliated firms are
14 family, friendship, religion, language and ethnicity (Khanna and Rivkin, 2000). The intensity of the ties amongst the firms involved in a particular business group can vary (Guillen, 2000; Heracleous and Murray, 2001). Highly vertically integrated business groups have more intense ties between affiliates as they work more closely together than less integrated business groups (Guillen, 2010).
Although legally independent, affiliated firms derive their main strategic advantages through their group membership and created synergies (Chang & Hong, 2000; Lamin, 2006).
Affiliated firms benefit through resource sharing, mutual loan guarantees,
cross-subsidization, creating economies of scale and scope and facilitating organizational learning through pooling and coordinating resources without facing high levels of risk (Hoskisson et al., 2000; Guillen, 2010).
As previously mentioned, business groups are controlled by one entity, which is often a family. This family is able to exert control through indirect ownership chains amongst affiliates via pyramiding. Therefore, it can have ownership over firms although only having minority equity stakes in most of the affiliated firms (Guillen, 2010). Many scholars have discussed board interlocks in the context of business groups as a mechanism used by owners to help them exert their control (Sarkar & Sarkar, 2008; Mani, 2010; Khanna & Palepu, 2000; Guillen, 2010). Sarkar & Sarkar (2008) highlight the way owners use board interlocks to reward loyal directors and as a tool to minimize the chance of losing control over the group in case of conflicts among owners. Owners may appoint the same directors on the board of member firms to force them to align their interests with that of the absolute owner.
Nonetheless, interlocks are also mentioned as knowledge transfers about future projects or upstream and downstream between affiliated firms which can be highly valuable for
directors in evaluating strategic planning of firms on which they act as board members (Sarkar & Sarkar, 2008; Mahmood, Zhu & Zajac, 2011). Some even bring forward that board interlocks among business group affiliates tend to provide more credible and richer
15 The membership of a firm to a business group plays a large role in the decision making processes of the affiliated firms (Sarkar, 2010). Due to its network, consisting of a large variety of informal and formal ties amongst group affiliates (Khanna & Palepu, 2000) these firms have a large vicarious learning network that can provide advice and experience. Business group affiliates can share their client contacts and knowledge of the foreign markets amongst each other (Lamin, 2006).
In this setting board interlocks are just one among many ways to learn vicariously, therefore the use of board interlocks to provide knowledge when experience is lacking is expected to be smaller compared to non-affiliated firms. Accordingly the following hypothesis is tested:
H2: In the context of emerging markets, the effect of board interlocks on the amount of acquisitions is weaker for business group affiliated firms than on non-business group affiliated firms.
The two hypotheses that have been created are visualized in the conceptual model below, in Figure 2.4.
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Data and method
Research setting
As mentioned earlier, India is the empirical context of this research. India has the fastest growing economy in the world after China. The market liberalizations of 1991 opened India up to foreign investors (Sarkar, 2010). India has well-developed educational institutions with good language skills and available labour (Hoskisson et al., 2012). As a consequence, Indian software industry, which is people and knowledge intensive, is globally well recognized and provides an excellent context for this research.
The software industry is one of the biggest industries in India and nicknamed the Indian Silicon Valley. The Indian software market grew by 13% in 2013 to reach a value of $3.5 billion with an annual growth rate of 15.1% in the period 2009–13. The biggest players in the Indian software industry are: International Business Machines Corporation (foreign),
Microsoft Corporation (foreign), Tata Consultancy Services Limited and Infosys Limited (Marketline, 2011).
The software industry is knowledge intensive and characterized by short product life cycles. Innovativeness is important and requires employees with specific know-how; skilled
programmers are the key to success in this market (Market Line, 2011). In a market where new products are frequently introduced, R&D investment is important. Larger software companies have the possibility to obtain intellectual property through acquiring firms that possess high quality know-how. An example is Oracle’s acquisition of Java technology as a result of its takeover of Sun Microsystems or Google's purchase of Android Inc. Both options to stay competitive require significant funds in either R&D or in capital investments
17 continually being introduced to the market and rivalry is enhanced; being dynamic and flexible can be a very important benefit in some industry segments like free open-source software applications. Here, smaller firms can benefit from their more dynamic and flexible structures and may be able to offer rapid progression (Athreye, 2005).
Data collection
For this research two key datasets have been used. The first dataset provided information concerning acquisitions in India from 2000-2010. The second dataset provided information concerning board interlocks and the third provided information concerning the control variables.
Dataset 1: Acquisitions
The most preferred and used information source in merger and acquisitions studies in developed countries is the Thomson Financial database. Thomson Financial Database is assumed to provide full coverage on all acquisitions. However, in an emerging market context like India this cannot be assumed, as coverage is sparse and fragmented, and thus relying upon a single source can be misleading. Therefore, after looking in to the data provided by the Thomson database in detail, the acquisition announcements made on the Bombay Stock Exchange (BSE) were taken into account as well. After that the Company Master Data (Ministry of Corporate Affairs, Government of India) was used to ascertain the identity of each acquiring firm in the dataset. Through cross-verification acquisitions erroneously attributed to Indian acquirers under Thomson Financial Database were eliminated.
The veracity of the event and deal related information was checked through several different sources like LexisNexis, company websites, business portals (i.e.
moneycontrol.com), newspapers, business magazines, and MAPE advisory group and Grand Thornton. The MAPE advisory group and Grant Thornton India have compiled basic deal specific information on M&A activities involving Indian firms. By using three different angles and unrelated sources that provide information regarding acquisitions, the method of
18 Next, the Prowess database was used to make sure that accessible firm level information from these Indian firms was available. Prowess maintains records of annual financial data for both private and public Indian firms starting from 1989; data on public firms being more comprehensive to comply with the prevalent disclosure norms (Gopalan, Nanda & Seru, 2007).
Through this process a sample of 361 acquisitions made by 87 Indian firms in the software industry from 2000-2010 was created. In this sample, 75 acquisitions were within-border and 286 were cross-border acquisitions.
Dataset 2: Board interlocks
The second dataset has been obtained through Prime Database; this company provides information on the boards of directors of the firms that are enlisted in the Bombay Stock Exchange. They provide information on boards of directors through their website that is accessible on: www.indianboards.com. Due to resource constraints, I was able to procure board interlock data for only 47 firms who made acquisitions in the year 2006. This particular year was selected since as per UNCTAD, maximum number of cross-border acquisitions were made by Indian firms in this year. To evaluate the validity of the dataset provided by Prime Database, five randomly selected individuals and firms were checked on their background information through Orbis and Lexis Nexus. The information was found to be accurate. Due to missing firm-specific data only 45 companies remained in the final sample analysed. Together, these 45 companies have a market share of 43% in the Indian software industry, of which 16 companies are business group affiliated firms and 29 are non-business group affiliated.
Dependent variable
19 strategic decisions over several years, in addition to acquisitions made in 2006, I also
examine the acquisitions made in the subsequent two years. Thus, the measure for acquisitions is stated as follows:
Independent variables
The board interlocks will be measured per firm for the year 2006. For each individual board member the amount of interlocks will be counted. After that they will all be added to each other, and divided by the overall number of directors
.
The formula is,Extent of board interlock (eBI) = ∑ =number of directors in board
= amountof board interlocks
Business group affiliation variable is measured using a dichotomous dummy variable taking
values of ‘1’ and ‘0’ respectively. If the focal firm belongs to business group as identified in the Prowess database the variable is assigned a value of ‘1’ and otherwise ‘0’.
In the model, we control for several previously known factors likely to impact the count of number of acquisitions such as previous acquisitions, firm performance, firm spending on R&D, firm size and firm age.
Experience from previous acquisitions is taken for the last five years, because after
knowledge is acquired it takes time before organizational learning has occurred. The general process of organizational learning is complex. It is a process of change that involves the entire organization of a firm. It is a continuous process that enhances the collective ability of the firm to accept, make sense of, and respond to internal and external change (Argote 1999). It is “the transfer of an organization’s experience from one event to a subsequent one” (Barkema & Schijven, 2008: 596). It requires systematic integration and collective
20 Thus, the measure for previous acquisitions is the amount of acquisitions the firm has done in the five years previous to the year 2006:
The second control variable that is important to take into account is firm performance. Differences in performance could have an effect on the number of acquisitions a firm does. Differences in performance will be measured by return on equity. This is one of the most used performance measures when different firms in one industry are compared (Barth, Beaver & Landsman, 1998). The measure for firm performance is:
=
The third control variable is the expenditures of a firm on research and development. Especially in the software industry innovativeness is important. In this industry firms gain a competitive advantage by investing in R&D or by acquiring firms or subunits that possess tacit knowledge (Marketline, 2011). Therefore R&D expenses could have an effect on the acquisitions a firm makes.
=
The fourth control variable is firm size. It is important to control for firm size, because a large firm can dominate the industry and it can have a large effect on the capabilities a firm has to execute multiple acquisitions. Firm size is measured by the revenue share:
= Total revenue / Total revenue industry
The fifth and last control variable is firm age and is measured as follows:
21 To conclude, an overview of the interaction between the variables and for which years they are measured is provided in Figure 3.1.
Figure 3.1: Overview of measurement of variables per firm including control variables
Statistical methods
Overall statistical model is,
=
Before a Linear Multiple Regression can be used (or any Ordinary Least Squares method), the assumptions have to be checked in order to make sure that the generated results will be reliable. The assumption of normality was not met (see Figure 3), Kolmogorov-Smirnov Test and the Shapiro-Wilk Test were significant, p < .01 and p < .01, respectively. The assumption of linearity and homoscedasticity were also not met as clearly visualized in Figure 4. In order to meet the assumptions the dependent variable (Af) was transformed using the natural
22 infinitively high numbers. However there was a clear bottom and decay effect visible in the data that was clustered around values of “0”, “1” or “2” and only a few higher values. These characteristics of the dependent variable fit the use of Poisson Regression (Dalgaard, 2008). In order to be able to use the Poisson Regression the variance should be almost equal to the mean, thus close to one. To check if this assumption is met the Goodness-of-Fit Test was used. The Deviance was significantly different with χ2(38) = 91.925, value/df = 2.419. Therefore the value/df was too far from one and the Poisson Regression could not be used. The dependent variable was over-dispersed count data. To fix this the Over-Dispersed Poisson Model was tried, however the Pearson Chi-Square still showed an even higher value/df level, χ2(38) = 118.509, value/df = 3.119. In case of such over-dispersed count data the Negative Binomial Regression needs to be used. This test can be considered as a
23
4. Results
The overview of the means, standard deviations and inter-correlations of all variables can be found in Table 1. The data was first examined for violations of the assumptions of normality and multicollinearity. The dependent variable followed a negative binomial distribution, and the remaining variables approximated normal distributions. The assumption of
multicollinearity was violated as can be seen in Table 1. Because our methodology was a maximum likelihood one, no statistics such as variance inflation factors (VIFs) were available to check the severity of the violation. However, the highly correlated variables were not significantly contributing to the model and were taken out eventually. Therefore we expected no bias through multicollinearity (McFadyen & Cannella, 2004).
Table 1: Mean, Standard Deviation, and Intercorrelations of Variables
Variable Mean s.d. 1 2 3 4 5 6 Dependent 1. Future Acquisitions 2.34 2.83 Control 2. Previous Acquisitions 1.51 2.39 .415** 3. Firm Performance 23.73 15.00 .069 .024 4. Firm Age -16.64 10.12 -.36* -.374** 0.004 5. Firm Size .01 .02 .36* .447** .272 -.638** 6. R&D Expenditures 1.26 4.94 .002 .214 -.155 -.095 -.045 Independent 7. Average Interlocks 1.60 .82 .227 .341* .135 -.503** .602** .237 ** p < .01 * p < .05
The results of the Negative Binominal Regression Model are reported in Table 2. For Model 1 using Negative Binomial Regression, the Goodness-of-Fit showed that the results of value/df were close enough to one and therefore the assumptions were met and the Negative
24 Model 1 showed that the results of the full model for hypothesis 1 were not significant with
χ2(6) = 6.805, p = .339. Through using a Backward Method (by hand) the predictors were deleted in order of highest p-value first (see Table 3). The order was FSize, eBI, FPerf, FR&D, and
FAge. The final significant model was:
Af = α+ β1 * AP
Table 2: Negative Binomial Regression Models of Future Acquisition Count.a
Variables Base Model Model 1 Model 2 Model 3
Independent
Average Interlocks -.01
(.33)
.11 (.45)
Business Group Affiliationb .42
(1.14)
Average Interlocks * Business Group Affiliation -.33
(.64) Control Intercept .24 (.59) .25 (.71) .09 (1.05) .50 (.23) Previous Acquisitions .14 (.09) .14 (.09) .13 (.09) .17* (.08) Firm Performance .01 (.02) .01 .(02) .01 (.02) Firm Age -.02 (.03) -.02 (.03) -.02 (.03) Firm Size -.71 (11.98) -.49 (13.79) -2.90 (14.91) R&D Expenditures -.01 (.04) -.01 (.04) -.01 (.05) Deviance 31.95 31.95 31.60 32.93 Pearson Chi-Square 36.614 36.55 34.61 33.45 Log-likelihood -88.58 -88.58 -88.41 -89.07 Degrees of Freedom 39 38 36 43
Deviance / Degrees of Freedom .82 .84 .88 .77
Pearson Chi-Square / Degrees of Freedom .94 .96 .96 .78
Pseudo-R2 c <.01 <.01 <.01
* p < .05
a
Unstandardized regression coefficients are shown, with standard errors in parentheses.
b
Business Group Affiliation was coded 0, “no”, and 1, “yes.”
c Computed as 1 – L
1/L0, where L1 is the log-likelihood of a given model and L0 is the log-likelihood of the
25 This model was significant with χ2(1) = 5.826, p = .016. AP is significant with χ2(1) = 5.826, p =
.016. Therefore only AP has a significant effect on future acquisitions. There seems to be no
significant effect between the future acquisitions a firm will make and the extent of board interlocks a firm has.
The second hypothesis was aimed to investigate whether the effect of board interlocks on future acquisitions differed between business group affiliated firms and non-business group affiliated firms. Therefore an interaction effect between eBI and BGA, namely BGA * eBI, was computed. The full model for the second hypothesis is shown in Table 2 under “Model 2”. Goodness-of-fit showed again results for value/df close enough to 1 so that the Negative Binomial Regression could be used. Model 2 was not significant with χ2(8) = 7.153, p = 0.52. By again manually using the backward model we took out the least significant variables first (see Table 4): FR&D, FPerf, eBI, FSize, BGA*eBI, BGA, FAge. The final significant model was again:
Af = α + β1 * AP
This model was significant with χ2(1) = 5.826, p = 0.016. AP was significant with χ2(1) = 5.826,
p = 0.016. There was no significant difference in the effect of interlocks on acquisitions
26
5. Discussion
The purpose of this study was to investigate the applicability of established theories of the effect of board interlocks on strategic decision-making to the emerging market context. According to developed market literature, board interlocks are relevant for firms to use when there is a) uncertainty due to a lack of experiential knowledge, and b) the missing knowledge concerns a specific and new issue. If these two conditions are met, board interlocks could be a substitute for experiential learning.
In emerging markets uncertainty is high due to institutional voids and market liberalization creates an influx of developed market competitors that expose the competitive weaknesses that emerging market firms have. In order to compensate for their weaknesses many
emerging market firms use aggressive and risk taking investments in the form of acquisitions in order to survive. However emerging market firms have a limited amount of knowledge of developed markets. The lack of experiential knowledge regarding acquisitions and the specificity of the issue fit follow the assumption that board interlocks could provide the knowledge the firm needs. Accordingly, the relevance of board interlocks was tested by the acquisitions the firm made. However based on the results it has to be concluded that there is no significant effect of the extent of board interlocks a firm has on the amount of future acquisitions a firm does. Additionally there is also no significant difference in this non-existing effect between business group affiliated firms and non-business group affiliated firms.
Since no significance was found it becomes apparent that the conditions under which board interlocks are relevant for strategic decision making in the developed market context is not transferable to the emerging market context. Therefore institutional differences should be taken into account and further research is needed to be able to discover if and under which conditions board interlocks are relevant for strategic decision making of the emerging market firm.
27 also do more acquisitions in the future. This shows that a firm does learn from its own
experiences regarding this specific subject. But that a lack of experiential knowledge does not make a firm more inclined to create board interlocks in order to substitute for the lack of experience and knowledge.
Only within-border interlocks could be measured and many interlocks are possibly missing from the dataset. This is unfortunate because as suggested in the literature review,
emerging market firms are relatively new players in the international market (Luo and Tung, 2007). Especially in the software industry, were the pressure to be innovative is high and competition worldwide (Marketline, 2011), acquiring new innovative assets through cross-border acquisitions can be important. Combining this with a lack of experiential knowledge about acquiring a firm cross-border, creating interlocks with foreign firms could be the most important interlocks to create in this case.
Another limitation is that the measure chosen to indicate the influence of interlocks on strategic decisions is based on only one variable; the amount of future acquisitions. It should be taken into account that interlocks are created for a general knowledge and experience provision concerning strategic decisions on which the firm lacks experiential knowledge. Interlocks are not only created for the provision of knowledge and experience about acquisitions. Therefore the influence of board interlocks on a diverse set of strategic decisions might be able to provide a better reflection of reality.
Also, the assumption that better and more knowledge and experience leads always to a higher amount of acquisitions could be considered arbitrary. Though other possible ways to measure the influence of interlocks on the acquisition process, i.e. through interviews or questionnaires, would have been biased by subjectivity and too time consuming to be considered in this case.
The last limitation that should be considered is that this research has a very small sample size of only 45 firms taken from only one industry in one country. Due to the small sample generalizations cannot really be made, although intended. A larger sample was not
28 This dissertation contributes to the research field of international business strategy by expanding the horizon of knowledge regarding the role of board interlocks as learning mechanisms in a different institutional context than developed markets. Never before has the strategic importance of board interlocks been tested in an emerging market context. This paper found that institutional differences should be taken into account and that just
assuming that former findings regarding learning mechanism are transferable across institutional contexts is not feasible.
29
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Appendix
Table 3: Negative Binomial Regression for H1 (Full model)
37
Figure 1: Cross-border acquisition behaviour in India after liberalization 1991 (Gubbi et al, 2010)
38
Figure 3: QQ-Plot for full model with untransformed DV
.
39
Figure 5: QQ-Plot for the full model with transformed DV.
