MIX AND MATCH
A research on board diversity and the influence on
innovation performance
J. Midavaine, April 2013
Abstract
This paper examines the relationship between board diversity and the innovation performance of high-tech firms by applying faultline theory. It is being assessed whether information-based characteristics (educational background and tenure) have a direct influence on the innovation performance of firms and whether social faultlines (age and gender) moderate this relationship. To test the model, 25 high-tech U.S.- based firms are being investigated over a period from 2005-2011. The results revealed that educational background has a positive, direct effect on innovation performance and is moderated by age diversity. Evidence for interactions between tenure and innovation performance or between tenure and the moderating variables has not been found.
MIX AND MATCH
A research on board diversity and the influence on innovation
performance
University of Groningen | Faculty of Economics and Business
MSc Thesis Business Administration | Specialization Strategy and Innovation
Jeanelle Midavaine | Student number 1634526 Soephuisstraatje 3A | 9712 BZ Groningen
Tel.: +31(6) 12 29 29 93 | Email: jeanelle.midavaine@gmail.com
Preface
Writing a master’s thesis is the final phase before graduation. So what comes next? Going into the field and experience business: that will be the next step and I am convinced that my years of study have created a solid fundament to build on. After years of reading articles, writing and critically assessing papers, it is now time for my own ‘masterpiece’. This thesis includes a research on board diversity and the influence on the innovation performance of high-technology firms.
When seen in today’s light, I have to admit that I enjoyed writing my master’s thesis much more than I thought I would. After an extensive search, board diversity was the most appealing subject to me and after shaping my proposal, it quickly felt like ‘my’ research. Of course, this thesis would not have been of this level without the help of my supervisor Prof. dr. W.A. Dolfsma. His enthusiasm, extensive and detailed knowledge (which surprised me every time), suggestions and perfectionism helped me to constantly scrutinize my own writing. Also, my family and friends who were always sincerely interested and supportive helped me in finalizing my thesis.
With the completion of this thesis, my years as a student in Groningen have come to an end. Besides my studies there was so much more that Groningen had to offer. I am grateful for the friends I have made, the experiences of joining committees and a board, as well as the opportunity to really enjoy student life to the fullest. If you read this thesis with the same feeling as I feel about my years in Groningen, I am sure you will find it fantastic!
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I.
Introduction
“Minds are like parachutes: they only function when open”
James Dewar, Scottish physicist 1842-1923
Organizations are constantly searching for the perfect fit within their firm to ensure survival, making innovation a highly important part of the agenda (van der Walt and Ingley, 2003). Various drivers behind innovation, like groupwork and diversification are rapidly growing in popularity and shall not be underestimated by organizations (Bezrukova et al, 2009). Besides the managerial interest in the topic, an emerging body of academic literature has started focussing on the diversity phenomenon (Goodstein et al, 1994).
The current focus of firms to discover new ways of approaching situations and coming up with creative solutions is to a larger extent related to collaboration. When people involve in teamwork, an open mindset is vital in making optimal use of the ideas and thoughts of each individual within the group. Relating this to business, the board of directors is the most powerful organ within an organization and it has to collaborate to make well-thought decisions to improve firm activities. But what if a board is not in its optimal shape? What if a better mixture of particular characteristics leads to minds which are much opener, leading to better decisions for the organization?
Nowadays, diversity is a booming phenomenon with global presence. Discussions on diversity are often related to race and gender and are being discussed up until the highest political levels of countries. In academic literature, diversity is discussed in more depth with multiple attributes and different research goals. During these pressured times in which the economic crisis still plays the leading part, most diversity literature focuses on board diversity due to the influencing, decision-making power it holds.
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Also innovation is in a number of studies related to diversity (Bantel and Jackson, 1989; Jehn et al, 1999) and is sometimes even mixed with psychological insights (Bezrukova et al, 2009). The phenomenon ‘faultline theory’ is an example of such a topic that has its roots in psychology and is applied in some studies on board diversity. It gathers attributes such as age and gender around a term called ‘social faultlines’ (Bezrukova et al, 2009) and it describes attributes like educational background and career experience as ‘information-based faultlines’. These faultlines turn out to have an effect on the creativity within groups and influence group performance (Bezrukova et al, 2009). Although research has been done on group performance, it has not been investigated in relation to innovation yet. Given that certain attributes influence group effectiveness, it is appealing to investigate if such attributes also have an influence on the innovation performance of a firm. When referring to the quote, we can ask ourselves: which of the attributes of social and information-based faultlines have an influence on the innovation strategy and thus open up board member’s minds?
As such a research has not been undertaken before, it adds to the body of knowledge on topics like diversity and innovation. Therefore, this thesis aims at answering the following research question:
How does board diversity influence the innovation performance of high-technology firms? In this study, the aim is to test if there exists a direct relationship between information-based characteristics and the innovation performance of firms. After this, the outcomes are assessed with the interaction of social attributes to see if these attributes have a moderating effect.
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II.
Literature review
During the last decade, board diversity has gained much attention in both academic literature and organizations. Studies on this topic are traditionally approached from a business perspective, but recently articles are to a greater extent bridging between business literature and psychological insights. In this section, it is firstly described what board diversity encompasses including an assessment of prior research undertaken on this topic. After this, faultline theory will be introduced, leading to the establishment of hypotheses for both information-based characteristics and social faultlines.
A. Board diversity and innovation
Objective and subjective differences amongst individuals on any characteristic that may lead to the perception that the one individual is different from the other refers to the term diversity (Knippenberg and Schippers, 2007). Theoretically, diversity can thus refer to numerous dimensions, varying from age to gender, from race to religious background or from task skills to political preference. Despite the plentiful interpretations of the term, academic research on diversity has mainly focused on gender, race, age, organizational background and tenure (Milliken and Martins, 1996).
Besides the fact that we experience diversity continuously during our private lives, organizations are currently to a larger extent subject to diversity. Matters like globalization have forced firms during the last decades to progressively start operating in an international environment, leading to more interaction between different cultures, persons and behaviours (van der Walt and Ingley, 2003). It is thus no surprise that, by patiently waiting for its big moment of fame, diversity has found his way to the top of organizations and receives more attention than ever before. The message for boards to pay attention to this topic and accordingly assess the composition and functioning of their board may come from different directions. When referring to existing literature, some authors argue that obligations from shareholders or stakeholders to become more diversity-oriented are an important influence (Carver, 2002; Keasey et al, 1997) whereas others relate board diversity to theories like the resource dependence view1 and agency theory2 as the underlying rationale for change.
1 Theory concerned with the influence of external resources of organizations and its effect on the behavior of the
organization (Pfeffer and Salancik, 1978)
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The objective of this paper is primarily to investigate board diversity and board’s strategic decisions concerning innovation performance. Regarding board diversity, ample research has been undertaken, focusing on various relations and presenting mixed results. Much attention goes out to board diversity and consequences on the financial performance of organizations (Erhardt et al 2003; Carter et al 2003). Others have investigated the influence of strategic change as a result of a diverse board (Goodstein et al, 1994) while attention also goes out to the relationship between diversity and firm performance (Johnson et al, 1996) or the influence of diversity on team effectiveness (Chowdhury, 2005). Innovation is in many board diversity-related papers of growing importance and it is frequently captured in a moderating perspective. Despite the acknowledgement of many authors emphasizing the importance of innovation, there is no research on innovation and board diversity yet. This is interesting, because the focus on innovation can be vital to compete in the industry.
i. Board diversity: a good and bad thing?
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Researchers continuously search for possible explanations on board diversity in which much attention goes out to the drivers behind the phenomenon. On the other hand the aim is to find plausible explanations for the growing interest of firms to diversify their leadership team in the hope of improving results.
The way diversity is being approached may differ significantly: one can look to exterior characteristics people hold, but diversity can also be considered as job-related characteristics. This latter dimension examines the characteristics one cannot see from the outside; it are those features such as educational background, tenure or functional background (Williams and O’Reilly, 1998) which are key for the completion of a certain task (Lau and Murninghan, 1998). Several authors have concluded that these, so called, information-based characteristics function as a catalyst for creativity and innovation in groups (Hülsheger et al, 2009). This creativity of employees can consequently be an important source of organizational innovation and competitive advantage, benefiting the entire organization (Oldham and Cummings, 1996; Amabile et al, 1996). The biggest advantages are seen in the stimulation of effective decision making within groups (Cramton and Hinds, 2005) as they may be able to see the added-value in their differences. Due to the ability to effectively utilize the cognitive resources available, group performance is likely to increase.
As we envision a board as a well-functioning management organ within the organization, we can state that information-based characteristics will have a positive effect on the decisions made regarding the innovation strategy of the firm. In order to investigate this, we split-up this statement into two distinct hypotheses, both with a separate attribute to analyse:
Hypothesis 1a: Large differences in the educational background of board members will be positively associated with the innovation performance of a firm
-6- C. Intervention of social faultlines
Despite the positive outcomes of research, diversity can also lead to chaos, too many voices in the boardroom and delays in the decision making process. This occurrence is known as ‘faultline theory’ and contributes to diversity theory by theorizing about the effects of underlying patterns of group member characteristics (Lau and Muringhan, 1998). Faultlines are hypothetical lines that can split up a group of people into subgroups based on one or more attributes (e.g. age, gender) (Lau and Muringhan, 1998). A ‘large faultline’ is one in which the difference (also called the ‘distance’) amongst the attributes is significantly large. Whether a large faultline distance is of benefit to the board or not depends on the type of faultline that is being researched.
i. Social faultlines
Apart from information-based characteristics which each person in a board holds, members of a group can also easily recognise each other in straightforward visible attributes, such as gender, age and race. These so called social faultlines are not directly relevant to a given task or job, but can influence already established relationships. When a social attribute, say age, is recognised by persons in a group, it is likely that subgroups are formed within the group that create the “us versus them” attitude (Li and Hambrick, 2005). Research has shown that awareness of people’s membership into a distinct subgroup is likely to initiate unproductive interactions between subgroups.
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From a board perspective we can assume that social faultlines will have a moderating effect. Arguments for this are that boards only meet a few times per year and we assume that their professional attitude would not lead to a direct judgement based on social characteristics. It is in this case more likely that, for instance, an opinion that is being shared by a board member comes across differently once other board members take external factors (e.g. the opinion sharing board member is a female) into account. Such a thought shapes people’s perception and behavior, leading to stereotyping or other preconceived opinions. These mechanisms can thus have a negative effect on the valuation of information-based characteristics, leading to the following hypotheses:
Hypotheses 2a: Age has a negative, moderating effect on the relation between information-based characteristics and the innovation performance of a firm
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III.
Methodology
A. Sample
For this research, data of 25 U.S. firms from the Fortune 500 will be used. The choice for Fortune 500 is based on the representativeness of the source: the Fortune 500 lists leaders in each industry which makes it excellent in meeting the needs for this research. As this research focuses in the essence on innovation, it is important to select suitable industries that at least meet the criterion of a high standard in innovation. In order to meet this ‘innovation standard’, industries were assessed on both the Oganisation for Economic Co-Operation and Development (OECD) classification of high- technology industries (which is based on Research and Development (R&D) expenses) as well as on their propensity to patent (Arundel and Kable, 1998). Using these two classifications provides distinct approaches as they apply their own measures towards innovation. From Arundel and Kable (1998), four industries with a propensity to patent of >50% are being selected. These four industries (pharmaceutical, chemical, machinery and aerospace) are also high-tech industries classified by the OECD. Comparing the outcomes of Arundel and Kable (1998) with those of the OECD is vital because Arundel and Kable’s study focuses on European firms while this paper assesses U.S.-based firms. The comparison of two studies increases validity and also confirms that the right industries have been selected on the basis of two classifications of innovation instead of only one.
-9- B. Conceptual model
A visual representation of the research as it should be undertaken.
C. Independent variables
In this study, we measure information-based characteristics as independent variables by making use of two measures.
Educational level. Educational level will be measured because it represents an internal, personal characteristic. The relevance for this variable in relation to the innovation strategy has been discussed by Wiersema and Bantel (1992) where it is being claimed that executives with an advanced level of education are more open to innovation as well as to risky investments. Diversity in the educational level is calculated using Blau’s index of heterogeneity (1977):
(1-∑ρi²)
where ρi represents the number of group members in each of the i number of categories. This implies that, in the case of educational level, each member is positioned in one of the four groups of Bachelors, Masters, PhD, or MBA. When a board member holds both a PhD and a MBA degree, the educational level will be directed to MBA as this represents a closer resemblance of characteristics a board member should have in his board position whereas a PhD in, for example, biology might add to scientific knowledge within the firm, but does not strengthen the managerial skills required in a board function.
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Tenure. The total amount of years a board member holds a position in the board is an important factor in the decision-making process. Long-tenured board members are less likely to introduce appropriate strategies that match their environmental requirements and might become reluctant to change. Additionally, due to their extensive knowledge of organizational policies and procedures they are less likely to make changes or take a risk (Miller, 1991; Kanter, 1977). Tenure will also be measured using Blau’s index with the following categorization: 0-2 years, 3-5 years, 6-9 years, 10-14 years and 15 years or more.
D. Dependent variable
Innovation performance. Because the relation towards the innovation performance is measured, R&D expenses will be used as a proxy and is measured in thousands of dollars. The main reason to choose for R&D instead of other measures, like patents, is because this proxy can be directly affected by the board and thus offers the highest validity. The number of patents cannot be seen as a direct factor influenced by the board, whereas decisions on R&D spending are most likely to be made by the executive board of the firm.
E. Moderating variables
The moderating variable will, similar to the independent variable, be split up in two variables which are in this research age and gender.
Age. The age of each board member has been calculated for the years this research has been executed. Year of birth of all board members has been extracted from either annual reports, the website of the firm or by websites such as NNDB and Bloomberg which hold biographies of many executives. In accordance to the independent variables, the age of the board members is also calculated using Blau’s index. In this, categories of board members are made in the following order: 39-45 years, 46-50 years, 51-55 years, 56-60 years, 61-65 years, 66-70 years and 70 years or older.
-11- F. Control Variables
We control for the following variables as recommended by an extensive literature review: firm age, firm size, and GDP growth.
In investigating the relationship between information-based characteristics and the innovation strategy of a firm (H1a and H1b) as well as testing the moderating effect of social faultlines on this established relationship (H2a and H2b), firm age (number of years since incorporation) and firm size (total number of employees for each observed year, derived from annual reports) are used as control variables. Reason for this is because firms with more experience and knowledge in the market are likely to maintain different spending patterns from firms that are smaller and younger (Brown and Perry, 1994).
In addition, it is wise to control for Gross Domestic Product (GDP) in these financially difficult times. It is likely for firms to adjust their R&D strategy to their current financial position. Therefore, GDP (as a percentage) is added as a control variable and is derived from the OECD website.
G. Analysis
By the means of statistical analyses, the aim is to find evidence to either accept or reject the hypotheses in this research. Prior to running the regressions, both variables R&D expense and firm size were transformed into normal logs due to their high outcomes.
To test hypotheses 1a and 1b, which predict that information-based characteristics of board members have a positive effect on the innovation strategy of a firm, the variables educational background and tenure were added to the regression model together with R&D expense and the control variables. For this analysis, R&D expense has undertaken a log transformation which was necessary because of the large differences in R&D spending between the firms. Prior to this transformation, the variable was not normally distributed ideally. After the transformation, R&D expense was normally distributed and thus approved to go through the analyses.
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IV. Results
We statistically tested the effects of both information-based characteristics on R&D expenditure and the moderating role of social faultlines in this perspective. As a starting point, Pearson’s correlation analyses were executed and can be assessed in Table I. The average Blau score on gender in our sample is 0.255678 where the highest possible Blau score was 0.50. The average education score was 0.620593 where a maximum score of 0.75 was possible. For tenure, the highest attainable score was 0.8 and reaches a score of 0.711853 in this research. Finally, age scores 0.722402 on average where the highest potential Blau score was 0.94. On average, boards thus appear to be more information-based diverse than social diverse. Table I also revealed significant correlations between particular variables. There is a significant and positive correlation between education and firm size (p < 0.05) which suggests that larger firms more often appoint educational diversified persons to the board. Gender is significantly and positively correlated with firm age (p < 0.01) which suggests that older firms are more age diverse than younger firms.
Table II summarizes the regression results from the hypotheses testing. Model 2 tested the effects of the independent variables on the dependent variable. Hypotheses 1a and 1b predict that, respectively, educational background and tenure have a positive influence on the innovation performance of a firm. The outcomes of the variables education (6.908; p < 0.01) and tenure (-3.860; p < 0.05) are both significant, however, it shall be noticed that tenure holds a negative B meaning that if the diversity of tenure goes up by one, R&D expense goes down by 3.860. Therefore, we can accept hypothesis 1a and reject hypothesis 1b. The adjusted R² for Model 2 was 0.398.
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-14- Table I. Means, standard deviations and pairwise correlations
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Variable Mean s.d. 1 2 3 4 5 6 7 1.R&D expense 13.2042 1.50276 2. GDP 1.2000 2.04827 -0.19 3. Size firm 10.7785 0.74227 0.495** -0.002 4. Firm age 89.52 40.653 -0.19 -0.16 -0.169* 5. Education 0.620593 0.0850223 0.462** 0.041 0.189* 0.187* 6. Tenure 0.711853 0.0653503 -0.137 0.070 0.055 -0.002 0.020 7. Gender 0.255678 0.0815016 0.337** -0.113 0.094 0.340** 0.331** 0.016 8. Age 0.722402 0.0544446 -0.137 0.030 -0.067 0.078 -0.208** 0.170* 0.128
-15- Table II. Results of regressionᵃ
Variables Innovation
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6
Firm size 1.025*** (0.136) 0.865*** (0.124) 0.853*** (0.121) 0.853***(0.121) 0.747*** (0.123) 0.747*** (0.123) Firm age 0.002 (0.002) -0.001 (0.002) 0.000 (0.002) 0.000 (0.002) -0.006** (0.002) -0.006** (0.002) GDP -0.012 (0.049) -0.016 (0.043) -0.008 (0.042) -0.008 (0.042) 0.004 (0.042) 0.004 (0.042) Education 6.908*** (1.120) 7.407*** (1.089) 7.407*** (1.089) 7.371*** (1.212) 7.371*** (1.212) Tenure -3.860** (1.384) -3.441** (1.334) -3.441** (1.334) -4.064*** (1.305) -4.064*** (1.305) Age 0.585 (1.650) 0.585 (1.650) Gender 3.735*** (1.176) 3.735*** (1.176) Education x Age -0.384*** (0.097) Tenure x Age 0.023 (0.094) Education x Gender 0.240** (0.095) Tenure x Gender 0.135 (0.102) R² 0.250 0.416 0.416 0.467 0.455 0.480 Adjusted R² 0.237 0.398 0.395 0.441 0.435 0.455 F-test 18.983 24.040 19.916 18.183 23.330 19.171
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V.
Discussion
This research analyzed 25 firms, all of which are represented in the Fortune 500 in high-tech, innovative sectors. The direct relationship between information-based characteristics and R&D expenses has been measured, as well as the (possible) intervention of moderating variables that fall under the ‘umbrella’ of social faultlines. Results provide us with evidence for the positive relationship between educational background and innovation performance as well as for the negative, moderating effect of age in the relationship between educational background and innovation performance.
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A possible explanation for this contradictive outcome is that age has a different role in the conceptual model of this research. When the direct effects of age are being measured it is expected that it results in different outcomes than when age is tested in a moderating role. In other words: a variable can have a direct influence on a relationship and not having a moderating role and vice versa.
Another, more managerial oriented, explanation is that if age diversity is greater (i.e. the ages of board members are spread over more categories), it is plausible that also higher-aged categories are present. Those board members who are older have more experience, but also have a different educational background than ‘younger’ board members does. Especially when focusing on the high-tech industries, visions of older-aged board members might hamper the innovation strategy as their views are outdated and not in line with the fast-moving high-tech industry the firm operates in.
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VI. Conclusion, limitations and avenues for future research
Theoretically, this research contributes to the existing board diversity literature as it bridges between booming topics in both the academic world and business. The basis of this study is build on the psychological perspective of ‘faultline theory’ and investigates the relation of particular attributes towards the innovation performance of highly innovative firms. It provides support for the positive relationship between educational background and innovation performance and partially supports the moderating effect of variables such as age and gender. Moreover, it also emphasizes the importance of innovation and the effects that boards have on decisions related to the innovation strategy of a firm.
Also, the bridging between different disciplines – psychology and business- is not often commenced in such a broad, innovation oriented, study. The roots of both disciplines meet each other in a pioneering state of the research, making it interesting for both disciplines to consider. This research thus opens a door for further exploration of different disciplines and, wherever it may be possible, the opportunity to combine them.
Despite the hope of finding support for all hypotheses, there was no evidence for the relationship between tenure and the interaction variables age and gender. Educational background, on the other hand, was highly significant in the direct relation towards innovation performance: something that is in line with prior research (Wiersema and Bantel, 1992). Relating the outcomes to the research question stated at the beginning of this paper, we can conclude that board diversity influences innovation performance in different perspectives. Internal characteristics of persons in this research have a positive effect on the innovation performance of firms, but for external characteristics the results are mixed. It shows that age indeed moderates the relationship between educational background and innovation performance, but such explanations are not found for tenure.
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Other researchers may thus think of a conceptual model and sample in which different industries with significantly different characteristics are being included (Miller et al, 2009). Also investigating boards which are located in a different country might be interesting, as cultural differences may change outcomes on the same study significantly. Doing this can lead to meeting two important conditions: firstly, the representation of a broad and diversified sample and secondly, a high level of validity is being presented. In addition, it can also be researched whether different disciplines in education lead to different outcomes, e.g.: does a board member with a PhD in biology makes different managerial, innovation related decisions than a board member with a PhD in business administration?
Reasons for the inconsistency in findings relating to diversity are hard to find. Harrison and Klein (2007) argue that these mixed results are due to the operationalization of diversity. Future research should thus carefully scrutinize the methods undertaken by others before using their methods as a basis for research.
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VII. References
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www.businessweek.com – last accessed: 21/03/2013
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Appendix
Figure I. Firms included in the dataset Johnson and Johnson
Pfizer Bristol-Myers Squibb Eli Lilly Amgen PPG Industries Praxair Sherwin Williams Eastman Chemical Monsanto Avery Dennison Ecolab Parker Hannifin Eaton
