‗The influence of environmental instability on the relationship between top management team demographic heterogeneity and airline performance’

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Master Thesis

‗The influence of environmental instability on the

relationship between top management team

demographic heterogeneity and airline performance’

A comparative study of strategic air carrier groups in the deregulated

airline industry

By

Vera Siebers

University of Groningen Faculty of Economics and Business MSC International Business and Management

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Abstract

This thesis explores the influence of environmental instability on the TMT demographic heterogeneity-airline performance relationship. Multiple regression analysis was performed, based on a collected database, consisting of secondary information of TMTs of 128 European, North American and Asian airlines, representing 1021 TMT members. Each airline was classified as ‗Legacy Carrier‘, ‗Low Cost Carrier‘ or ‗Legacy Carrier following a combination strategy‘, in order to make comparison possible and to discover possible similarities and differences in the influence of environmental instability on the TMT demographic heterogeneity-airline performance relationship.

The major contribution of this thesis is the outcome that environmental instability strengthens the positive or negative relations between specific TMT heterogeneity- airline performance relationships in each strategic group. Furthermore, some TMT demographic heterogeneity-airline performance relationships only exist significantly when environmental instability is taken into account, and some significant relationships disappear due to the inclusion. Besides, this study shows the importance to distinguish in the strategic context of firms operating in the same industry, because it may explain differences in the advantage or disadvantage of TMT demographic heterogeneity levels on financial performance.

Keywords: TMT demographic heterogeneity; airline performance; environmental instability;

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Acknowledgments

‘One's first step in wisdom is to question everything - and one's last is to come to terms with everything’ -George Christoph Lichtenberg (1792-1799)-

It is a pleasure to thank those who made this thesis possible. First and foremost I would like to thank my supervisor, Dr. Stanislav Stakhovych for his time, support and effort and above all for his willingness to provide me with valuable advice, even after he moved to Australia.

Further thanks goes to my referent, Drs. Huib Stek for his help and guidance. Thanks also to my colleague students, with whom I had interesting discussions during various stages of writing this thesis.

Special thanks goes to my parents and my sister, for their unconditional support and encouragement during my studies. I could not have completed this thesis without their everlasting faith and believe in me.

At last, I would like to extent my thanks to all of those who supported me in any respect during the completion of this project.

Groningen, August 2010

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1. Introduction

The airline industry can be described as a very cyclical industry in which profits, made in successful periods, can be swept away immediately in recessionary periods (Bamber et al., 2008). In 2008 and 2009 commercial airlines faced difficult economic circumstances, due to the recession caused by the global crisis in the banking and financial sector (Graham, 2010; Bamber et al., 2008).Especially the major airlines were hit with operating losses of a total of $15 billion (Graham, 2010). Forecasts of the International Air Transport Association (IATA) for 2010 suggested that worldwide losses in the airline industry will continue, however the losses are expected to be at a lower level of $3 billion (IATA, 2010). On top of that, the economic recovery of airlines is expected to be very unequally spread across countries and markets. In general it is concluded that revival of economic growth mainly will be visible in the emerging markets of Asia, while in Europe and North America the growth is expected to be more slowly (IATA, 2009).

This shows that most airlines have to cope with unpredictable environmental influences, of which they have very little control over (Sadi and Henderson, 2000). The high fragility of airlines for economic circumstances is to a large extent caused by the deregulation of airline markets (Sadi and Henderson, 2000). In the regulated airline industry, governments controlled prices and industry entry and exit. There was no threat of new competition entering the market (Johnson et al., 1989) and (environmental) uncertainty was diminished (Bresser & Harl, 1986; Pennings, 1981). As a consequence, there was little encouragement for airlines to plan or identify successful markets or market failures, or to keep costs under control and to be responsive to consumer demands in the regulated airline markets (Gillen & Gados, 2008). The Legacy Carriers (LC‘s), the long established traditional airlines, were mainly forced to compete on quality only, because of their privileges in the market created by the government policy. This changed, when deregulation took place in North America1 in 1978, in Europe in 1997 and in Asia2 in 2000 (Pitfield, 2008). From those years on, airlines were licensed under similar conditions and entry barriers were lifted to the extent, that market access was essentially free (Scharpenseel, 2001). The deregulated airline markets turned into highly fragile industries, often characterized by overcapacity and price wars (Jarach, 2003). The airlines experienced an increase in financial pressures, more competitive uncertainty and

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higher financial resource dependencies (Lang and Lockhart, 1990). Low Cost Carriers (LCC‘s) were encouraged to enter the airline markets and changed the competitive market by picking up the price sensitive market share (Gillen & Gados, 2008). In response, various Legacy Carriers structured themselves (partly) according to the low cost model (Dobruszkes, 2009).

1.1 Problem statement and research question

As can be derived from the introduction, the removal of the entry and exit barriers caused considerable changes and forced the airlines to reconsider their strategies and to implement changes, in order to deal with changed economic and environmental circumstances and to remain competitive and successful in the deregulated airline markets (Schnell, 2003). This is also confirmed by Goll et al. (2006), who show significant correlations between business strategies and airline performance.

Nevertheless, poor management can obstruct the performance of every company in any business model (Finkelstein et al., 2009). However, there is a lack of studies identifying the effects of top management team characteristics on the performance of an airline, despite the recognition of the influence of applied strategies on airline performance (Goll, 2007). This is surprising, because the airline industry is one of the largest service industries of the world, in which human resource can be seen as the major input (Wang et al., 2001). According to Hambrick and Mason (1984), firm performance and strategies are a reflection of the human resources a company possesses. Several studies have examined the relationship between executive‘s characteristics and financial measures of organizational performances, which shows that individuals are responsible for the organization and its outcomes (Certo et al. 2006; Finkelstein and Hambrick, 1996). In this research field top management teams (TMT) in particular have been examined. One particular focus of this research stream is the attention to the influence of TMT heterogeneity on financial performance. TMT heterogeneity refers to diversity of demographic characteristics of team members within TMTs, which is considered to is advantageous or disadvantageous to firm performance (Finkelstein et al., 2009).

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responses from the management of the airlines (Jarach et al, 2009). This indicates that environmental instability influences the complexity of the tasks the TMT has to perform, which could affect the firm performance (Huan-Qiong et al., 2008). Hence, including the environment as an variable will contribute to a richer understanding of strategic decision making in an organization (Goll, 2007) and may help to explain what the TMT really means for a company (Finkelstein et al., 2009).

Next to that, the context in which the team operates might be relevant as well (Ramos-Garza 2009). Contextual conditions may arise from environmental and organizational factors. Changing the composition of the TMT is a way to deal with a changed environment (Cho and Hambrick, 2006). However, the effect on the shape of the TMT is quite limited (Finkelstein et al., 2009). So far only little attention has focused directly on the composition of the top management team (Finkelstein et al., 2009, Palmer and Varner, 2006). Previous research has showed that different companies, operating in the same industry might adopt different positions in response to cope with the environment (Kangis and O‘Reilly, 2003). Besides, the basic assumption is that a successful implementation of different strategies, also require different management practices, and therefore different management skills and experiences are likely to be required for a certain strategy (Marlin et al., 2004). For that reason, it is assumed that the strategic context of airlines influences the TMT composition. This may also explain why differences in the TMT composition in different companies exist. In the end, if scholars wish to understand why organizations do the things they do, and why they perform the way they do, top managers must be a central part of the explanatory theory (Finkelstein et al., 2009).

As can be concluded, the deregulated airline industry had to deal with environmental change, and still needs to deal with environmental instability. Even though the environment is a key variable that helps explains strategic behavior, it has been ignored in past studies (Finkelstein et al., 2009). Therefore this gap in literature can be valued as an important area of research and also as an emerging one, because there is a lack of studies taking the influence of the environment on the TMT-firm performance relationship into account (Finkelstein et al., 2009: Goll, 2007).

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and takes European, North American and Asian airlines into account. Looking for similarities and differences across companies operating in the same industry in different areas will help to make comparisons and generalization possible (Amason et al., 2006).

Therefore, this study can contribute in a way that will show if differences in TMT heterogeneity levels of airlines pursuing different strategies exists, and will indicate if and how environmental instability influence the relationship between TMT demographic heterogeneity and airline performance of different strategic airline groups. Based on the arguments stated above the following research question was developed.

‘How does environmental instability influence the relationship between demographic heterogeneity of top management teams and airline performance of Legacy Carriers, Low-Cost Carriers and Legacy Carriers pursuing a combination strategy, in the deregulated airline markets?’

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2. Literature Review and Theoretical Background

2.1 Strategy and Strategic Groups

In literature, the term strategy has been defined in numerous ways (Barney and Arikan, 2001). A review on strategic management literature suggests that the definition of strategy comes from the work of Schendel and Hofer (1979). This definition can be seen as the most widely accepted one and refers to strategy at the business level as ‗the way a firm competes in a particular market‘ (Takeuchi, 2009). The core of the development of a strategy is the ability of a firm to find or create a position in the market. By following a strategy, a business tries to achieve competitive advantage in the market in which it operates. Therefore, the strategy pursued by an organization means a summary of its approach to manage competition in its environment (Cooke and Armstrong 1990; Sanz-Valle, Sabater-Sanchez and Aragon-Sanchez 1999). According to Grant (1996), the strategy of a firm must be based on its resources and its capabilities and must be determined in relation to its external opportunities. This means, that the formulation of a strategy comprises the combination of a firm‘s strengths, weaknesses, opportunities and threats in its environment (Andrews, 1971). To achieve the best fit between organizational capabilities and the external environment, strategy is conceptualized and operationalized as a pattern or stream of decisions, in order to achieve goals and to sustain competitive advantage over other firms (Kang and Brewer, 2009).

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the same line of reasoning, the strategy approach argues that an organization can achieve an outcome by a variety of strategic actions or strategies. According to this school, different strategies can result in the same outcome (Jennings et al., 2003). Porter (1986) argues that within a certain strategic typology no strategy is neither inferior nor superior to another strategy (Jennings et al., 2003). Nevertheless, prior research suggests that even though a firm may do this, the importance and implementation of different types of strategies will vary (Schular and Jackson 1987). This led to attempts to develop classification schemes for strategies.

The theory of strategic groups argues, that firms operating by a similar competitive strategy, are segmentable into the same strategic group within an industry and different strategic groups have different levels of performance (Caves and Porter, 1977; Hatten and Hatten, 1987; Mascarenhas and Aaker, 1989). The strategic group theory is introduced by Hunt (1972), who defines it as ‗a group of firms in an industry following the same or similar strategy along a set of strategic dimensions.‘ Reger and Huff (1993) suggested that a strategic group might be best conceptualized as a core group of firms and secondary firms that share some of the attitudes of core members of different strategic groups. The concept of strategic groups was used to explain possible performance differences between firms operating in the same industry, but belonging to different strategic groups in various industries such as construction and banking (Budayan et al., 2009).

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new companies often focus on innovation and differentiation (Amalson et al., 2006). A refinement of this thought is that some companies pursue a strategy that can be considered as ‗truly novel‘ and other companies pursuing a strategy which focus on improvements of what simply exists (Amalson et al, 2006: Cheah, 1990).

2.2 Strategies in the (de)regulated airline industry

In a regulated environment, a regulatory agency controls the scale and scope of firm operating authority (Hambrick & Finkelstein, 1987; Smith & Grimm, 1987). Consequently, firms are limited to achieve maximum efficiency from their resources. In the regulated aviation industry, airlines were able to survive trough capital injections from the state (Kangis and O‘Reilly, 2003). The entry and exit barriers were so high and competitors weak, which made competition relatively non-existent (Kangis and O‘Reilly, 2003). Past research of Johnson et al. (1989) showed that in the regulated airline industry, airlines did not pursue strategies that would enhance their efficiency. Attention to services in efficiency was almost of second importance, and out of the scope of the concern of the management of airlines (Kangis and O‘Reilly, 2003). The main idea of LC‘s was, that delivering high quality service to passengers was important to survive, to strengthen the competitiveness and would lead to increased profitability (Gillen & Gados, 2008).

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Therefore, a key difference between LCC‘s and traditional carriers (LC), is that LC‘s have a complex range of products which lead to complex pricing strategies, while LCC‘s have simple products and simple pricing strategies (Gillen & Gados, 2008). A study by Cappel et al. (2003) based on Porters (1980) generic strategy framework, shows that there are three main strategies in the airline industry nowadays. An examination of which of the three competitive approaches is the most popular within a single organization may allow the author to clarify the firm‘s strategic focus for market survival (Finkelstein et al., 2009). As a result, the three strategic typologies can be assumed to represent the business strategies in the airline industry and can be used to classify the different airlines into the three different strategic groups: Legacy Carriers, Low Cost Carriers and Legacy Carriers pursuing a combination strategy.

1. Strategy of differentiation: Even though it is not easy to define a ‗Legacy Carrier‘, it refers to airlines which are able to realize premium prices and offer a premium quality to its customers (Franke, 2007). The most important idea is to become the most unique producer or service provider. Therefore, it is often referred to as a ‗value-added‘ strategy (Kangis and O‘Reilly, 2003). This approach is used by an airline that sees itself as unique regarding certain characteristics like service or quality. Consequently, major LC‘s have successfully established or sustained a premium brand perception in the marketplace. These strategies can only be successful followed if they highlight the need in the company to maintain a competitive skill base and to motivate employees toward the basis for differentiation (Porter 1986). This strategy is followed by the traditional LC‘s, such as Singapore airlines (Cappel, 2003).

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effectiveness, is strongly integrated in the whole organization (Porter 1986). By focusing on cost reduction, the LCC‘s were able to open the market of low fares, and to increase the volume of expansion of air travel (Kangis and O‘Reilly, 2003). This strategy is followed by LCC‘s, like Easy Jet and Ryanair (Cappel et al., 2003).

3. Combination strategies: Some airlines have adopted an approach which combines cost leadership and differentiation (Pels, 2008). This strategy is pursued, in order to simultaneously pursue low cost while attempting to achieve maximum profit. Porter (1980) argued that most of the firms, pursuing such a strategy are ‗stucked in the middle‘. The airlines are positioned between premium and low cost carriers, because they are unable to focus on one particular approach (Franke, 2007). This is also referred to as ‗airline‘s no-man‘s land, because of the hard position to survive in the market (Manning et al., 2006). One possible explanation for pursuing such a strategy is that transformation of an airline into a premium airline or a low cost carrier can be seen as a ‗big bet‘ and requires considerable investments and high risks (Franke, 2007). Hence, this can be considered as a company‘s failure to make a choice between cost leadership and differentiation, which results in a poor differentiation, and makes profitable operations a real challenge (Franke, 2007). This strategy if followed by LC‘s, in response to the entrance of the LCC‘s. An example is the American airline United Airlines (Cappel, 2003).

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2.3 Strategy and Human Capital

As can be concluded, strategy is one of the most important firm factors, but is also considered as double-edged. Some studies indicate that structure follows strategy, which means that the management should be a function of the organization‘s strategy (Chandler, 1962). A company‘s strategy can be based on external norms and circumstances (Di Maggo and Powell, 1993), it can applied based on careful analysis of the company‘s resources (Barney, 1991), or on the external environment (Porter, 1980), or it can be simply a variation of the prior strategy of the company (Quinn, 1980), or based on imitations, inertia and objective decision making (Finkelstein et al., 2009). However, other research streams believe that strategies applied by organizations, may be a reflection of their human capital (Hambrick and Mason, 1984). This literature stream indicates that strategy and other major organizational choices are made by humans, who act on their base of experiences, motives and dispositions. Therefore, to understand strategy, the ‗strategists‘ must be understand (Finkelstein et al., 2009). This highlights the importance of human capital in an organization.

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Barney (1991) propose that these resource results in a firm competitive advantage within the marketplace.

2.4 The Resource-Based View

The resource-based view (RBV) of the firm is built on Penrose‘s work (1959). This theory indicates that internal resources and capabilities of the firm are relevant, because they represent the source of competitive advantage of a firm. Following the definition of Barney (2001), the term ‗resource‘ can be defined as tangible and intangible assets of firms, used to conceive of and implement strategies‘. The widely accepted point of consensus is that resources enable a firm to improve its efficiency and effectiveness, while being imperfectly imitable and non-substitutable (Green et al., 2008). Firms are supposed to be unique bundle of resources, and the task of the management is to increase firm value through the optimal deployment and development of internal assets (Ceci and Prencipe, 2008). When the firm resources enable a firm to develop and implement a strategy efficiently and effectively, the firm attributes can be valued as strategically relevant (Barney, 2001). In case the firm attributes do not enable such actions, they cannot be considered as valuable resources (Green et al., 2008). As indicated by Barney and Arikan (2001) there are different ways to evaluate the strategic value of a firm‘s attributes. An example is the extent in which attributes of a firm are enable to develop and implement strategies that reduce for example a firm‘s net costs, or increase its net revenues. This can be seen for example in the cost leadership strategy, followed by LCC‘s.

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2.5 Upper Echelon Perspective

Next to recognition of human capital in an organization, a growing body of literature indicates the advantages of shared leadership in an organization (Pearce & Conger, 2003). The small group of people at the top of an organization can considerably affect organizat ional outcomes (Finkelstein et al., 2009). This selected group of most influential executives in an organization has been defined as the top management team (further TMT) by strategic leadership theorists (Finkelstein et al., 2009).

Interest in the theory of the upper level executives can be traced back to March and Simon‘s behavioral theory of the firm (March and Simon 1958, Cyert and March, 1963). This theory argues, that decision makers must act in a social context of multiple and conflicting goals (Hambrick et al., 1996). Moreover, previous research provides ―clear support for the conclusion that upper echelon, rather than a single person, has the greatest effects on organizational functioning‖ (O'Reilly, Snyder, & Boothe, 1993, p. 150). Upper-level executives have the largest influence on what happens within a company, even though they do not make all decisions. The widely accepted point is that the upper echelon is the only small group that has so much effect on the structure and goals of an enterprise (Finkelstein et al., 2009). TMT‘s are expected to contribute to economic benefits in firms, when implemented in such a way, that they strengthen the competitive strategies being followed to compete in the market (Takeuchi, 2009). Next to that, Lado et al. (1992) argue that the presence of managerial characteristics is one of the most important capabilities of a firm.

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According to the UE perspective, executive cognitions, values, and perceptions influence process of strategic choice and as a result influence performance outcomes (Carpenter et al., 2004). The cognitive models of top managers determine how the environment is perceived, and determine how information from the environment is gathered and filtered (Finkelstein and Hambrick, 1996). Executives base their actions on their interpretation of the information. Since executive cognitions, values, and perceptions are complex to measure, the Upper Echelon theory refers to past research on demography, which assumes that managerial characteristics are reasonable alternatives for primary differences in cognitions, values, and perceptions (Carpenter et al., 2004). Therefore, Hambrick and Mason (1984) suggest to measure observable managerial and demographic characteristics of the upper echelon, with the purpose to investigate the relationship between managers, strategy making and organizational performance. In general, researchers relate 4 variables to organizational outcomes: age (Datta and Rajagopalan, 1998; Tihanyi et al., 2000), tenure (Bergh, 2001; Herrmann and Datta, 2005), education (Jensen and Zajac, 2004) and experiences (Kor, 2003). These characteristics are used, because executives make strategic decisions which closely reflect their backgrounds, educational experiences, age and tenure (Carpenter et al., 2003).

2.6 Top Management Teams

The strategic decision-making process is considered to be uncertain, complex, and unstructured (Dutton & Duncan, 1987). As can be derived from the UE theory, the composition of the TMT influences a firm‘s strategic context and affects firm performance considerably (Auh and Menguc, 2005). Given that a firm‘s strategic orientation is determined at the senior management level, it is especially important to understand the impact of the TMT composition on the strategic orientation of a firm (Auh en Menguc, 2005). The term composition can refer to many features of a group (Jackson, 1992). The term can be used for example, to refer to concepts such as size and structure, as well as the distribution of members' personal attributes (Bunderson, 2003). This is based on the idea that managerial perception of competition is considered as a key determinant of strategic plans they make and the subsequent outcomes (Andrews, 1971).

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competitive moves (Hambrick et al., 1996). Relating this to the airline industry, characteristics of the top management team influence what an airline is noticed and attend to. The capabilities of top management team are largely determined by its composition, and different types of teams should be best suited to different types of tasks (Hambrick and Mason, 1984: Finkelstein and Hambrick, 1996). The characteristics of the TMT are valued as rare, difficult and costly to imitate, which is partly caused by unique historical conditions of an organization (like ownership and age of organizations) (Michalsin et al., 2004).

The competitive or business strategy of a firm is likely to affect the composition, structure and process of a TMT. As a matter of fact, it may be assumed that organizations should reflect their strategies (Dotty, Glick and Huber 1993). Since the characteristics of the top management team influence the abilities of information processing, the performance of companies should partly reflect the fit between TMT characteristics and the level of novelty (Amalson et al., 2006). Therefore it can be assumed that a company, following a specific strategy, also has a specific composition of the top management team and as a result, the composition of TMT‘s may give insight in the strategy pursued by an airline.

Comparable past research on the railroad industry revealed that the deregulation resulted in younger, short tenured and more highly educated top management teams (Smith and Grimm, 1987). This is confirmed by Guthrie et al. (1991) who showed that companies with the most changed TMT‘s, also most changed their strategies. Cho and Hambrick (2006) pointed out, that changes in the composition of the top management team were associated with strategic change in airlines in the US as well.

2.7 TMT Heterogeneity

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3. Hypotheses and Conceptual Model

It is important to discover the underlying theoretical reasons why relationships exist. This helps to establish the internal validity of findings (Eisenhardt, 1989). In order to examine how well or poorly the theory fits with the data, hypotheses are formulated, which can be tested with the help of observations (Eisenhardt, 1989). First, some hypothesis about TMT demographic heterogeneity levels of airlines are given for each strategic group (LC‘s, LCC‘s and LC‘s pursuing a combination strategy). Afterwards, predictions about the relationship between TMT demographic heterogeneity levels and airline performance are formulated. The role of environmental instability is considered in the expected relationships.

3.1 TMT Heterogeneity, airline strategies and environment

Strategic contingency theorists identified that the influence of the environment on firms, results in change of organizational structure through adaption of strategies, in line with its goals (Kang and Brewer, 2009). The strategic choice perspective argues that organizations do not simply react to their environments, but dynamically interact via the strategic and proactive actions of top managers (Shipilov and Danis, 2006). A change in the composition of the team will cause a change in scanning the environment and the field of vision of the senior group. In general, the environment of a company can be characterized by the variation in the level of unpredictability and unexpected change (Mintzberg, 1979). A business‘ environment can be referred to as ‗complex‘ and ‗instable‘ (Finkelstein et al., 2009). ‗Complexity‘ can be described as the amount of environmental factors that influence an organization, as for instance the consequences of deregulation (Finkelstein et al., 2009). ‗Instability‘ may refer to the steady state rate of change in environmental factors affecting organizations (Tushman and Romanelli, 1985). As a consequence, environmental instability affects the way organizations are structured, how they operate and in particular affect the nature of TMT composition, structure and even process (Finkelstein et al., 2009). For instance, instable environments can increase the variation and fragmentation of managerial work, and can increase the information processing demand on the upper echelon. Besides, environmental instability may require larger demands of team members to cope with external requirements, in which the team size can play an important role too (Finkelstein et al., 2009).

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expertise and skills filled the gaps in response to the changed environment (Cho and Hambrick, 2006). Companies with different operating environments, will have different strategic initiatives, and therefore require different management info systems and styles, in order to improve the performance of an organization (Finkelstein et al, 2009). As previous research revealed, the more diverse the environment of the organization, the more necessary it becomes to have a differentiated top management team, in order to monitor the diversity of the environment (Finkelstein et al., 2009). According to Finkelstein et al. (2009) environmental instability increase the need for a higher level of heterogeneity within TMT‘s. As a result, Finkelstein et al. (2009) made assumptions about the relationship of TMT diversity and the specific strategy pursued by a firm. Their first believe is that a firm‘s business strategy is likely to affect the composition, and structure of the TMT. This means that companies pursuing different strategies are expected have a different composition of the TMT. Based on the typology of Miles and Snow (1979), Finkelstein et al. (2009) differentiate between two types of strategies: prospectors and differentiated defenders. Prospectors are characterized by growth, innovation and the search for new and unique market opportunities. Differentiated defenders try to maintain a relatively stable domain by providing superior service and/or product quality that is consistent (Slater and Olson, 2000). Therefore, they are typified to focus on control, stability and efficiency. Finkelstein et al. (2009) argue that defenders face few strategic contingencies compared to prospectors, and therefore do not require larger and more differentiated TMT‘s. In contrast, prospectors are more innovative and forward looking, and are assumed to have a higher degree of differentiation of the TMT. Consequently, the authors propose that defenders will consist of TMT‘s which are less heterogeneous, and firms pursuing prospector strategies, should have higher levels of heterogeneity in their TMT‘s, than defender firms do.

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familiarity between them (Amalson et al., 2006). Based on these thoughts, predictions about the relationship between TMT heterogeneity of strategic air groups and team size are made.

3.1.1 TMT Heterogeneity and Legacy Carriers

In conformity with the ‗defenders‘, the management of LC‘s focuses more on the company‘s presence and value, by referring back to the elements of the business model that made the airline successful over the years (Jarach et al., 2009). Studies showed that TMT homogeneity was found to be strongly associated with strategic persistence, or absence of change (Finkelstein and Hambrick, 1990; Grimm & Smith 1991; Wiersema and Bantel, 1992). However, to remain a premium airline and to pursue the differentiation strategy, a lot of expertise is required (Franke, 2007). A higher the level of human capital within the upper echelon, results in a greater probability to compete in the market (Offstein et al., 2005). A larger team size results in a higher degree of awareness of environmental conditions and opportunities in the marketplace (Offstein et al., 2005). In addition, awareness of the marketplace allows the TMT to be more attuned to market niches (Egelhoff, 1982: Smith et al., 1992). Consequently, in order to pursue a differentiation strategy, LC‘s should have large and homogeneous TMT‘s.

3.1.2 TMT Heterogeneity and Low Cost Carriers

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Hypothesis 1. Legacy Carriers have larger homogeneous top management teams compared to Low Cost Carriers.

3.1.3 TMT Heterogeneity and Legacy Carriers pursuing combination strategies

Even though, Legacy Carriers, that applied a combination strategy, cannot be classified as ‗prospectors‘ or ‗defenders‘, predictions about the TMT heterogeneity can be made. When companies are changing their followed strategy, as these airlines did, the existing way of doing business is disrupted as well. This requires shifts to new domains or new tactics within the same domain, in order to create new power bases within the firm (Starbuck et al., 1978). Hence, a shift is noticeable in established patterns of communication, knowledge structures, patterns of interaction and needed competencies. As a result, the TMT is affected in its functioning. A change in the composition of the top management team needs to be made in order to affect the patterns of managerial attention (Cho and Hambrick, 2006). This is confirmed by Amason et al. (2006) who argue that an increase in novelty requires a change in TMT composition as well. Finkelstein and al. (2009) suggest that a greater amount of strategic change should result in greater heterogeneity within TMT‘s, in order to better be able to compete in the market. Under these circumstances, it might be expected that a greater

heterogeneity and size is required for these kinds of Legacy Carriers to cope with the strategic changes. Derived from the arguments stated above, it is assumed that:

Hypothesis 2. Legacy carriers pursuing a ‘combination’ strategy have larger heterogeneous top management teams compared to Low Cost Carriers.

3.2 The influence of environmental instability in the TMT demographic heterogeneity- performance relationship

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changed situation (Sadi and Henderson, 2000). A financial crisis affects the profitability of airlines and forces the management to rethink the efficiency of their business process, in order to earn the maximum of value out of each customer. Economic growth and increases in air travel demand are important for the airline industry and partly determine the success of airlines (Bowen and Leinbach, 1995). A fall in currencies or a raise in fuel prices, immediately hits both the business and leisure travelers (Graham, 2010). This results in losses of aircraft capability utilization, passenger load factor and a decrease of the development of unit costs, which are factors influencing the profitability of airlines (Asbeck, 1999). Especially strategies of cost-leadership and a differentiation strategy are expected to promote sales without causing high additional costs (Sadi and Henderson, 2000). However, the followed strategy has to be in line with the views and feelings of those who implement it: the upper echelon (Burton, 2004). In line with the theory about TMT‘s mentioned before, airlines applying a differentiation strategy should consist of homogeneous TMT‘s and airlines following a cost-leadership strategy or a combination strategy, will consist of more heterogeneous top management teams. Given the predicted advantages of heterogeneous TMT‘s on airline performance, it might also be expected that a more heterogeneous TMT has a more positive relationship during a period of environmental instability, like an economic crisis (Finkelstein et al., 2009). As a consequence, levels of heterogeneity within TMT‘s should positively influence airline performance of LCC‘s and LC‘s pursuing a combination strategy and negatively influences airline performance of LC‘s. Based on these thoughts, several hypotheses are formulated.

3.2.1 Educational level heterogeneity

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(Wally and Baum, 1994). The significance and quality of these decisions are also associated with the educational level of TMT‘s (Bantel & Jackson, 1989).

Furthermore, the ability of an individual to recognize the value of new information, and to apply it, is strongly related to prior knowledge and skills and for a part acquired through education (Cohen and Levinthal, 1990). Consequently, managers who are higher educated, are expected to have a greater need to gain understanding of a complex situation (Pegels and Yang, 2000). Next to that, relationships exists between the average educational level of a team and the firm's competitive behavior. Teams which are highly educated are more responsive to the moves of the competitors. Highly educated teams are shown to be faster in executing both competitive actions and responses. As a result, this should be a benefit for LC‘s following a combination strategy and LCC‘s in periods of environmental instability. Some research show the opposite conclusion, by indicating that education background heterogeneity is negatively related to action speed (Ferrier and Lyon, 2004). Diverse educated teams are recognized to be slower in formulating responses (Cho, 2006). This can result in slower initiative to undertake competitive actions. This may explain why TMT‘s of LC do not benefit from education heterogeneity. Consequently, the following expectations are formulated:

Hypothesis 3a. Environmental instability strengthens the positive correlation between top management team educational background heterogeneity of Low Cost Carriers and airline performance.

Hypothesis 3b. Environmental instability strengthens the positive correlation between top management team educational background heterogeneity of Legacy Carriers pursuing a combination strategy and airline performance

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3.2.2 Top management team tenure heterogeneity

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(Ciccotello et al., 2000). Based on the arguments stated above, the following propositions are made:

Hypothesis 4a. Environmental instability strengthens the positive correlation between top management team tenure heterogeneity of Low Cost Carriers and airline performance.

Hypothesis 4b. Environmental instability strengthens the positive correlation between top management team tenure heterogeneity of Legacy Carriers pursuing a combination strategy, and airline performance.

Hypothesis 4c. Environmental instability strengthens the negative correlation between top management team tenure heterogeneity of Legacy Carriers, and airline performance.

3.2.3 International experience heterogeneity

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Hypothesis 5a. Environmental instability strengthens the positive correlation between top management team international experience heterogeneity of Low Cost Carriers and airline performance.

Hypothesis 5b. Environmental instability strengthens the positive correlation between top management team international experience heterogeneity of Legacy Carriers pursuing a combination strategy and airline performance.

Hypothesis 5c. Environmental instability strengthens the negative correlation between top management team international experience heterogeneity of Legacy Carriers and airline performance.

3.2.4 Age heterogeneity

Age as a TMT characteristic is measured as the average age of a firm‘s TMT, and plays an important role in a top management team. According to literature, age affects TMT‘s in several ways. First of all, the influence of age stems from the idea of Hambrick and Mason (1984), that age may be related to the commitment of team members to the status quo and the willingness to accept (strategic) change (Stevens et al., 1978). Other researchers have indicated that the team average age can influence the ability of the team to recognize change and to implement responsive actions (Bantel and Jackson, 1989). In other words, old and young managers influence the TMT‘s differently.

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contradiction, older managers might tend to avoid complexity in their decision making by decreasing their information gathering and decreasing the search for new ideas, activities that are consistent with planning openness (Pegels and Yang, 2000), Besides, according to literature, older managers are likely to be more risk averse (Wiersema and Bantel, 1992). Finally, older TMT members are usually more resistant to change and will therefore prefer less risky strategic actions (Wiersema and Bantel, 1992). Based on the arguments stated above, LC‘s should have advantage by a lower level of age heterogeneity, while LCC‘s and LC‘s following a combination strategy should benefit from a higher level of age heterogeneity. As a result the following propositions can be made regarding TMT age heterogeneity in the airline industry:

Hypothesis 6a. Environmental instability strengthens the positive correlation between age heterogeneity of top management teams of Low Cost Carriers and airline performance.

Hypothesis 6b. Environmental instability strengthens the positive correlation between age heterogeneity of top management teams of Legacy Carriers pursuing a combination strategy and airline performance.

Hypothesis 6c Environmental instability strengthens the negative correlation between age heterogeneity of top management teams of Legacy Carriers, and airline performance.

3.2.5 National background heterogeneity

National origin of team members may have implications on both individual personalities and team dynamics, but also on strategic decision making. Even though national origin is valued as an important aspect of a TMT, this characteristic is under-studied in TMT literature (Nielsen and Nielsen, 2008). There has been little focus on the national composition of the top management (Gong, 2003). According to Gulken et al. (2001) this is caused by the focus of researchers on the outcomes of the attributes of top management teams, instead of the determinants a TMT consist of.

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variables such as attitudes towards organizational practices, motivational techniques, leadership styles (Erez, 1993; Erez & Earley, 1987; Hui, 1990), as well as the social cohesion of a group (Elron, 1997). Given that national diversity of TMT‘s are rare, valuable and difficult to imitate they contain a competitive advantage for firms in international competition (Barney, 1991; Nielsen and Nielsen, 2008). TMT members that are born in foreign countries, posses valuable knowledge about economic and market factors and institutions, as well as about culture, behavior and norms of the country or region, from which they originate (Nielsen and Nielsen, 2008). Managers with different nationalities have been exposed to dissimilar influencing factors, and as a consequence have different values, cognition and experiences (Glunk et al., 2001). This will influence the choices managers make, how they interact within the management team and it influence the type of manager who will make it to the top (Glunk et al., 2001). This knowledge may play a very important role in for example, decision-making about the strategy of a firm in a specific country or region, or in international operations in general. In addition, national diversity in TMT‘s is important for a firm‘s strategy. According to Nielsen en Nielsen (2008), diversity leads to different perspectives on and interpretations of a particular situation, which prevents individual bias and group thinking and increases the quality of decision making. Besides, national diversity of TMT‘s may help decision-makers to better understand and interpret the complexity of a firms (international) environment (Nielsen and Nielsen, 2008). However, other studies on TMT heterogeneity showed that national background diversity results in unfamiliar language within TMT‘s, dissimilar experiences, different backgrounds, and a wide variety of beliefs and values (Finkelstein et al., 2009; Wiersema and Bantel, 1992). Consequently, difficulties in communication and weak integration is experienced within the TMT. Additionally, team homogeneity would result in better team communication, better and faster decision making (Zenger & Lawrence, 1989). In line with the other hypotheses, a higher level of heterogeneity should have a positive impact on the airline performance of LCC‘s and LC‘s pursuing a combination strategy and a negative impact on the performance of LC‘s. Keeping this in mind, it is expected that:

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Hypothesis 7b. Environmental instability strengthens the positive correlation between heterogeneity of national diversity of top management teams of Legacy Carriers pursuing a combination strategy, and airline performance.

Hypothesis 7c Environmental instability strengthens the negative correlation between heterogeneity of national diversity of top management teams of Legacy Carriers and airline performance.

3.2.6 Gender heterogeneity

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teams, experienced significantly higher returns on equity and total return to shareholders compared to firms with the lowest female representation (Catalyst, 2004). The advantages of women in the board are characterized as higher levels of board accountability and more effective communication (Terjesen et al., 2009). Research revealed, that women tend to serve on boards of better performing firms, in which the firms are able to focus more on diversity goals (Farrell and Hersch, 2005). Nelson and Levesque (2007) indicate that organizations undergoing regulatory and market review should exists of a more diverse leadership. This may imply that the influence of gender diversity on firm performance depends partly on the organizational context or on the strategy as well (Dwyer et al., 2003). These arguments lead to the following expectations:

Hypothesis 8a. Environmental instability strengthens the positive correlation between gender heterogeneity of top management teams of Low Cost Carriers and airline performance.

Hypothesis 8b. Environmental instability strengthens the positive correlation between gender heterogeneity of top management teams of Legacy Carriers pursuing a combination strategy and airline performance.

Hypothesis 8c. Environmental instability strengthens the negative correlation between gender heterogeneity of top management teams of Legacy Carriers and airline performance.

3.3 Conceptual Model

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4. Methodology and Data Collection

4.1 Type of Research

The main objective of this thesis is, to investigate the influence of the environment on the relationship between TMT composition and airline performance and to obtain accurate statistical evidence (Eisenhardt, 1989). The results of this research are divided into two parts, and therefore can be classified as two types of research.

The first part of this research can be categorized as a descriptive research. A descriptive investigation attempts to discover answers to the questions who, what, when,

where and how (Cooper and Schindler, 2003). Descriptive research may comprise data

collection, in order to describe the research subject, a group profile, people or events (Cooper and Schindler, 2003). The objective of the first research part is to demonstrate if differences exists between the heterogeneity of the TMT‘s and the applied airline strategy. By analyzing TMT characteristics of airlines in different strategic groups, statements can be made about possible differences of TMT demographic heterogeneity levels of different strategies. This results in answering hypothesis 1 and hypothesis 2.

The second part of this research examines if and in which direction TMT demographic heterogeneity influences airline performance, and investigates if and how environmental instability strengthens this relationship. In order to explore this, a theoretical and conceptual model have been developed, and hypothesis have been formulated (hypothesis 3 till hypothesis 8). The research methodology is deductive and relies on theoretical sampling, in order to extend emerging theory (Thomas, 2004; Thomas, 2006). By carefully reviewing existing literature, the relevant dependent and independent variables are identified and tested through empirical observations, in order to indicate if expected relationships exists. To make the empirical observation possible, careful attention was paid to the sample design and the data collection.

4.2 Data collection and research sample

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annual reports and websites of the airlines provided the most information needed for this research. In case the needed information was not available, online search engines were used to complete the missing information.

4.2.1 The selection of airlines in Europe, North America and Asia

There are a large number of airlines competing in the deregulated airline industry in Europe, North America and Asia, and therefore providing a reasonable sample size for this research. To collect data, the probability method was used (Thomas, 2004). This method includes a sample which represents a part (and not all) of the airlines in the EU, the US and Asia, but will resemble the whole population closely (Thomas, 2004). This method has been chosen, because it is not necessarily that a large sample ensures the representativeness of a sample (Thomas, 2004).

The yearly published report ‗World Airline Report‘ provides an overview of the major and most profitable airlines worldwide, together with the most up to date performance indicators of each airline. This report is published in the magazine ‗Air Transport World‘ and a summary can be found on the website www.atwonline.com. The world airline report provides balanced international coverage of the airline industry for nearly 47 years. Besides, collecting data from one source guarantees consistency in the overview of major airlines and their performance results.

A total number of 86 airlines in Europe, 76 airlines in the US and 54 airlines in Asia were listed in the World Airline Report 2009. In line with Chen and Hambrick (1995), only data is collected of the major national and large regional commercial air carriers with a minimum of $100 million operating revenues in Europe, North America and Asia. As a result, not all the airlines on the list of the World Airline Report met the requirements of the minimum operating revenues. In addition, some airlines experienced bankruptcy and some airlines offered customer charter services or cargo and freight services only. These airlines were not included in this investigation. The final research sample consists of 46 airlines in Europe, 48 airlines in North America and 34 airlines in Asia. The size of this research sample is in line with the rule of thumb of Green (1991). According to Green (1991) the sample size should be greater than fifty plus eight times the number of independent variables: N ≥ 50 + 8m. In this investigation the minimum sample size should be 98 (N ≥ 50 + 8×6).

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Differentiation strategy: Airlines who stated in their mission to be focused on highest quality and service for their passengers (Legacy Carriers).

Cost leadership: Airlines who described in their mission statement to offer the lowest fares in the market (Low Cost Carriers).

Combination strategy: Airlines who indicated to strive for low fares, but also offer services and quality on board (Legacy Carriers).

The airlines of Europe, North America and Asia are classified to one of the three strategic groups. This results in 78 Legacy Carrier, 31 Low Cost Carriers and 19 Legacy Carriers pursuing a combination strategy (Appendix C). Since performance can lead to important patterns of within-group similarity, and across group differences, this is a tactic, to look for similarities coupled with intergroup differences between the strategic groups (Eisenhardt, 1989).

4.2.2 The selection of performance data

The performance data of each airline was collected from the years 2004, 2005, 2006, 2007, 2008 and 2009. The reason for this is twofold. First of all, the period of 2004-2005-2006 can be characterized as a ‗stable‘ environment in the airline industry (IATA, 2006). The years 2007-2008-2009 can be typified as a period of ‗high environmental instability‘, in which the airline industry had to deal with the global crisis and a raise in fuel prices. Secondly, the average airline performance of the airlines was calculated, in order to avoid a wave in performance over the years. No longer time period will be taken into account, because the aim of this research is, to investigate if relationships exists.

4.2.3 The selection of members of the Top Management Team

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their website. In general, this information can be found under ‗investor relations‘ or ‗corporate governance‘.

In case, both annual report and website didn‘t provide all the needed information about the characteristics of the top management team, online search engines such as Google Finance, (finance.google.com), Zoominfo (www.zoominfo.com), Linkedin (www.linkedin.com), Business Week (investing.businessreview.com) and Amadeus (www.amadeus.bvdep.com) were used to complete the missing information. In total, data of 1021 top management team members were collected (LC‘s: 707 team members, LCC‘s: 207 team members, LC‘s-combi: 107 team members).

4.3 Measurement

During the data collection process, information was gathered in SPSS-spreadsheets.

In order to answer the research question, the technique of multiple linear regression analyses was used. Linear regression analysis models and analyzes data, which consist of values of a dependent variable and of one or more independent variables (Thomas, 2004). The data was analyzed by using SPSS 17.0. This program offers the opportunity to do multiple regression analyses, to test the hypotheses, to evaluate them and finally be able to answer the research question (Thomas, 2004). The analysis not only indicate if a significant relationship exists between de dependent and independent variables, but also indicates a positive or negative direction of the relationship. In this analysis, the dependent variable is modeled as a function of the independent variables. The general form of a regression analysis is:

Formula 1. Regression analysis

b.

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Formula 2. Regression analysis with moderator effect             C

In which''represents the dependent variable ROA.'' represents the individual independent variables of heterogeneity: age, education, national background, international experience, tenure and gender. '' represents the added independent variable of environmental instability.

'

'C represents control variables firm age, firm size, team size and fuel prices. In order to enter the moderator effect into the regression analyses '' is multiplied with each independent variable''. In this way, the independent variable moderates itself (Hair et al., 2005). Therefore, '' is a dummy variable, with the values ‗0‘ (in case of no environmental instability) and ‗1‘ (in case of environmental instability). This results in the two following alternatives:

0) C (in case of no environmental instability)

1)            C  (  ) (  )XC (in case of environmental instability)

Furthermore, this research consist of the following variables, which are measured as follows.

4.3.1 Dependent variable: Airline Performance

The dependent variable in this research is airline performance, which was measured as ‗Return on Assets‘ (ROA) by the following formula.

Formula 3. Return on Assets

assets Total

income Net

ROA

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4.3.2 Independent variables: Top Management Team Heterogeneity Demographics

The independent variable, the top management team heterogeneity demographics of airlines, is the one that is assumed to influence the dependent variable (Thomas, 2006). To determine the heterogeneity of a TMT, several indicators of TMT background diversity are measured including educational level, tenure, international experience, age, national background and gender. After measuring the characteristics of each top management team, the heterogeneity level can be determined by using Blau‘s Index (Blau, 1977). Blau‘s heterogeneity index measures the proportion of each specific characteristic within the TMT.

Formula 4. Blau’s heterogeneity index

1

n i i

p



 



H

This formula computes  as the percentage of the top management team members in the ith group,  indicates the number of possible categories of each characteristic and H is the value of heterogeneity, which is ranged between 0 to 1. A score of ‗0‘ indicates complete homogeneity and a score of ‗1‘ indicates complete heterogeneity. As a result, higher scores on this index indicate more diversity in terms of the specific characteristic (Narjano et al., 2008). The total score of heterogeneity of each TMT is measured as the mean of heterogeneity of the six independent variables. This way of determining TMT heterogeneity is in line with previous studies (Narjano et al., 2008; Amason et al., 2006; Wiersema and Bantel, 1992).

Educational Level: This characteristic can be described as the highest education level a TMT member has completed. The average educational level of the TMT is determined based on the classification of each TMT member according to the five educational levels: 1: ‗no degree 2: ‗bachelor degree‘, 3: ‗master‘s degree‘ 4: ‗MBA‘ 5: ‗PHD‘ 6: ‗other‘.

After that, the average TMT educational level was calculated as the mean of the top management‘s educational level. The diversity of the educational level is computed by the coefficient of variation in TMT members‘ educational level using Blau‘s heterogeneity index (1977), as explained before.

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management team tenure of all TMT members. The heterogeneity, in terms of diversity of TMT tenure was measured as the coefficients of variation (their respective standard deviations divided by their means as indicated by Allison (1978), Wiersema and Bantel (1992) and Cho and Hambrick (2007). A high score indicates tenure heterogeneity and a low score indicates tenure homogeneity. The coefficient of variation is preferred for continuous measures like tenure, because it provides a direct and scale-invariant outcome (Allison, 1978; Wiersema and Bantel, 1992).

International experience: This refers to the international experience TMT member gained in terms of study, work or expatriate experience abroad (Herrmann and Datta, 2002). The international experience of each TMT member is determined by the categorical value ‗1‘, in case the team member has international experience and ‗2‘ in case the team member has not international experience. Then, the diversity of international experience was calculated by Blau‘s heterogeneity index (1977) in order to give an overview of the percentage of international experience within the TMT.

Age: This variable is measured as the reported age of the individual members of the top management team. The average age of the TMT was measured as the mean of ages of the TMT members.

The diversity of age within the TMT was measured using the coefficient of variation in TMT members‘ age, which is the standard deviation divided by the mean. A score of ‗0‘ would indicate low age heterogeneity and a score of ‗1‘ would indicate high age heterogeneity.

National background: This can be defined as the degree of different nationalities within a TMT (Staples, 2007). To measure the national diversity, the national origin of each TMT member was listed. Blau‘s index of heterogeneity (Blau, 1977) was used to make a calculation of the variation of different nationalities within the TMT.

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4.3.3 Moderating variable: Environmental instability

The environment of the airline industry is expected to influence the TMT-performance relationship. Consequently, the environmental instability is included in this research as a moderator variable. To measure environmental instability, a ‗variation‘ can be calculated, according to previous research of Carpenter and Frederickson (2001).

Formula 5. Environmental instability

income operating income operating y instabilit tal Environmen   

The mean and standard deviation of the airline‘s operating income is calculated for the years 2004-2005-2006 and 2007-2008-2009. Then, the mean is divided by the standard deviation, in order to determine the environmental instability (He Yuan and Wen, 2008). A high score indicates low environmental instability and a low score means high environmental instability. Consequently, a high score was revealed for the time period 2004-2005-2006, and a low score for the time period 2007-2008-2009.

4.3.4 Control variables

Airline performance can be influenced by a variety of factors. Therefore, some control variables are included to avoid potential impacts.

Firm size. Firm size is a frequently used control variable, influencing firm performance in the research of the influence of the TMT (Finkelstein et al., 2009). Firm size is measured as the log of the mean of total assets of years 2004-2009 of each airline (He-Yuan et al., 2008).

TMT size: The number of individuals listed as top managers of the TMT was included to control for the size dependence in the measurement of TMT diversity (Carpenter & Fredrickson,2001).

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Fuel prices: According to the Air Transportation Association (ATA), fuel is the second largest expense of airlines, and therefore makes up a significant part of an airline's total costs. Besides, high and unstable fuel prices were a dominant factor of the losses of airlines in 2008 and 2009 (Bamber et al., 2008). Given different rates of fuel prices in Europe, North-America and Asia, the average fuel prices of the years 2004-2009 are included as well (Goll et al., 2007).

4.4 Operationalization of concepts

This research includes the analysis of 8 hypotheses. To avoid misunderstanding and misperception about the terms used in this study, a definition of the remaining concept is given.

Top Management Team

In the Upper Echelon research stream, the definition of the TMT is a widely discussed topic. Some studies include only the top level executives, the CEO and vice presidents, where other researchers include executive board directors and non-executive board directors as well (Patzelt et al., 2008).

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5. Results

As indicated before, the outcomes of the data analyses can be divided in a descriptive part and an empirical part. The descriptive part summarizes differences and similarities of TMT demographic heterogeneity of LC‘s, LCC‘s and LC‘s pursuing a combination strategy (appendix A1-A3). Based on the outcomes, hypothesis 1 and 2 are answered. The empirical part consist of the results of the regression analysis, in order to determine if significant relationships exists between TMT heterogeneity and airline performance, when the influence of environmental instability is taken into consideration. Based on the results of the analyses, hypothesis 3 till hypothesis 8 are answered.

5.1.1 Descriptive results: TMT Heterogeneity of Legacy Carriers

‗The influence of environmental instability on the relationship between top management team demographic heterogeneity and airline performance’

Master Thesis