“The influence of Top Management Team
experience on firm performance”
Master Thesis Author: Kevin Schadenberg S1612859 KSchadenberg@gmail.com Supervisor: Dr. P. Rao Sahib Second supervisor
Prof. dr. H. van Ees
University of Groningen Faculty of Economics and Business
“The influence of Top Management Team
experience on firm performance”
Master Thesis Author: Kevin Schadenberg S1612859 KSchadenberg@gmail.com Supervisor: Dr. P. Rao Sahib Second supervisor
Prof. dr. H. van Ees
University of Groningen Faculty of Economics and Business
2
Abstract
Using cross- sectional data on 56 listed Dutch companies and their 219 top management team members this paper attempts to investigate how the work experience and strategic experience of directors affect firm performance. By studying this relationship between strategic experience and firm performance, this paper not only attempts shine more light on the functional background of TMT, but it also moves away from the more established literature which predominantly focuses on the US. Using OLS, this research finds that company experience and industry experience in years preceding becoming part of the executive board has a significant negative effect on firm performance which might reflect the commitment to status quo. Unfortunately, no significant results were found for the relation between strategic experience with Mergers and Acquisitions and/ or Reorganisations.
Table of Content
1. Introduction ... 4
2. Literature review: Theory and Hypotheses ... 6
2.1. Literature review... 6
2.1.1. Executive board ... 6
2.1.2. TMT Diversity and composition ... 7
2.1.3. Background and professional experience... 9
2.2. Hypotheses ... 11
2.2.1. Company experience ... 11
2.2.2. International experience ... 13
2.2.3. Industry experience ... 15
2.2.4. Strategic experience ... 17
3. Research Methodology and Data ... 20
3.1. Sample Data and collection ... 20
3.2. Data sources ... 20
3.3. The variables ... 21
3.3.1. Dependent variable ... 21
3.3.2. Independent variables ... 21
3.4. The model ... 23
3.5. Explanation of data and variables ... 25
3.5.1. Dependent variable ... 25
3.5.2. Independent variable ... 25
3.5.3. Control variables: firm- level variables... 26
3.6. Multicollinearity ... 27
4. Empirical results and analysis ... 28
4.1. Descriptive Statistics ... 28
4.1.1. Industry Descriptives ... 28
4.1.2. TMT member background and professional experience ... 30
4.2. Empirical results ... 32
5. Discussion and Conclusion ... 35
6. Limitation and future research ... 38
7. References ... 40
8. Appendices ... 47
Appendix One: Descriptive statistics and Correlation of all variables ... 47
Appendix Two: Regression ... 49
Appendix Three: Data Encoding ... 52
Appendix Four: Industry Categorisation ... 54
Appendix Five: Company Sample Selection ... 55
Appendix Six: Blau Index ... 56
4
1. Introduction
Over the past decades the topic of Top Management Team (TMT) has seen an exponential increase in research, in particular since the corporate scandals in the 2000’s. Furthermore, factors such as globalization and liberalization accentuated the importance of the TMT (Carpenter and Frederickson, 2001). Whereas previously, companies solely relied on the capabilities of their CEO’s, increasing complexity and uncertainty in the competitive environment have made it necessary to look at the TMT as a whole. It is the combined capacity of the TMT that influences long term success (Carpenter et. al., 2004). In this respect the executives of companies, the group of people responsible for the day- to- day functioning of the company and who have the task of ensuring the effective and rational execution of a firm‘s strategy play an important role in the success and performance of the firm in order to achieve company goals. Therefore, TMT characteristics are pertinent to corporate performance. Thus, not only from the shareholder point of view (maximising value), but also from the academic perspective the nexus between TMT characteristics and firm performance is relevant.
Central focus in the study of boards on firm performance is the seminal article of Hambrick and Mason (1984) introducing the Upper Echelons Theory. This perspective argues that characteristics such as age, tenure, functional background and personality traits influence the preferences and attitudes of managers, as well as their strategic choice and the resulting organisational outcomes (Carpenter et. al., 2004; Hambrick and Mason, 1984). In this context, prior literature amongst others examines the issue, whether certain of these TMT characteristics impact firm performance. The main stream of research has been dominated by studies exploring the relationship between board diversity or heterogeneity (i.e. background characteristics) and firm performance. Overall, despite a large effort, results are ambiguous (Dalton et al., 1998; Hermalin and Weisbach, 2010).
Unfortunately, studies have been largely confined to the US, this study will examine the relationship between the functional background (i.e. past experience) of TMT (members), and how this influences current firm performance, for Dutch firms.
The research question of this this is formulated as:
A significant problem in examining the impact of TMT members on firm performance is that of endogeneity as causality might run both ways. It could be that firms perform better because their TMT members are more experienced (and perform better), but the opposing could also hold that more experienced TMT members are attracted to better performing firms. Previous studies have attempted to overcome these problems by employing instrumental variable techniques (van Ees, et al., 2003; Beiner et al. 2006). Although instrumental variable regressions potentially eliminate endogeneity, they require the identification of strictly exogenous instrumental variables.1 However, another measure to get around the problem of endogeneity is to look at past (work- related) experience of current TMT members. For instance international experience, industry experience but also strategic experience (i.e. Merger and Acquisition activity and Restructuring activity) of board members. A more detailed description can be read in section three. Logical reasoning predicts that past (strategy) experience will influence current strategy and ultimately firm performance. By looking at past strategy the problem of endogeneity will be, at least, partially resolved.
Given the theoretical perspectives relating to TMT impact on firm performance this study expects to find a measurable effect of prior management board experience on firm performance. Apart from the fact that past research has paid little to no attention to past work (strategic) experience of board members, empirical literature on this topic have been confined largely to the US. This study will, therefore, contribute to existing literature by looking at Dutch data and fill the gap existing literature has thus far overlooked. To further extend the contribution of this paper, the focus will also be on past strategic experience of board members rather than only their functional background.
This paper will continue, first of all, by presenting a literature review in section two. Herein, relevant literature and subsequent hypotheses are represented. This is followed by the methodology section wherein first the data is described followed by the empirical research design. Section four is devoted to presenting the results. Finally section five and six will discuss and conclude this thesis.
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2. Literature review: Theory and Hypotheses
This chapter reviews the literature and provides theoretical background relating to firm success, in particular TMT characteristics and firm performance. The theoretical background has been structured in the following sections: the first part will briefly describe the characteristics of TMT and its relation with firm performance. The second section will review relevant literature to date. Finally, this is followed by a section in which theoretical perspectives relating to boards’ impact on firm performance are presented and hypotheses are derived.
2.1. Literature review
2.1.1. Executive board
The influence of TMT on firm performance has been well researched. The seminal article introducing the Upper Echelons theory (Hambrick and Mason, 1984) has been a focal point since its publishing. The central premise of this paper is that organisational outcomes are a consequence of executive backgrounds. More precisely, the executives‘ actions, are driven by their own interpretations of the strategic situation. Furthermore, these interpretations are determined by mangers’ experiences, values, and personalities, reflected by observable characteristics such as age, educational background, organizational tenure, and so on (Hambrick and Mason, 1984; Hambrick, 2007). Basically, this defines the important role personal characteristics of individual TMT members have on firm outcomes.
It has thus been established that executives‘ characteristics determine their personal interpretation of situations, which in turn determine the way they respond to situations, which ultimately determine organisational outcomes. In short, corporate boards of directors play a central role in the performance of modern companies, and hence understanding this relationship is very important to our understanding of firm performance.
2.1.2. TMT Diversity and composition
According to Westphal and Milton (2000) boards have conventionally been viewed as a homogenous group of elites with similar socio- economic backgrounds, educational degrees and professional training (also known as homophily, or the law of homo- social reproduction (Boone et.al., 2004)). As a result, board members develop similar understandings about practices. Several authors (Carter et al, 2003; Singh and Vinnicombe, 2004) claim this unveils deficiencies in corporate governance.
A diverse board is said to positively affect company outcomes in a number of ways. A composition of (qualified) individuals who reflect diversity in gender, nationality and experience, can take advantage of their members‘ differences to efficiently work together to support the organisation. Therefore, boards are thought to be able to enhance both their team performance as well as their company‘s performance by diversifying their membership (Singh and Vinnicombe, 2004; van der Walt and Ingley, 2003).
However, the few existing studies provide mixed results as to whether board diversity has a positive or negative impact on firm level outcomes. This inconsistency of findings on the relationship between group diversity and organizational performance is partly due to the nature of the concept. Diversity may in fact be characterized as a double-edged sword that brings along both costs and benefits (Milliken and Martins, 1996; Williams and O’Reilly, 1998). On the one hand, diversity increases experience, expertise, creativity and innovation (Finkelstein and Hambrick, 1996; Carter et al., 2003). On the other hand, it might also induce conflict and disagreement.
It is a well-researched fact that diverse TMT, in more ways than one, have an advantage over homogenous boards when it comes to many company performance measures. For instance, Carter et. al., (2002) and Boone and Hendriks, (2009), find that a more diverse TMT leads to a wider variety of ideas, alternatives and solutions which improves the quality of decision- making.
8 et. al., 1989). Furthermore, as found by Wiersema and Bantel (1992), managers in the same
age category have similar values and experiences, so their behaviour is more similar to each other and will, therefore, communicate more easily. On the contrary, age heterogeneity is favoured as it includes members with different perspectives which will improve quality of decision- making, working efficiency and then lead to a higher team performance (Chatman and Flynn, 2001; Haleblian and Finkelstein, 1993; Wei and Wang, 2002).
Closely related age diversity is tenure diversity. Priem et. al., (1999) show that although homogeneous teams may have low levels of conflict and good communication, they lack broad perspectives and information sources. High diversity improves information gathering and interpretation of information, thereby, ensuring the quality of decision-making and promote the development of the organization (Dutton, 1987). Nevertheless, the greater the degree of tenure heterogeneity within a TMT, the less run-in time among team members which will affect the communication among team members, and could arouse conflict.
Finally, previous research on education show that TMT members of different educational backgrounds will help to improve the quality of decision-making, as they can analyse a complex issue from different angles (Amason and Sapienza, 1997; Zhang, 2006). On the other hand, education diversity can lead to conflicts. The greater the educational differences, the more prone the TMT becomes to conflicts when developing team strategy, strategic goals and strategic plans (Knight et al, 1999).
In addition to superior monitoring, outside directors represent a link to resource provides and an indication of a firms’ ability to access scarce resources (Boeker and Goodstein, 1991). Outside directors contribute significantly to strategic decision making through valuable insights from other industries and experiences (Carpenter and Westphal, 2001).
To conclude, as mentioned previously, diversity can be characterised as a double- edged sword. Homogeneity provides certain benefits, such as shared world views, and efficient decision making routines (Williams & O’Reilly, 1998). It also shows the commitment to the status quo and stability (Hambrick, 1994). However, diversity increases problem solving capabilities and can enhance the level of access to critical resources that are relevant to the organization. (Hillman and Dalziel, 2003; Pfeffer and Salancik, 1978). In addition, by bringing together a broader set of backgrounds who bring about varied ideas and intellect boards can improve firm competitiveness (Dalton et al., 1998; Hambrick, 1994)
2.1.3. Background and professional experience.
Often, when the composition of a group is studied, a diversity index is constructed that forms an overall classification of observable (age, experience, nationality) or non-observable (attitudes, values) attributes that are independent of each other (Millikin and Martins, 1996). Frequently, it is the observable attributes that are studied in this literature. Though the importance of non- observable attributes to diversity literature is acknowledged, the focus will be purely on observable characteristics of which substantial evidence has been generated that they are highly related to strategy and performance outcomes (Erhardt et al.; 2003; Hambrick, 2007; Millikin and Martins, 1996; Tacheva, 2007).
Research has made a distinction between two sets of observable variables. The first class is background characteristics which form the basis that describe board members’ backgrounds and demographics (age, education gender etc.) and is discussed in the previous section. The second class is experience variables which account for specific experience that board members have obtained throughout their careers such as company-, industry-, and international experience. This paper is only interested in the professional experience which reflect board members’ valuable sources of knowledge and expertise.
10 cultures different from the home country. As illustrated by Carpenter et. al., (2001)
international experience is positively related with firm performance as it has been shown that international assignment experience has a positive influence on managerial skills. Further, as Tacheva (2007) explains, managers with international experience have a better understanding of the complexity and dynamics of managing a firms’ operation. In addition, Sambharya (1996) found that executives international experience is positively related to internationalisation and that such experience would likely contribute to increased firm performance through management development and coordination. Internationally experienced TMT are believed to be able at coping with diverse cultural, institutional, and competitive environments and make strategic decisions that result in superior performance. (Gupta and Govindarajan, 2002).
Similarly, industry experience, increases the opportunity for boundary- spanning activities through industry specific knowledge, access to network contacts or organisations within the industry (Geletkanycz and Hambrick, 1997). Finally, research on company experience (Finkelstein and Hambrick, 1996), indicate that tenure within the present company will improve efficiency as members are familiar with the processes within the company and thus has a positive effect on firm performance.
2.2. Hypotheses
2.2.1. Company experience
Company experience, illustrates if executive board members have prior experience in the company in question before becoming part of its executive board. Members with prior company experience will have more knowledge of the processes within the companies itself which streamlines decision-making processes and could improve efficiency. In essence, members with prior experience will have been with the company longer and will therefore have a greater understanding of the inner workings of the company itself (Finkelstein and Hambrick, 1996).
However, more diversity (experience within multiple firms) will raise flexibility as it increases a company‘s access to valuable resources and becomes better equipped to deal with the higher management demands (Carter et al., 2003; Pfeffer and Salancik, 1978; Stiles and Taylor, 2001). In addition, board members with no experience to the focal firm can represent a link to external resources (Boeker and Goodstein, 1991). These directors can significantly contribute to decision making and firm success through their valuable insights from other companies (Carpenter and Westphal, 2001).
Of course, multiple company experience might have some drawbacks. For example, the fact that executives have a wide variety of experiences also implies that they have few deep allegiances. This could reduce the extent of their influence, making it difficult for them to secure support (Ouchi, 1980).
Alternatively, more experience within different companies can generate more alternatives to creatively solve complex problems, and ultimately increase the quality of decisions made (Carpenter et. al., 2004; Doz and Kosonen, 2007). Further, a wider range of experiences and perspectives could lead to better and more thorough evaluation of alternatives, thus increasing decision effectiveness (Smith et. al., 1994).
While there clearly is a case to be made for low company experience this might be accompanied by important costs. The more diverse the top management team in terms of company experience, the higher the risk of a dysfunctional conflict, and the lower the speed of decision making (Chatman and Flynn, 2001; Harrison et. al., 2002).
To sum up, ‘outsiders’2 may bring a broader cognitive map, while ‘insiders’ may have more specific knowledge about the inner workings of the company which may improve the
2
12 likelihood of firm success. However, longer company experience at one organization relates
to commitment to the status quo, which may affect the ability of the firm to change (Hambrick, et al., 1993).
Based on previous discussion, the following hypothesis is stated:
2.2.2. International experience
International experience is an element of the observable background characteristics in the upper echelons model. It could provide managers with inimitable knowledge, worldviews and professional ties which makes it a valuable asset (Athanassiou and Nigh, 1999). International experience not only entails knowledge and expertise about foreign markets and cultures but also psychological accompaniments in the form of values, cognitive beliefs and other personality traits. It is conceivable that an internationally experienced manager can embody foreign psychological characteristics after an international assignment in which foreign values and knowledge of other cultures are assimilated. Bringing this expertise to the board further diversifies the TMT and could thus benefit the firm. However, such experiences could be limited in time and scope (Caligiuri and DeSanto, 2001)
Not only through psychological characteristics but knowledge and skills obtained through international experience can also improve to information processing within the TMT (Sanders and Carpenter, 1998). Managers with international experience are accustomed with diverse cultural mindsets and could thus limit the potential problems when expanding abroad as they bring different values and particular knowledge about other cultures to the TMT.
The bulk of research on international experience, however, focuses on the effect it has on managerial ability to perceive opportunities and threats and future actions (Sambharya, 1996; Tihanyi et. al., 2000). International experience, is often positively associated with firm performance as international assignment experience has been shown to positively affects managerial skills in perceiving environmental opportunities and threats (Carpenter et al., 2001). As illustrated by Tacheva (2007), “top executives‘ with international experience are expected to have a better understanding of the complexity and dynamics of managing a firm‘s (international) operations”. Therefore, it does not only affect multinational firms but also domestic firm as managers are better capable of perceiving valuable opportunities. By the same token, international experience among TMT has been linked to firm’s effectiveness in operating in international markets (Carpenter et. al., 2001; Daily et. al., 2000; Tihanyi et. al., 2000).
14 As Reuber and Fischer (1997) state, decision- makers with more experience are more
likely to have first- hand experience with the advantages of operating in an international environment (e.g. foreign partnerships, networks) and have developed skills that are necessary in the competitive environment. In line with this, the international attributes can be perceived as firm- specific tacit knowledge and has been demonstrated to lead to higher firm performance. (Carpenter et. al, 2001; Daily et al., 2000)
This leads to the following hypothesis:
2.2.3. Industry experience
In the aftermath of the financial crisis, press, shareholders and corporate experts have expressed their concerns about the lack of sufficient industry experience within the board of directors. As Pozen (2010) puts forth, besides being faced with continuously changing competitive environment and insufficient time to devote to boards tasks, today’s boards frequently lack sufficient expertise in the relevant industry.
Unfortunately, empirical research on the relation between industry experience of TMT and firm performance is limited. Partially due to the absence of theoretical foundations, but also because experience can be difficult to proxy. An exception is Meyerink, et al. (2012). They find that when companies appoint a new director with experience in the appointing company’s industry they exhibit significantly higher returns than companies that appoint a new director without industry experience. However, they also state that the value of industry experience seems to depend on the function in which the director gained their industry experience. Experience as an outside director and experience as an employee without board seat are both not associated with significantly higher returns.
Apart from this specific research, the resource dependency theory offers some insight how industry experience might affect firm performance. Industry experience is expected to give board members increased opportunity for boundary-spanning activities through industry specific knowledge, expertise and access to external organizations or network contacts within the industry (Geletkanycz and Hambrick, 1997). These opportunities, if an when capitalised, in turn influence firm performance. Furthermore, within certain industries, knowledge of the specific industry is a pre-requisite. For instance, complex banking regulations require bank executives to have significant banking experience (DiMaggio and Powell, 1983)
16 avoid routine planning patterns (Bantel, 1993). Furthermore, firms with inferior performance
often seek directors with a different background and perspective from outside the industry (Datta and Guthrie, 1994).
In conclusion, directors with lower industry experience may bring a fresh perspective to the organizations’ environment and threats, while insiders may have industry-specific knowledge which improve the likelihood of firm success.
As a result, it is argued that:
2.2.4. Strategic experience
Although board studies have consistently isolated several important factors relating to boards (e.g. size, education, tenure, composition), only few studies have looked at the board’s specific experience with a particular strategy (in the case of this study, Merger and Acquisition, and Reorganisation- strategy). For instance Kroll et. al., (2008), found that acquiring firms accumulate significant performance benefits as a result of having boards comprised of members with strategy- specific experience. Additionally, the study of McDonald et. al., (2008) show that “outside” director experience was positively related to firm-level performance outcomes after a strategic change especially when the specific expertise and experience of the board was closely aligned with the strategy change being pursued.
General research, apart from these two studies, on strategic experience of board members influence on firm performance is virtually non- existent or, at best, limited. There is, however, research on how CEO past strategic experience could influence firm performance (Giambatista et. al., 2005). However, this research only looks into strategic change in the period directly following a change in the top management. Some research, however, support the contention that strategic changes that occur following a succession are ascribable to the experience of the directors on the board and not necessarily to the experiences of the CEO (Westphal and Fredrickson, 2001). Therefore, as the composition and experience of the board changes over time, strategic changes that occur in a firm during a period of CEO stability could be affected by the changing nature and experiences of the board with specific strategies. Furthermore, as Hambrick and Mason (1984) argued, how executives perceive their experiences influences future strategic choices.
Having established the importance of directors strategic experience, in what follows, psychological literature on expertise is used to develop a theoretical framework. This literature is used to argument that firm will have higher performance to the extent that a firms’ directors have experience with, and resulting knowledge and expertise in certain strategies. In light of this paper, specifically, Merger and Acquisition strategy experience and Reorganisation experience. 3
18 Theory on solution strategy states that when faced with challenges people apply
analogical reasoning, which involves referencing specific prior challenges that they have faced, to identify effective solutions to current problems and avoid ineffective ones (Anderson et. al., 1997).
Furthermore, theories on strategic decision making suggest that strategic choices are subject to personal background and prior experience of directors. As previously introduced, the upper echelons theory states that decisions are made under conditions of information overload, limited time, and ambiguity. Drawing from behavioral theory (Cyert and March, 1963), Hambrick and Mason (1984) argued that executives cope with the inherent complexity of strategic decision making by referring to their pre-existing beliefs about strategic behavior, and that these values are formed by prior experience in similar roles. In addition, as Sternberg (1997) contends, these executives are better capable to separate important from unimportant information.
More interestingly, is that experts are more adept at employing analogical reasoning to help them arrive at quality solutions and avoid the ones that are most likely to fail (Reeves and Weisberg, 1994). The basic premise of analogical reasoning is that decision makers to draw comparison between current challenges and specific example problems that they have been exposed to in the past (Thompson et. al., 2000). Prior experience is a key source of expert knowledge, as problems faced in the past will help them quickly identify effective solutions to similar current challenges (Ericsson and Charness, 1994).
Nonetheless, the advantages of experience and use of analogical reasoning should help directors with relatively high levels of expertise (experience) in making strategic decisions more effectively and thus influence firm performance.
As a result, the following hypothesis is offered:
Hypothesis 4: There will be a positive relationship between strategic experience of the TMT and firm performance.
In order to make this relation more suitable to be investigated, this study will focus on the Merger and Acquisition experience, and Reorganisation experience.
Therefore, hypothesis four can be separated in the following two hypotheses:
Hypothesis 4a: There will be a positive relationship between strategic experience with Mergers and Acquisitions of the TMT and firm performance.
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3. Research Methodology and Data
3.1. Sample Data and collection
The initial data sample for this study consisted of 107 stock- listed Dutch companies and their respective board members for the period 2002 – 2006 and was hand- collected.4 Data was collected on board members background, but also firm level data such as employees, assets and return on Assets. There were a number of companies that were eliminated from this group for several reasons. First of all, companies that had missing data on earnings, and operating income, for at least two years. during this period were neglected, 26 in total. Furthermore, companies that ceased to exist in their past state, either due to bankruptcy or a merger, were also eliminated, Eliminating all firms that ceased to exist could bias the results, however, these firms could be subject to complete management overhauls and were therefore excluded. This resulted in 64 firm observations. Finally, companies which lacked adequate information on at least four members of the executive board were excluded from the data set as well. This left a final sample of 56 companies, and generated 219 observations on executive board members. Please see appendix three for all the data.
3.2. Data sources
The data on board members stem from sources of secondary data. The majority of data on is taken from annual reports. These annual reports are available on the company websites and other sources such as LexisNexis. Further information on executives is taken from sources as Reach, personal websites and newspapers articles. From the Amadeus data set I obtain the variable that measures firm performance ROA. Furthermore, Amadeus was used for the determination of the firm-level control variable firm age and firm size. Finally, the Zephyr database offers information on the Mergers and Acquisitions made by each firm. It should be taken into account that my data sources are heterogeneous. While it could be argued that multiple sources strengthen the research, multiple data sources can lead to discrepancies and bias the outcome of the study, as each source has different recording standards. Furthermore, the use of personal websites has its risks. For instance, a distinguished board members could indicate that he/ she has worked within a certain organisation while in fact he/ she was merely a consultant.
3.3. The variables
3.3.1. Dependent variable
The quantitative empirical investigation of the impact of board characteristics on firm performance requires a thoughtful practical use of a proper performance indicator. Nonetheless, the issue how firm performance can be defined is a debate among researchers. In general, performance indicators that were used in prior research can be differentiated into accounting based- and market based measures (van Ees et al., 2003). The first group comprises return on investment (ROI), return on assets (ROA), return on equity (ROE), return on invested capital (ROIC) and net profit margin (Bauer et al., 2004). The latter group consists of earnings per share (EPS) and Tobin’s Q.
It should be noted, that the reliability of all these indicators have been criticised by many scholars. Kapopoulos and Lazaretou (2007) argue market based measures as influenced by shareholders psychological perception and thus by future events. Conversely, country based accounting standards influence accounting based measures. The accounting based measures return on Assets (ROA) is used in this thesis as performance indicator. The advantage of using ROA, is that it gives investors an idea of how effectively the company is converting the money it has to invest into net income. The higher the ROA number, the better, because the company is earning more money on less investment.
3.3.2. Independent variables
The main independent variables included in this thesis are industry experience, international experience, current company experience and strategy experience. For strategy experience, the focus will be on experience with Restructuring and Mergers and Acquisition as these are directly influenced by the executive board.5
Restructuring is defined as: “a significant modification made to the debt, operations or structure of the company” (Gilson, 2010). For the purpose of this study, I will investigate whether the board members have experienced such actions. However, the problem lies in finding the right operationalization of the variable. One measure is counting the number of actions and deciding on a cut- off point. When the number exceeds this point, a company has experienced some kind of restructuring (Denis and Kruse, 2000) and therefore, the board
22 member has experience with this kind of strategic actions. The problem with this measure is
that even small changes in the structure of the company are taken into account and therefore might inflate the results. Another measure is to check the press releases of the firm itself and whether the firm has been cited in national newspapers. For lack of a proper instrument, in this thesis I will combine both measures by reporting data on the frequency of restructuring events occurring at the firms. Data will be collected for the period 1997 until 2002 on the instances a firm has made cut- back-, lay-off- and demerger announcements.6
The second measure of strategy experience is merger and acquisition activity. Instead of relying on newspapers, the Zephyr database offers information about the merger and acquisitions made by the firm in which board members were active in the period 1997 till 2002. If the firm has experienced merger and or acquisition activity the board member will consequently have experience in these activities. Further explanation on the operationalization of these variables and the industry-, international-, and company experience can be read in section 3.5.2.
3.4. The model
Based on the theoretical considerations and previous literature I set up the following empirical model. The method utilised in previous literature analysing the influence of management board experience on firm performance applies a linear regression of the following form:
Firm performance it = α + β1X1it + β2X2 it + γ1Control + εit Where X is some measure of experience.
For this paper, a similar regression will be used. After inserting the variables I obtain:
ROAi = α + β1COMPEXPPRE97i + β2COMPEXPi + β3 INTEXPPRE97i+ β4 INTEXPi + β5 INDEXPEMPLi + β6INDEXPBOARDi + β7STRATEXP1EMPLi + β8STRATEXP1BOARDi + β9 STRATEXP2EMPLi + β10 STRATEXP2i + γ1FSIZEi + γ2AGEi + γ3BOARDSIZE + εt
Here, α is the intercept which is unknown (i.e. constant), β1,2…n designates the unknown parameter for the specific management board variable, γ1,2…n designates the unknown parameter for the specific control variables (firm size, board member age, and board size), εt is a standard error term and ‘i’ denotes each of the individual companies separately.7 For the designation of the dependent and independent variables please see table I, a full explanation of each variable can be read in section 3.5.2.
First, each independent variable will be regressed against the dependent variable ROA. Subsequent models will include the other independent variables to check whether the resulting sign (positive or negative) still holds and whether the level of significance changes.
7
In order to calculate the TMT experience of each company a weighted average of the experience is calculated using ̅ = ∑
24 Table 1: Variables and operationalization
Variables Operationalization of the variable
Return on Assets (ROA) Operative income/ Assets
Management board company experience pre 97 (compexppre97)
Board member has prior experience within the same company (in the period pre 1997)
Management board company experience (compexp)
Board member has prior experience within the same company (for the period 1997 - 2002)
Management board international experience (intexppre97)
Board member has experience abroad; lived/worked in country other than his home country (in the period pre 1997)
Management board international experience (intexp)
Board member has experience abroad; lived/worked in country other than his home country (for the period 1997 - 2002)
Management board industry experience (indexpempl)
Board member has prior experience within the same industry the company in question is part of as an employee (for the period 1997 - 2002)
Management board industry experience (indexpboad)
Board member has prior experience within the same industry the company in question is part of as member of the board of directors (for the period 1997 - 2002)
Management Strategy Experience (STRATEXP1EMPL)
Board member has prior experience with M&A activity as an employee within his/ her previous company (for the period 1997- 2002)
Management Strategy Experience (STRATEXP1BOAD)
Board member has prior experience with M&A activity as member of the board of directors (for the period 1997- 2002) Management Strategy Experience
(STRATEXP2EMPL)
Board member has prior experience with Reorganisation activity as an employee within his/ her previous company (for the period 1997- 2002)
Management Strategy Experience (STRATEXP2BOARD)
Board member has prior experience with Reorganisation activity as member of the board of directors (for the period 1997- 2002)
Firm size (FSIZE) Natural logarithm of total assets
Age Age of the specific board member
Board Size (BOARDSIZE) Total number of supervisory and executive
3.5. Explanation of data and variables
The method of multiple regression, precisely ordinary least squares (OLS) is used to test the set of hypothesis. This section introduces the operationalization and measurement of the dependent variable, independent variables and control variables.
3.5.1. Dependent variable
As mentioned previously, ROA is used as performance measure. For the period 2002 until 2006 I have collected data on this variable for all firms. Analysing this data shows little variance in ROA for each firm in this period. Therefore, I have constructed an average for each firm and this will be used as dependent variable.
3.5.2. Independent variable
For an exact stipulation of the below developed variables please see Appendix Three. Industry experience: for the period 1997 – 2002, I will investigate whether each TMT member has worked within the same industry as the firm he/ she is currently employed at. For a board member to have sufficient experience, he/ she has to a least have worked for two years within the same industry. For this variable a dummy will be constructed, a -one‘ distinguished board members with prior experience (i.e. at least two years) in the same industry sector in which he/she currently operates and a -zero‘ if otherwise. 8
International experience: a distinction is made between board members that had fulfilled international assignments or had full-time work experience in a country different to their home country, denoted with a -one‘, and those that had spent their entire career in home country, denoted with a -zero‘. In line with the research of Gregersen et. al., (1998) for a board member to have adequate experience he/ she has to have worked at least one year in a country different to their home country in the period 1997 – 2002.
Company experience: is denoted a ‘one’ for those with a prior commitment to the same company and a ‘zero’ if otherwise. For this variable, the period 1997 until 2002 is investigated. However, contrary to the previous variables, a board member has company experience if he/she has worked at least one year at the present company.
8
26 Strategic experience1: a dummy variable will be constructed and denoted ‘one’ if board
members had prior experience in merger and acquisition activity in companies other than the current firm and ‘zero’ if not for the period 1997- 2002. For this variable to accurately reflect the experience of a board member with these types of strategic activities a ‘one’ will only be denoted if the distinguished board member was in the board a directors at the time of the activity. 9
Strategic experience2: a dummy variable will be constructed and denoted ‘one’ if board members had prior experience in restructuring activity in companies other than the current firm and ‘zero’ if not for the period 1997- 2002. For this variable to accurately reflect the experience of a board member with these types of strategic activities a ‘one’ will only be denoted if the distinguished board member was in the board a directors at the time of the activity. 10
3.5.3. Control variables: firm- level variables
Based on prior literature (Hermalin and Weisbach, 2010; Joh, 2003), control variables on firm size and executive age were added to the model. Holding firm size and the age of board members constant could remove the positive impact larger firms and board members have on firm performance. Previous literature, (Singh and Davidson, 2003) shows that larger firm have more slack resources and more funds available and at the same time are more bureaucratic, both of which could be reflected in performance. Therefore, firm size, was included as a control and was measured as the log of total assets.
Furthermore, with age comes experience. Therefore, younger members of the board are assumed to generate lower earning than more experienced (older) board members. Opposing this view, older board members may be more inert to change which could lead to lower earnings and profits for the firm.
9/10
3.6. Multicollinearity
Before running the regressions, the problem of multicollinearity (correlation among independent variables) needs to be tackled. In order to assess the possibility of multicollinearity a ‘Pearson Correlation test’ is performed. There is a perfect correlation if the coefficient between two variables is |1|. However, if a correlation coefficient matrix demonstrates correlations higher than |0.7| (Pallant, 2007) there might be multicollinearity and one variables could provide redundant information.11 The resulting correlation matrix can be found in Appendix one. Table B (Appendix one) indicates that the measures of number of M&A, known M&A, Volume, and MAexp show high correlations to one another and to the Stratexpboard, Stratexpempl variables. This is not surprising as all variables are quantify the same phenomenon and are computed from one another (e.g. Volume = the value of the known M&A). Therefore, as a measure of Merger and Acquisition experience only the experience as board member and employee is used. The correlation on all other variables can be found in Appendix one (table C).
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4. Empirical results and analysis
4.1. Descriptive Statistics
Appendix one provides descriptive statistics and correlation for all variables used in this research. With respect to financial performance, on average the sample firms have a positive ROA (5,65 percent). However, the least performing companies in these 5 years have a ROA of minus 18,2 percent, while the top performing companies, on average, present a ROA of 15,5 percent. Furthermore, an average board entails approximately 11 members and has an average age of 49 years. As data shows, on almost all experience variables at least half of the board members has some experience with the exception of the strategic experience which ranges from a quarter to one third.
4.1.1. Industry Descriptives
Table two: Industry Dispersion
GICS- Code12 Industry Sector # Firms # Board members 10 & 15 Energy & Materials 7 26
Oil/ Petroleum Chemicals Steel 1 5 1 3 20 3 20 Industrials 14 47 Construction Electronics Engineering Logistics 3 3 4 4 10 10 12 15 25 Consumer Discretionary 10 38 Media Services 3 7 14 24 30 Consumer Staples 13 53 Consumption Retail 7 6 31 22 35 Health Care 2 6 Pharmaceuticals 2 6 40 Financials 8 36 Financial 8 36
45 & 50 Information Technology 3 13 IT Telecommunications 1 2 4 9 Total 56 219
Table three shows the average board size, company size in terms of employees and total assets across all industry sectors.
Table three: Average board size, company size and total assets
Industry Sector Board
Size
Employees Total Assets (log)
Energy & Materials 3,71 53321,23 7,29
Industrials 3,36 32294,77 6,29 Consumer Discretionary 3,80 43460,23 6,12 Consumer Staples 4,08 46124,55 6,46 Health Care 3 3021,3 5,45 Financials 4,50 36894,88 7,96 Information Technology 4,33 18616,53 6,58
It seems that on average most boards in all sectors have 3 to 4 executive board members. The largest and smallest boards are found in the Financials and Health Care sector respectively. In contrast, the number of employees is by far the largest in the Energy and Materials sector which in terms of board size is comparable to the Industrials sector but has
30 over 50 percent more employees. Apparently, the board size is not a reflection of the
companies size in terms of employees. Board size does seem to signify the complexity of the environment. The companies with the most complexity (highest total assets) are found in the sectors which the largest boards.
4.1.2. TMT member background and professional experience
In table four, the background characteristics and professional experience are given. Table four: Background characteristics and professional experiences
Background
Mean Nationality DB 0,47
Education DB 0,42
Professional Experience
Mean Min Max Std. Dev.
Company E. 0.66 0 1 0.47 International E. 0.56 0 1 0.49 Industry E. Board 0.53 0 1 0.49 Industry E. Empl 0.78 0 1 0.41 Stratexp1board 0.36 0 1 0.48 Stratexp1empl 0.27 0 1 0.44 Stratexp2board 0.32 0 1 0.47 Stratexp2empl 0.26 0 1 0.44
B – Blau Index: Blau = [1- Σ (p i2)]
Starting with nationality diversity, an 0.47 in terms of Blau indices13 indicates moderate differences in nationality. This value is mainly due to the factor that of the 219 board members 157 are Dutch (≈72%). Second and third are Belgians and Americans with, respectively 14 and 13 board members. Diversity with respect to educational level is also moderate at 0.42. Of the 219 board members 163 (≈74%) have a master title. These two results indicate that the notion of homophily is not as present for Dutch firms as indicated by for instance Claessens et. al., (2000).
Continuing with the professional experience, for international experience, the executive board scored 56%, which indicates that just over half of all current board executive board members have worked at least two years within a foreign environment. In terms of prior experience in the industry as an employee the executives scored a surprising 78% versus 53% as a board members. More interestingly, however, is the company experience. 66% of all
current board members had at least two years of prior experience within the current company. This could indicate that many executives have worked their way up the corporate ladder.
4.2. Empirical results
A summary of the regression results is reported in table five, where each column denotes a separate hypothesis. The final column shows all variables including the control variables. The complete regressions can be found separately in Appendix two.
Table five: Regression results.
Dependent Variable: ROA Independent
Variables
Expected
sign Model 1 Model 2 Model 3 Model 4a Model 4b Model 5
1. Constant None 0.0110951 0.0073775 0.0005143 -0.0025068 0.0109464 -0.0683 2. Age + 0.0005973 0.0005613 0.0008044 0.0005077 0.0005205 0.0007 3. Firm Size - 0.0047653 0.0031312 0.0038089 0.0038640 0.0035892 0.0032 4. Board Size - -0.0010800 -0.0010016 -0.0007409 0.0005077 -0.0009849 -0.0006 5. Compexppre + 0.0283022 *** 0.0347 *** 6. Compexp + -0.0271230 *** -0.0237 ** 7. Intexppre + 0.0062440 0.0082 8. Intexp + 0.0089076 0.1255 9. IndexpB + -0.0161568 * -0.0180 * 10. IndexpE + 0.0060663 0.0028 11. Stratexp1B + 0.0146164 0.0198 12. Stratexp1E + 0.0159790 0.0074 13. Stratexp2B + 0.0048794 0.0004 14. Stratexp2E + 0.0080838 0.0014 R-squared 0.0538 0.0183 0.0229 0.0227 0.0112 0.1016 Adj R-squared 0.0315 -0.0058 0.01 -0.0002 -0.012 0.0417
Hypothesis one predicted a positive relationship between the company experience of board members and firm performance. The results show company experience to have a mixed, yet, significant influence on firm performance. Further, even after including all other variables, and controlling for age and size, the findings remain significant. Interestingly, however, is the negative sign of company experience during the period 1997 until 2002. As stated earlier, members with prior experience are expected to have a greater understanding of the inner workings of the company itself, which improves efficiency. This notion seems to be supported for the period pre 1997 but not for the years just preceding becoming part of the executive board. Alternatively, one could say that experience in preceding years close to becoming part of the board enforces commitment to the status quo which may affect the ability of the firm to change (Hambrick, et al., 1993). Moreover, these results might confirm the findings from Carter et. al., (2003) and Pfeffer and Salancik (1978) who state that more company experience increases access to valuable external sources.
The second hypothesis predicted international experience to have a positive effect on firm performance. As the findings presented in table five show, international experience is not associated with firm performance with- and without control effects. It seems that the relationship found by Bloodgood et. al., (1995) who find that international experience of the top management team is related to greater internationalisation of the firm which positively affects firm performance, is not supported. One explanation could be the fact that the companies in this data sample did not show increased internationalisation during the period 2002- 2006. In addition, this insignificant relation could indicate international experience has become a common resource in today’s business and therefore not contributing to firm performance.
34 only a single industry narrows the perspective of board members and limits their strategic
choices as proposed by Walsh (1988) and Wiersema and Bantel (1992)
5. Discussion and Conclusion
In an attempt at explaining the influence of executive board members on firm performance, this paper hypothesised about different work experience factors influencing current firm performance. This link was tested by setting firm performance as outcome of a board members’ experience, international-, industry-, company-, and strategic (M&A, and Reorganisation). By taking an interest in the executive board rather than the supervisory board and focussing on the possibility of strategic experience to influence firm performance, this paper stepped away from the more traditional research that has dominated this field. Using cross- sectional data on 56 listed Dutch companies and their 219 executive board members this research found some interesting results.
First of all, we would expect company experience to have a significant positive effect on firm performance. Board members with prior company experience are believed to have more knowledge of the processes within the company which could improve efficiency. Indeed, a positive significant relation was found if a board member had experience within the current company preceding becoming part of the executive board. However, this only held for the period preceding 1997. Results on company experience in the 5 years preceding entrance to the board indicate a negative significant relation. An explanation for this could be that experience in preceding years close to becoming part of the board enforces commitment to the status quo which may affect the ability of the firm to change (Hambrick, et al., 1993). As predicted by Carter et. al., (2002), ‘outside’ directors bring in a new perspective and increases companies access to valuable resources. Deeper analysis of these results show that for every industry, except Consumer Discretionary, this relation holds. This would indicate that companies should actively promote their employees to work their way up the corporate ladder, but also allow these managers to gain experience in different companies if they turn out to be valuable assets. On the other hand, these result support the view that ‘outside’ directors bring in a fresh perspective, are able to break the inertial forces and bring the company to a higher level.
36 board members international experience and firm performance. However, these findings were
not significant. Interestingly however, a negative (though insignificant) coefficient was found for the Financials sector. A possible explanation could be that certain banking regulations are country specific and therefore, it would take time to get accustomed with these rules and regulations. International experience would thus have a negative impact compared to having worked within the same environment previously. On the other hand, international experience is found to have a significant positive effect in the Consumer Discretionary sector. This is not surprising as the nature of this industry is internationally oriented. Finally, not finding a significant relation for all industries could indicate that international experience has become a common resource in today’s business and therefore does not, significantly, contribute to firm performance as proposed by Tacheva (2007).
The third hypothesis stipulated that board members with industry experience are expected to give board members increased opportunity for boundary-spanning activities and access to external organisations within the industry (Geletkanycz and Hambrick, 1997) and thus positively affect firm performance. Critical in examining the impact of industry experience is the function in which current board members have obtained their industry experience. As stated by Meyerink et. al., (2012), the value of industry experience depends on whether this experience was gained as an employee or as a member of the board of director. Empirical results show that over 50 per cent of all current board members have experience within the industry they are currently working. Therefore, this result does not confirm the findings from Pozen (2010), who state that current US board members lacks sufficient industry expertise. However, contradicting literature (Meyerink et. al., 2012), a negative, significant relation was found, but only, if the significance level was raised to 10 per cent. Nevertheless, this does show some support for the research of Wiersema and Bantel (1992) who found longer single industry experience to be negatively correlated with strategic change.
Finally, hypothesis four predicted a positive relationship between a board members experience with Mergers and Acquisitions and/ or Reorganisation and firm performance. As discussed previously, literature clearly indicates the importance of directors strategic experience instead of exclusively relying on the experience of the CEO (Giambatista et. al., 2005; Westphal and Fredrickson, 2001). As expected a positive association was found, however, insignificant. Remarkably, strategic experience with M&A has a negative coefficient for the Consumer and Staples sector and a positive significant coefficient if a board members has gained experience as a board member with Reorganisations. This final thought could be due to the nature of this industry which is characterised by many reorganisations. See for instance how the competitive landscape of the retail industry changed during the period 2002– 2006. Increased competition, price wars and resulting cut backs.
In conclusion, this research does not confirm the study of McDonald et. al., (2008) that director experience is positively related to firm-level performance outcomes. It appears experience with Mergers and Acquisitions and/ or Reorganisations do not benefit the board, and hence do not positively affect firm performance. This could point toward the notion that expertise tends to be specific and relatively narrow. Experience with M&A and/ or Reorganisations within one industry (company) cannot be easily transferred to other industries (companies)
38
6. Limitation and future research
As with other empirical studies the findings presented in this thesis are subject to some limitations that should be taken into account. First, the data is limited to Dutch corporations only. Regardless transfer of these findings to other countries is not possible, which restricts the validity of the results. Nevertheless, it does give an inside in whether results on US- data also holds for the Netherlands. Second, only a limited number of variables are taken into account in this study. Future empirical study should take more or other variables into account in order to increase the explanatory power. Future research may also improve the explanatory power by increasing the number of firms in the sample. I acknowledge that my sample is quite small due to the amount of information available on Dutch firms, expanding research to more firms or other European countries could be effective. Deeper analysis could unveil interesting perspectives. Furthermore, firm level data in this thesis were averaged for the investigated period. Recording data over several years will add an element of change to the equation and could change the outcomes.
Finally, only observable traits of board members were included. This paper did not allow for non- observable traits such as skills, attitudes and/ or values. Perhaps board are, in effect, more diverse than one would believe.
Future investigation on this topic should take these limitations into account and follow the research into the influence of the management board on firm performance. Unfortunately, there are only a few countries which have a clear two tier system with separation of executive- and supervisory board however, for other countries similar research can be done. As well as expanding research to different countries, future research may want to include complex dynamics such as the distribution of power within the board (theory of fault lines) and the effect of team roles.
40
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