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Making incentives worthwhile - The

impact of top management team alignment

and diversity on organizational

ambidexterity

By

Lois Greving S2724510

L.Greving@student.rug.nl

Master’s thesis, MSc Business Administration: Change Management January 21st, 2019

Supervisor: Prof. Dr. J.D.R. Oehmichen Co-assessor: Drs. H.P. van Peet

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Abstract

Little is known about how top management teams` (TMTs) compensation can be used to foster organizational ambidexterity. Using data from two different databases, the present study empirically investigated this theoretical gap. To accomplish this, it utilized executive compensation to create the constructs of external and internal TMT alignment. This study incorporated a sample of 277 US firms and applied a hierarchical regression analysis to determine if external and internal TMT alignment can foster organizational ambidexterity. This research found that external TMT alignment has a negative influence on organizational ambidexterity. Further, TMT diversity positively moderates the relationship between external TMT alignment and organizational ambidexterity. Finally, internal TMT alignment has no significant impact on organizational ambidexterity. Drawing on research in the areas of agency and behavioral integration theory, compensation, and organizational ambidexterity it became clear that many factors influence organizational ambidexterity. This study provides a first peek into the complex nature that surrounds the interrelationship between executive compensation, TMT alignment, and organizational ambidexterity and paves the way for future research in this area.

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Table of Contents

1. Introduction ... 3

2. Theoretical Background and Hypotheses Building ... 5

2.1. Agency Theory ... 6

2.2. Behavioral Integration Theory ... 6

2.3. Organizational Ambidexterity ... 8

2.4. TMT Compensation ... 9

2.5. External TMT Alignment and Organizational Ambidexterity ... 10

2.6. Internal TMT Alignment and Organizational Ambidexterity ... 11

2.7. The Moderating Role of TMT Diversity ... 13

3. Methodology... 14

3.1. Sample and Data Collection ... 14

4. Analysis ... 18 5. Results ... 19 5.1. Descriptive Statistics ... 19 5.2. Preliminary Analysis ... 21 5.3. Hypotheses Testing ... 22 5.4. Robustness Check ... 25

6. Discussion and Conclusion ... 26

6.1. Limitations and Future Research ... 28

6.2. Theoretical Contributions... 29

6.3. Practical Implications ... 30

7. References ... 31

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1. Introduction

Andrew Carnegie once said "Teamwork is the ability to work together toward a common vision. The ability to direct individual accomplishments toward organizational objectives. It is the fuel that allows common people to attain uncommon results" (Mercer & Myers, 2013, p. 2).

Many organizations fail to attain the right balance of organizational ambidexterity, since it requires pursuing opposing strategies that compete for scarce resources (Lubatkin, Simsek, Ling, & Veiga, 2006; March, 1991). Previous research investigated how to achieve a balance between exploration and exploitation strategies. These approaches include: providing a supportive organizational context (Gibson & Birkinshaw, 2004), establishing an organizational culture that endorses flexibility and control simultaneously (Bueschgens, Bausch, & Balkin, 2010; Khazanchi, Lewis, & Boyer, 2007) or moving the locus of innovation to open communities instead of keeping it inside the firm (Benner & Tushman, 2013). Even though, some scholars (e.g. Lubatkin, Simsek, Ling, & Veiga, 2006; Carpenter & Sanders, 2002) have touched upon the topics of executive alignment, executive compensation and organizational ambidexterity, little is known about how the interplay between the first two factors can lead to the appropriate balance of organizational ambidexterity.

For instance, despite the fact, that the importance of a team has been stated so clearly by Andrew Carnegie, research on the alignment of a top management team (TMT) is scarce. While literature is abundant on CEO compensation, research on TMT compensation is rare (Carpenter & Sanders, 2002). One reason for this may be the implicit assumption that CEO and TMT compensation are correlated, due to similar pay determinants, including firm and industry characteristics (Carpenter & Sanders, 2002). Nevertheless, scholars (Henderson & Fredrickson, 2001; Finkelstein & Hambrick, 1996) found that executive pay is rarely the same, due to distinctive roles and areas of expertise as well as using compensation gaps as a motivator for top managers (Carpenter & Sanders, 2002). Focusing on TMTs is crucial since the executive level of a firm makes the strategic choices concerning the future well-being of a company (Talke, Salomo, & Kock, 2011).

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integration of a TMT. An underlying reason for establishing internal alignment is the increased perception of fairness when offering pay equity (Kim & Mauborgne, 1996), since this might positively influence TMT behavioral integration, which eventually reduces the agency problem (Carpenter & Sanders, 2002).

From a resource-based view, aligned and integrated teams are rare, valuable and difficult to imitate and therefore provide an organization with a competitive advantage, which can be used to enhance a firm’s performance (Hambrick, 1995; Barney, 1991). In addition, in order to improve performance, it is necessary to streamline existing activities and explore new business opportunities (De Clercq, Thongpapanl, & Dimov, 2014). This challenge is referred to as ‘organizational ambidexterity’. Many scholars have shown an interest in organizational ambidexterity (e.g. Swift, 2016; García-Lillo, Úbeda-García, & Marco-Lajara, 2016; Jansen, Van Den Bosch, & Volberda, 2006). O'Reilly & Tushman (2013), define organizational ambidexterity as the ability to explore and exploit simultaneously. This capability is crucial since, companies need to constantly evolve to be one step ahead of the competition (Sheetrit, 2017). However, achieving organizational ambidexterity is a perplex undertaking, as the right balance between exploration and exploitation is hard to attain (Simsek, 2009). The main reason for this are the contradicting activities necessary to attain both innovation strategies, due to exploitation pursuing short-term and exploration pursuing long-term goals (Raisch & Birkinshaw, 2008). Focusing too much on exploitation may lead to a ‘competency trap’ because of firms reacting inefficiently to environmental changes (Ahuja & Lampert, 2001). On the contrary, focusing too much on exploration can trap a firm in a constant process of renewing its knowledge base without accomplishing any rewards (Volberda & Lewin, 2003). Nevertheless, the pursuit of organizational ambidexterity is worthwhile, since it offers many benefits to a firm, such as being innovative and efficient simultaneously (Simsek, 2009) or an increased firm performance (O'Reilly & Tushman, 2013).

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The goal of this study is to understand the relationship between executive compensation, external and internal TMT alignment, and organizational ambidexterity. Consequently, this paper aims at offering a more concrete, practical insight on how to achieve the right balance between exploration and exploitation, which is missing so far.

This thesis contributes to the current research stream in several ways. First, it attempts to extend the knowledge on the organizational ambidexterity and TMT research stream by empirically examining how TMT alignment and compensation can enhance organizational ambidexterity. Second, it attempts to contribute to agency and behavioral integration theory by linking both theories to organizational ambidexterity. Linking the different concepts will provide a deeper insight into how executive compensation, TMT alignment, and organizational ambidexterity fit in these two research streams. Third, it shows how TMT diversity moderates the relationship between internal, as well as external, TMT alignment and organizational ambidexterity. Accordingly, the following research question has been established:

RQ: How does the alignment of top management team compensation influence the degree of organizational ambidexterity?

To the best of the author’s knowledge, no prior study exists that investigates the interplay of the three factors executive compensation, TMT alignment, and organizational ambidexterity. Therefore, this study is a significant and essential extension to the current literature, since it provides a more practical approach to the topic and attempts to fill this literature gap.

In the following sections existing literature will be analyzed, which functions as the theoretical foundation for this study and the creation of hypotheses. Next, the research methods will be explained, followed by an assessment of the empirical findings. Then the results will be discussed, and the paper will conclude by debating implications, limitations, and possibilities for future research.

2. Theoretical Background and Hypotheses Building

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2.1. Agency Theory

Most companies, analyzed in this study, have a separated ownership and control structure, meaning that the executives that manage the companies are not the owners of the company. This separated structure is key to agency theory, which makes a distinction between the principal, for instance, the owner of a firm (i.e. shareholders) and the agent, who manages the firm (i.e. executives) (Jensen & Meckling, 1976). The principal and agent engage in a relationship where the agent performs specific tasks on behalf of the principal, which includes assigning decision-making authority to the agent (Jensen & Meckling, 1976). However, this ‘contracting’ does not come without problems. One of the fundamental problems within agency theory are so-called ‘agency costs’, which occur due to the agent not acting in the interest of the principal and therefore requiring monitoring activities (Tosi Jr & Gomez-Mejia, 1989). The issue of diverging interests surfaces when the interests of the principal (i.e. shareholders) and those of the agent (i.e. manager) conflict and the agent rather acts upon his interests than that of the principal. Moreover, it is challenging for the principal to monitor what the agent is doing, due to information asymmetry (Eisenhardt, 1989). The phenomenon of information asymmetry derives from two factors. Namely, agents controlling organizational resources and knowing more about the tasks they need to perform in order to maximize value than the principal does (Pratt & Zeckhauser, 1985; Tosi Jr & Gomez-Mejia, 1989).

Another fundamental problem that arises in agency theory is the notion of risk sharing. Risk sharing arises because the principal and agent have different attitudes towards risk and consequently prefer pursuing different actions when coping with risk (Eisenhardt, 1989). Research generally assumes, that an agent is more risk-averse, due to his or her inability of employment diversification. Whereas, a principal can diversify his or her investments into different opportunities and should, therefore, be risk neutral (Eisenhardt, 1989).

It is appropriate to use agency theory as theoretical lens since it provides a “unique, realistic, and empirically testable perspective on problems of cooperative effort” (Eisenhardt, 1989, p. 72) and the concept of external alignment fits perfectly into it. Nevertheless, it is a simplistic conceptualization of the manager-shareholder relationship and ignores other aspects that are important for decision making (Ogden, 1993). One of these aspects is the behavioral characteristic of teamwork, hence behavioral integration theory will be applied as a second theoretical lens.

2.2. Behavioral Integration Theory

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complexity, and a firm’s general pay practices (Carpenter & Sanders, 2002). Nevertheless, studies have shown that multiple factors exist that acknowledge the prevailing pay differences, such as performance-based pay or using pay as a motivator (Hayward & Hambrick, 1997; Hambrick, 1995). Even though traditional leadership studies have focused on the CEO as unit of analysis, recent research has witnessed a shift of focus from the CEO to the TMT (e.g. Lubatkin, Simsek, Ling, & Veiga, 2006; Finkelstein & Hambrick, 1996). One reason for this shift in attention is the notion that a TMT has more effects on the organization and its performance than the CEO alone (O’Reilly, Snyder, & Boothe, 1993). Additionally, Carmeli (2008) identified two research trends regarding TMT; TMT composition and TMT processes. TMT composition argues that a TMT’s characteristics are the foundation of an organization, whereas TMT processes focus on how executives manage their tasks (Carmeli, 2008). A key aspect of TMT process studies focuses on the behavioral integration within a TMT (Hambrick, 1994). Moreover, TMT’s attributes and behaviors reflect upon a firm. That is why a well-integrated TMT, mirrors a positive image to its employees, who then are better motivated to do their best, which eventually leads to improved firm performance (Carmeli, 2008).

According to Carmeli and Halevi (2009), behavioral integration consists of three parts. Firstly, (1) collaboration, which is the social-related process of TMT behavioral integration. It includes two-way communication, influencing each other, solving conflicts and supporting each other's ideas for innovations (Carmeli & Halevi, 2009). With the help of collaborative processes, TMT members are able to exploit each other's complementary resources and skills, develop the team’s mental capacity to deal with information and understand various complex processes and allows a TMT to take the most appropriate course of action in various social situations (Carmeli & Halevi, 2009). Secondly, (2) joint decision-making, a task-related process, enhances employee’s motivation, job satisfaction and commitment, transparent communication and information flow between the team members. Joint decision-making improves an individual’s, as well as a team’s, capabilities to deal with internal and external strategies, and supports changes in organizational competencies, increasing either flexibility or control within the organization (Carmeli & Halevi, 2009). Thirdly, (3) another task-related process, information exchange, helps an individual or team to make more informed decisions since it refers to the quantity and quality of exchanged information between team members (Carmeli & Halevi, 2009). These three factors are interrelated and when combined lead to better use of knowledge and well-developed strategic approaches (Lubatkin, Simsek, Ling, & Veiga, 2006).

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2.3. Organizational Ambidexterity

As early as the 1930s, Schumpeter (1934) argued that, based on technological and environmental change, companies need to change their structural alignments to succeed. Since then various scholars supported the idea of organizational adaptation (e.g. Tushman & O'Reilly, 2002; March, 1991; Burns & Stalker, 1961). The challenge of being adaptive and flexible while concurrently maintaining efficiency is described as ‘paradox of administration’ (Thompson, 1967). This dilemma, better known as ‘organizational ambidexterity’, is defined as "the ability to simultaneously pursue both incremental and discontinuous innovation … from hosting multiple contradictory structures, processes, and cultures within the same firm" (Tushman & O'Reilly, 1996, p. 24), or the ability to exploit and explore simultaneously (O'Reilly & Tushman, 2013). Exploitation stresses the reinforcement and building on existing skills, processes, and technologies to meet existing customer and market needs (Li, 2013). However, focusing only on exploitation will lead to suffering from outmodedness and lacking behind (Levinthal & March, 1993). On the contrary, exploration strategies concentrate on meeting the needs of emerging customers and markets by pursuing and offering new organizational routines, technologies, processes, and products (Li, 2013). Nevertheless, solely paying attention to exploration also has a disadvantage. In fact, a firm will not be able to make a profit from the new knowledge gained, since it is constantly developing new ideas and does not get the opportunity to collect any pay-outs (Levinthal & March, 1993).

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First, it is located at the individual level rather than firm level, meaning it depends on each employee individually.

Second, attaining organizational ambidexterity entails individuals agreeing on a unit being aligned and adaptable. Third, individuals are enabled by stretch, discipline, and trust (O'Reilly & Tushman, 2013); where stretch and discipline refer to the hard elements and trust to the soft elements within an organizational context that need to be balanced (Raisch & Birkinshaw, 2008). This approach faces criticism for remaining rather vague and not explicitly stating how the balance between exploration and exploitation can be achieved (Kauppila, 2012).

Generally, most firms apply a combination of structural and consequential ambidexterity, or all three forms to achieve organizational ambidexterity since they operate in a diverse range of competitive markets that require different rates of exploration and exploitation (O'Reilly & Tushman, 2013). Even though organizational ambidexterity is hard to accomplish many studies argue in favor for the benefits of organizational ambidexterity (Simsek, 2009; O'Reilly & Tushman, 2013; Gibson & Birkinshaw, 2004; March, 1991). These advantages include, for instance, allowing a company to be innovative and flexible while maintaining stability and efficiency (Simsek, 2009). Additionally, research shows that organizational ambidexterity is positively related to firm performance, in terms of sales growth, subjective ratings of performance, innovation, market valuation measured by Tobin’s Q and firm survival, especially in uncertain environments (O'Reilly & Tushman, 2013). Nevertheless, achieving a perfect balance between exploration and exploitation is difficult, because it requires accomplishing a paradoxical framework and combining contrary competencies (Li, 2013).

2.4. TMT Compensation

Carmeli and Halevi’s definition clarifies the concept of TMTs. A TMT consists of the “CEO and senior executives who hold positions at or above the level of vice president, such as president, chief financial officer (CFO), and chief operational officer (COO) and are considered to be ‘direct reports’” (2009, p. 208).

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In order to study the concepts of executive compensation and organizational ambidexterity on a depper level, compensation is utilized as a means to derive the constructs of external and internal TMT alignment. Linking compensation to organizational ambidexerity, previous research shows that companies adjust their pay structures to fit innovation strategies. Thus a connection has already been established between compensation, exploration, and exploitation (Yanadori & Marler, 2006). Their findings suggest that employees’ focus is steered either to short-term or long-term firm performance through a company’s compensation strategy. However, none of the firms included in the research tried to attain a balance between exploration and exploitation; instead, they just focused on one of them (Yanadori & Marler, 2006). Thus, this research will contribute to the existing literature by focusing on the impact of long-term pay structure on organizational ambidexterity, as well as the indirect impact of the total compensation level in terms of internal and external TMT alignment.

Including restricted stock holdings, option grants, and other long-term compensation forms conceptualizes long-term pay structure, where the long-term pay structure lays the foundation for external TMT alignment. Internal TMT alignment builds upon the total compensation an executive receives and the managerial complexity a TMT member encounters (Carpenter & Sanders, 2002).

2.5. External TMT Alignment and Organizational Ambidexterity

Steering attention to the risk sharing problem of agency theory is of great interest since risk is a central theme in organizational ambidexterity (March, 1991). Organizational ambidexterity strategies are associated with varying levels of risk, given that exploration, in comparison to exploitation, requires substantial investments with unclear payoffs (Gupta, Smith, & Shalley, 2006). Based on agency theory it is assumed that manager and shareholders prefer different innovation strategies since managers favor minimizing risk-taking while shareholders willingly take on greater risks (Eisenhardt, 1989).

Exploitation strategies relate to the pursuit of short-term performance, which is preferred by managers due to avoiding risk and uncertainty, and gaining in the short-term (Raisch & Birkinshaw, 2008). Hence, one can assume that executives prefer to pursue exploitation strategies. However, this may impede future performance since it decreases the ability to respond to environmental changes effectively (Raisch & Birkinshaw, 2008; Ahuja & Lampert, 2001). In comparison, Flammer and Bansal (2017) discovered that shareholders are willing to take on higher risks since long-term orientation positively impacts firm value. Thus, implying a greater return received as, for instance, dividends paid. Therefore, implicitly, shareholders are eager to pursue exploration strategies because these focus on long-term success (Raisch & Birkinshaw, 2008). Hence, the interests of managers and shareholders collide and need to be aligned.

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Sanders, 2002; Jensen & Murphy, 1990). Yet, using a long-term pay structure may impede the pursuit of organizational ambidexterity, as it is more likely that a TMT will focus on exploration strategies rather than exploitation strategies since this will increase firm value and maximize their benefits when paid in mostly long-term incentives (Flammer & Bansal, 2017).

Based on the article by Carpenter & Sanders (2002) long-term components of pay are utilized in order to measure the external alignment of TMT members with a company’s shareholders. External alignment, defined as “the degree to which the structure of TMT member compensation takes into account the interests of shareholders” (Carpenter & Sanders, 2002, p. 369), is critical as according to agency theory long-term incentives align top management’s interests with that of shareholders (Jensen & Murphy, 1990). This is a consequence of long-term pay structures rewarding executives when they meet long-standing firm performance goals (Baysinger & Hoskisson, 1990). Additionally, long-term pay structure increases investments into long-term strategies by managers, thus executing exploration strategies, which in turn line up with the shareholders preferred innovation focus (Flammer & Bansal, 2017).

Gibson and Birkinshaw (2004) have argued that organizational ambidexterity is detrimental to sustainable performance. Borrowing the concept of sustainability from environmental studies, such as forestry, it is defined as the fulfillment of present needs while being concerned with the well-being of future generations (Kuhlman & Farrington, 2010). This idea implies that a firm needs to make the best out of its current activities to gain in the short-term (exploitation), while not losing sight of the future and thus investing into long-term strategies (exploration). Hence, while the external alignment of a TMT with shareholders will directly positively influence exploration, it does not mean that a company fails to acknowledge exploitation. Nevertheless, this research paper assumes that external TMT alignment will be negatively related to achieving the balance of organizational ambidexterity since TMT members will focus on pursuing exploration strategies to meet shareholders’ needs. Therefore, this paper hypothesizes that:

Hypothesis 1(H1): The external alignment of TMT pay will be negatively related to the pursuit of organizational ambidexterity.

2.6. Internal TMT Alignment and Organizational Ambidexterity

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total level of pay and managerial complexity within a firm (Carpenter & Sanders, 2002). Internal alignment is important, regarding the fact that its absence may lead to conflicts and eventually limits a team’s collective effectiveness (Hambrick, 1995), which relates back to the field of behavioral integration. Behavioral integration is the principle of matching “the social and task processes associated with collaborative behavior, quality of information exchange, and joint decision making”, in order to promote a deeper understanding and a better use of a TMT’s knowledge base (Lubatkin, Simsek, Ling, & Veiga, 2006, p. 651).

Achieving internal alignment is possible through several means. Firstly, a firm may utilize its external alignment strategy by means of providing equal long-term pay incentives. Offering the same rewards to the CEO and other TMT members increases cooperation and justice perceptions, since firm-level rewards, such as stocks, promote a perception of fairness and teamwork (Carpenter & Sanders, 2002). Also, having the same benefits and constraints, in the form of pay, increases the behavioral integration, due to the phenomenon of ‘sitting in the same boat’ (Carpenter & Sanders, 2002). For instance, when a firm is performing poorly, a TMT is more likely to work together to find a solution since everyone’s pay is affected in the same way and it is in everyone’s interest to find a way out. Thirdly, internal alignment also surfaces when TMT members believe that compensation is set fairly compared to the CEO’s pay with regards to managerial complexity. One of the determinants of CEO compensation is the complexity within a firm. When the TMT’s pay is also based on managerial complexity, this will eventually lead to behavioral integration through team members perceiving the compensation regulations as just (Carpenter & Sanders, 2002). Managerial complexity consists of the managerial demands a firm is facing, such as its size or R&D intensity (Carpenter & Sanders, 2002). To conclude, offering a similar pay structure as internal alignment mechanism may lead to perceived procedural justice, which then again leads to behavioral integration (Carpenter & Sanders, 2002).

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and under the aspect of managerial complexity will lead to a behaviorally integrated team, which in turn allows for a grander pursuit of organizational ambidexterity. Formally stated:

Hypothesis 2 (H2): The internal alignment of TMT pay will be positively related to the pursuit of organizational ambidexterity.

2.7. The Moderating Role of TMT Diversity

Besides analyzing the relationship between TMT alignment and organizational ambidexterity one may also investigate the moderating effect of TMT diversity on this relationship. The focus here lies on the impact of diversity, since previous research linked it to having an impact on organizational processes and outcomes, such as organizational ambidexterity (Hambrick & Mason, 1984; Shaw, 1981). Upper echelons theory implicates that executive’s decisions are based on cognitive as well as executive orientation, where the latter includes observable experiences (Knight et al., 1999). Observable experiences contain demographic measures, such as age, which are used as filters, steer managerial perceptions and are related to executive orientation (Hambrick & Mason, 1984). Consecutively, managerial perceptions guide strategic choices and actions, such as pursuing organizational ambidexterity (Knight et al., 1999). The information-processing view states that the ‘composition’ of a TMT is central for solving the contradictory challenges of organizational ambidexterity since a diverse team has the “ability to handle large amounts of information and decision alternatives, and deal with conflict and ambiguity” at the same time (Li, 2013, p. 875). Consequently, diversity generates a greater foundation of ideas, innovations, and creativity, which implicitly leads to more organizational ambidexterity (Knight et al., 1999). However, side effects of diversity within senior management teams include communication and collaboration issues, due to interpersonal conflicts based on group heterogeneity. These issues lead to inefficient information sharing and diffusion among a TMT, and eventually to undesirable outcomes (Li, 2013).

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Hypothesis 3a (H3a): TMT diversity negatively moderates the relationship between external TMT alignment and the pursuit of organizational ambidexterity.

Hypothesis 3b (H3b): TMT diversity negatively moderates the relationship between internal TMT alignment and the pursuit of organizational ambidexterity.

To summarize, this paper assumes that external TMT alignment has a negative impact on organizational ambidexterity, internal TMT alignment has a positive effect on organizational ambidexterity and TMT diversity negatively moderates both of these relationships. Figure 1 pictures the conceptual model based on the established hypotheses.

Figure 1: Conceptual model

3. Methodology

This section outlines the methodology. First, information is given on the sample and data collection, illustrating the construction of the sample. Second, data measurements for the dependent, independent, moderator and control variables are operationalized and debated.

3.1. Sample and Data Collection

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Carpenter & Sanders, 2002; Chhaochharia & Grinstein, 2009; Aggarwal & Samwick, 1999). This database includes financial data and information related to US companies’ top executives from 1992 onwards. ExecuComp comprises the data of 277 firms. Organizational ambidexterity data came from a database provided by this thesis’ supervisor (Prof. Dr. Oehmichen), who based the data’s sampling frame on McKenny, Aguinis, Short, & Anglin (2018). The organizational ambidexterity databank consists of 284 firms over a time period from 2000 – 2015. This paper focuses on data from 2007 – 2015, due to regulatory changes, which altered the availability of certain variables, such as long-term incentive payouts (LTIP), within ExecuComp (Wharton, n.d.). The original sample consisted of 2646 observations, but merging the two data sets omitted some of the observations, leaving a longitudinal panel dataset ranging between 1458 and 2295 observations. The number of observations differs, due to differences in data availability of different variables used in separate regressions. Table 1 provides an overview of the number of observations per incorporated variable. The applied control variables were retrieved from the organizational ambidexterity data bank or created by using ExecuComp values.

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This paragraph provides a framework for the various variables and how they are measured. Firstly, the dependent variable ‘organizational ambidexterity’ is illustrated. Secondly, the independent variables ‘external’ and ‘internal TMT alignment’ are operationalized. Thirdly, the moderator variable ‘TMT diversity’ is outlined. Finally, an explanation of the measures for several control variables (e.g. firm size, firm age) follows.

Dependent Variable. This study uses computer-aided text analysis (CATA), a form of content analysis, to compute the concept of organizational ambidexterity. Based on the frequency of words, CATA processes text into quantitative data and thereby enables the measurement of constructs, such as organizational ambidexterity (McKenny, Aguinis, Short, & Anglin, 2018; Short, Broberg, Cogliser, & Brigham, 2010).Since the collected organizational ambidexterity data of this research focuses on annual reports, this paper follows the narrative of previous studies that have applied content analysis to examine organizational communications, such as shareholder letters, organizational mission statements or annual reports (e.g. Duriau, Reger, & Pfarrer, 2007; Moss, Short, Payne, & Lumpkin, 2011; Payne, Moore, Bell, & Zachary, 2013). Since content analysis has several advantages over interviews and surveys, it is frequently used within the field of management (Carley, 1997; Morris, 1994; Woodrum, 1984). These advantages include applying to quantitative as well as qualitative research and to longitudinal studies. Furthermore, it diminishes the researcher demand bias by being nonintrusive (Duriau, Reger, & Pfarrer, 2007). Since this study is one of longitudinal research, content analysis is used to overcome the difficulties of interviews and surveys, such as sample attrition (see Lynn, 2009).Furthermore, previous research has used different types of measurements to grasp the concept of organizational ambidexterity, e.g. proxies or questionnaires. However, they lack generalizability and applicability (Uotila, Maula, Keil, & Zahra, 2009). In comparison, content analysis offers a generalizable way of determining organizational ambidexterity in this research’s context, since publicly-traded companies are obligated to provide an annual report for shareholders (Moss, Payne, & Moore, 2014). Consequently, there is an abundance of data to use for a content analysis. CATA has been used and validated previously as tool to measure organizational ambidexterity (e.g. McKenny, Aguinis, Short, & Anglin, 2018; Uotila, Maula, Keil, & Zahra, 2009). Therefore, the superior method of CATA will be used to measure organizational ambidexterity in this study.

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ambidexterity variable analyzed with LIWC (‘Linguistics Inquiry and Word Count’), a computer-assisted text analysis program, to examine the management discussion and analysis (MD&A) sections of 10-k reports (Pennebaker, Booth, & Francis, 2007). Moss, Payne, & Moore (2014) have shown that LIWC is a common tool used in content analysis in varied contexts, for instance, negotiations, newspaper articles, and annual reports. This serves as a justification to use the LIWC organizational ambidexterity variable. Finally, the logarithm of organizational ambidexterity is calculated to fulfill the assumptions of linear regression. This will be explained in the preliminary analysis in the result section.

Independent Variables. Measuring external and internal TMT alignment is of a tricky nature since the available variables to measure the constructs are versatile. Previous research has adopted several concepts to calculate alignment.

External TMT alignment. In order to measure external TMT alignment, this research paper utilizes the proposed long-term pay structure by Carpenter and Sanders (2002) based on data from ExecuComp. According to the scholars, external alignment with shareholders is computed as “the proportion of total compensation paid in long-term forms, averaged over the top […] executives” (Carpenter & Sanders, 2002, p. 370). This ratio includes several components, such as stock or option awards. In order to investigate the retrieved data from ExecuComp, it is necessary to elevate the individual compensation data on firm level since the organizational ambidexterity data and the unit of analysis for the study are also on a firm level. This was done by summing up data for each variable per executive during the available years between 2007 and 2015 and then dividing them by the number of executives in each corresponding TMT. In order to calculate the long-term pay structure, the following formula (Formula 1) has been created including the elements restricted stock holdings, all other compensation and options granted based on fair value (FV), which are assumed to be a reliable representation of long-term variables. Furthermore, they were summed up and divided by the total compensation.

𝐸𝑥𝑡𝑒𝑟𝑛𝑎𝑙 𝑇𝑀𝑇 𝑎𝑙𝑖𝑔𝑛𝑚𝑒𝑛𝑡

=𝑅𝑒𝑠𝑡𝑟𝑖𝑐𝑡𝑒𝑑 𝑆𝑡𝑜𝑐𝑘 𝐻𝑜𝑙𝑑𝑖𝑛𝑔𝑠 + 𝐴𝑙𝑙 𝑂𝑡ℎ𝑒𝑟 𝐶𝑜𝑚𝑝𝑒𝑛𝑠𝑎𝑡𝑖𝑜𝑛 + 𝑂𝑝𝑡𝑖𝑜𝑛𝑠 𝐺𝑟𝑎𝑛𝑡𝑒𝑑 𝐵𝑎𝑠𝑒𝑑 𝑜𝑛 𝐹𝑉 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑚𝑝𝑒𝑛𝑠𝑎𝑡𝑖𝑜𝑛

Formula 1: External TMT alignment calculation

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𝐼𝑛𝑡𝑒𝑟𝑛𝑎𝑙 𝑇𝑀𝑇 𝑎𝑙𝑖𝑔𝑛𝑚𝑒𝑛𝑡 = 𝐶𝐸𝑂 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑚𝑝𝑒𝑛𝑠𝑎𝑡𝑖𝑜𝑛 + 𝑀𝑎𝑛𝑎𝑔𝑒𝑟𝑖𝑎𝑙 𝐶𝑜𝑚𝑝𝑙𝑒𝑥𝑖𝑡𝑦 𝑇𝑀𝑇 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑚𝑝𝑒𝑛𝑠𝑎𝑡𝑖𝑜𝑛

Formula 2: Internal TMT alignment calculation

In general, total compensation refers to all monetary (e.g. salary, bonus) and non-monetary rewards (e.g. stock options) an executive receives (Yanadori & Marler, 2006). More specifically, CEO total compensation refers to all the rewards a CEO received in a given year, while TMT total compensation relates to the average pay a TMT (without CEO) member received. Following the principle of Carpenter and Sanders (2002) managerial complexity consists of the sum of several proxies, namely company size, R&D investments and number of people in the TMT team. This equation is used to create a value for every firm per available year during the applied time frame.

Moderating Variable. Besides testing the main relationships, a moderator analysis is utilized to test whether a third variable, namely TMT diversity, influences the relationship between TMT alignment and organizational ambidexterity. Since only limited data and time is available the construct of diversity is measured with the average age. The average age has been calculated by adding the ages of executives up and divide them by the number of people in a TMT for a respective year and company.

Control Variables. This study includes several control variables that have been previously linked to this study’s constructs. Firstly, in order to test possible influencing effects of firm-level characteristics, firm size and firm age have been incorporated. Firm size, measured by number of employees, is associated with complications in information processing related to changing resources and the inability to adapt to shifting resource conditions (Lubatkin, Simsek, Ling, & Veiga, 2006). Firm age, the number of years since the establishment of the firm, possibly creates routines and norms within a company that are linked to inertial behavior (Tushman & Romanelli, 1985). Secondly, to control for firm performance return on assets (ROA) and Tobin’s Q were included. Heyden, Oehmichen, Nichting, & Volberda (2015) included firm performance measures since strategic orientations may be affected by dissimilarities in financial performance. Thirdly, to account for possible differences in organizational ambidexterity R&D investment has been included (Uotila, Maula, Keil, & Zahra, 2009). In order to control for TMT effects, team size was incorporated, as the number of people in a TMT. This has previously been done to test its impact on behavioral integration (Simsek, Veiga, Lubatkin, & Dino, 2005). Finally, in order to measure unobserved time and industry effects, year and industry dummies were included (Yanadori & Marler, 2006; McGuire, Oehmichen, Wolff, & Hilgers, 2017).

4. Analysis

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moderating variable diversity, a hierarchical regression analysis is conducted. More precisely, ordinary least squares (OLS) tests appear to be the superior method, since the dependent, independent and moderator variables are all continuous and should be treated separately. Hierarchical regression analysis entails adding and/or removing predictor variables from the regression model stepwise, to see the potential prediction power of the independent and moderator variables on the dependent variable (David, 2018).

This paper tests several models, each adding and/or removing variables. First, solely the effect of control variables on the dependent variable is tested. The second model adds the first independent variable (external TMT alignment) to the prior model. Third, external TMT alignment was removed from the equation and replaced by the second independent variable, namely internal TMT alignment. In the fourth model, internal TMT alignment was dropped again, and external TMT alignment included as well as the moderator. Next, external TMT alignment was substituted by internal TMT alignment again, and the moderator was incorporated as well. Finally, in the sixth model both independent variables were included in addition to the moderator, to test the combined effect on the dependent variable.

5. Results

In the following section, the generated data is examined, and the hypotheses tested. Moreover, this section is divided into three subparts. First, the descriptive statistics are interpreted to give an overall overview. Second, a preliminary analysis is given to test the assumptions of the linear regression. Third, the hypotheses are tested.

5.1. Descriptive Statistics

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mean of 50.663 and a standard deviation of 5.211. The youngest member of a TMT is 35 and the oldest 72. The descriptives for the control variables will not be further explained but can be found in Table 2.

Table 2: Descriptive Statistics

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moderator variable, TMT diversity, is either positively or negatively correlated to all control variables. Finally, correlations also exist between most control variables.

Table 3: Correlation Matrix

5.2. Preliminary Analysis

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of homoscedasticity a residual-versus-fitted plot was applied (Appendix C). The distribution seems to indicate that homoscedasticity is apparent. Finally, the residuals need to be approximately normally distributed. Employing a histogram, the residuals appear to be approximately normally distributed when inspected visional (Appendix D).

5.3. Hypotheses Testing

As mentioned previously, the hypotheses were tested using a hierarchical regression model conducted in the statistical software Stata. Having compared the outcomes of the regression models with and without winsorized transformation of the outliers, it became evident that the findings are more relevant when keeping the original outliers since the R² of the regression equations is higher with the outliers. Thus, the dataset without winsorized transformation was used for the following analysis. In total, six different models have been created to investigate the individual significance and additional variance explained by the two independent variables and the control variables. The year and industry variables are included in the regression analysis but are not reported in the table. Each model includes a different number of observations, based on missing values for some of the variables. Moreover, every model includes b, the unstandardized coefficient, its standard error, as well as R², the explanatory variance of each model.

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23 Table 4: Linear regression model

Hypothesis 1: The first hypothesis predicts a negative relationship between organizational ambidexterity and external TMT alignment. Hence, it is expected that the unstandardized coefficient (b) is negatively significant. As can be seen in model 2 (Table 4) external TMT is, indeed, negatively significant at the p0.05 level. Moreover, the regression equation is significant at p0.000 with F (17, 1453) = 9.53 and an R² = 0.103. Consequently, the higher external TMT alignment, the lower is the level of organizational ambidexterity, which provides evidence to support hypothesis 1.

Hypothesis 2: Hypothesis 2 expects a positive relationship between internal TMT alignment and the level of organizational ambidexterity. Thus, the higher the internal alignment between TMT members the higher the level of organizational ambidexterity is within a firm. The regression equation itself is significant at p0.000 with F (23, 2253) = 12.93 and an R²= 0.116. However, as model 3 shows, the unstandardized coefficient is not significant, thus no support for hypothesis 2 is found, and it is rejected that internal TMT alignment positively influences organizational ambidexterity.

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alignment and TMT diversity. The visual representation shows that the slope of TMT diversity is negatively sloped under low conditions and vice versa. This implies that for a high TMT diversity organizational ambidexterity increases when external TMT alignment rises. Consequently, there is no evidence to support hypothesis 3a and TMT diversity positively moderates the relationship between external TMT alignment and organizational ambidexterity. The more TMT diversity, the smaller the negative relationship between external TMT alignment and organizational ambidexterity, implying higher levels of organizational ambidexterity.

Hypothesis 3b: Model 5 displays the relationship between internal TMT alignment and organizational ambidexterity and the moderating effect TMT diversity has on this relationship (H3b). Contrary to what was expected, TMT diversity has no significant moderation effect on the interaction of internal TMT alignment and organizational ambidexterity. Also, the explained variance (R²) stays the same, so there is not enough evidence to support hypothesis 3b, and it should be rejected.

Figure 2: Interaction plot for hypothesis 3a

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5.4. Robustness Check

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6. Discussion and Conclusion

This study aimed at investigating the impact of TMT alignment on organizational ambidexterity, more specifically, the effect of internal and external alignment and how executive compensation plays a role in achieving alignment between TMT members. This study offers a first glimpse into a relatively unexplored field of research revolving around TMT compensation (Carpenter & Sanders, 2002) and organizational ambidexterity, still an emerging research field (Raisch & Birkinshaw, 2008). This objective was partially achieved since the hypotheses regarding external TMT alignment were supported, while those concerned with internal TMT alignment were not.

The findings of both tests, hierarchical regression and robustness check, show that external TMT alignment negatively influences organizational ambidexterity (H1), implying that a greater level of external alignment leads to a lower level of organizational ambidexterity. This is consistent with agency theory and previous findings (Flammer & Bansal, 2017) since the authors state that external alignment is concerned with aligning the interests of managers with that of shareholders who pursue long-term or exploration strategies. When focusing mostly on exploration, it becomes difficult to achieve the necessary balance between exploration and exploitation to realize organizational ambidexterity (Li, 2013; Simsek, 2009). Additionally, this paper’s findings support Levinthal and March’s (1993) view on the simultaneous pursuit of exploration and exploitation in the field of organizational learning. They clearly state that striving only for exploration will lead to incurring losses, due to missed opportunities of not extracting gains from generating knowledge.

Moreover, both analyses prove that TMT diversity positively moderates the relationship between external TMT alignment and organizational ambidexterity (H3a). The higher the level of TMT diversity and the higher the level of external TMT alignment the greater the level of organizational ambidexterity. Prior findings showed that team diversity has two opposing consequences. On the one hand, diversity brings forth adverse effects, such as reduced group cohesion and communication frequency (O'Reilly, Caldwell, & Barnett, 1989; Smith et al., 1994) as well as increased group conflict and political games (Eisenhardt & Schoonhoven, 1990; Pfeffer, 1981). On the other hand, diversity enables more variety in decision-making possibilities due to enabling creativity and innovation (Jackson, May, & Whitney, 1995). This thesis’ findings are in line with positive views on TMT diversity (e.g. Talke, Salomo, & Kock, 2011; Jackson, May, & Whitney, 1995).

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alignment will thus both increase the level of external alignment and therefore also the level of exploration, resulting in an imbalance of organizational ambidexterity.

Contrary to what hypothesis 2 expected, internal TMT alignment does not appear to have a significant influence on organizational ambidexterity, implying that a behaviorally integrated team does not necessarily foster the pursuit of organizational ambidexterity. This is opposing to prior findings that a behaviorally integrated TMT is necessary to achieve organizational ambidexterity, at least in SMEs (Lubatkin, Simsek, Ling, & Veiga, 2006). A potential explanation for this can be found when shifting the focus from behavioral integration theory to tournament theory.

Tournament theory, which is a subcategory of agency theory, uses pay as a motivation incentive. Tournament theory originates and deals with the explanation of prize structure divergence, e.g. excessive high CEO payments in contrast to a ‘regular’ employee’s salary (Connelly, Tihanyi, Crook, & Gangloff, 2014). Moreover, it implies that TMT members are best motivated to perform when compensation is based on a “function of winners and losers” rather than absolute output levels (Connelly, Tihanyi, Crook, & Gangloff, 2014, p. 17). Authors in several disciplines, such as law (Anabtawi, 2005), finance (Kale, Reis, & Venkateswaran, 2009) and psychology (Nieken & Sliwka, 2010) have confirmed the existence of this phenomenon. Tournament theory helps to understand the missing link between organizational ambidexterity and TMT internal alignment, since pay divergence, thus the team members seeing themselves as ‘losers’ and the CEO as the ‘winner’, motivates the TMT to outperform others by pursuing their own goals, having their own sub-department performing at its best in order to achieve the highest payouts. However, organizational ambidexterity requires a collective and integrated effort of all departments (O'Reilly, Harreld, & Tushman, 2009; O'Reilly & Tushman, 2004), which is not necessarily given when everyone pursues their own interests to make personal gains.

Another explanation for the insignificant results could be the complex nature of organizational ambidexterity itself. Disagreement among scholars proves that it is a complicated construct to measure (Simsek, Heavey, Veiga, & Souder, 2009). Therefore, to empirically test the effect of internal TMT alignment on organizational ambidexterity, requires the consideration of more factors that may affect organizational ambidexterity as well.

Finally, hypothesis 3b is rejected as well. The findings do not show sufficient empirical evidence that TMT diversity has a moderating effect on the relationship between internal TMT alignment and organizational ambidexterity.

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ambidexterity. External TMT alignment does not necessarily aim at achieving organizational ambidexterity since alignment with the shareholders implies an exploration orientation. Nevertheless, TMT diversity positively influences the relationship between the two and hence helps to achieve a higher level of organizational ambidexterity. This study extends previous research on organizational ambidexterity and executive compensation, by using compensation as a mean to derive the concepts of external and internal TMT alignment and test its relationship with organizational ambidexterity.

6.1. Limitations and Future Research

This research paper is susceptible to several limitations, which can pave the way for future research. Scholars should focus on these issues to provide further insight into the interrelationships between executive compensation, TMT alignment, and organizational ambidexterity.

Firstly, the sample used in this study focuses only on US firms. In order to derive general implications, it is advisable to extend to include multiple countries to account for national differences (Heyden, Oehmichen, Nichting, & Volberda, 2015). For instance, in order to generalize not only the findings of this paper but findings on the effects of antecedents, such as executive compensation, on organizational ambidexterity it would be interesting to test a similar approach on firms from different countries rather than only from the USA. Nevertheless, creating an appropriate research design and gathering data may be challenging.

Secondly, using the logarithm of the dependent variable organizational ambidexterity provides the benefit of conforming the data to normality. However, this is accompanied by difficulties, since log-transformed data differs from the original data, making it harder to interpret the original data (Feng et al., 2014). Instead, one may use generalized estimating equations (GEE), a newer analytic method that waives the distribution assumption. Therefore, it offers valid inference irrespective of the data distribution (Feng et al., 2014).

Thirdly, the construct of internal TMT alignment was adapted to fit the available data and therefore diverged from the original formula by Carpenter and Sanders (2002). This is because elements of managerial complexity, such as geographic and product diversity, were not included in this data set. Nevertheless, including team size into managerial complexity was meaningful for this study’s purpose, since this paper is interested in the effects of TMT alignment and size “may affect the heterogeneity of a senior team and also influence the dynamics in strategy implementing processes” (Li, 2013, p. 882). Whether the right elements were used also concerns the formula for external alignment; this requires further investigation.

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diversity, or surface- and deep-level diversity as elements of TMT diversity (Harrison, Price, Gavin, & Florey, 2002). These may have different moderating effects on the relationship between TMT alignment and organizational ambidexterity.

Finally, this paper neglects the influence of environmental factors, such as market conditions and competitors, on organizational ambidexterity. It focuses solely on an internal factor analysis. Future research should incorporate aspects, such as level of competition, patent rates or market conditions, in the analysis. Also, to provide a broader picture of the measure that constructed internal and external TMT alignment, more relevant variables should be included. This will lead to the creation of a full picture that includes more information and possibly leads to more significant findings.

6.2. Theoretical Contributions

This study contributes to current research streams in several ways. First of all, it extends the field of organizational ambidexterity by investigating TMT alignment as an antecedent, specifically with a distinction between external and internal alignment. Even though some scholars have focused on the effects of internal and external TMT alignment they mostly did so concerning financial performance (Carpenter & Sanders, 2002; Flammer & Bansal, 2017). This study goes even further by conceptualizing executive compensation as a mean for alignment, which, in turn, indirectly extends the current knowledge on the interplay between the two fields, executive compensation, and organizational ambidexterity.

As mentioned earlier, most research so far has focused solely on the CEO and the effects of his or her compensation plan. However, this paper extends the focus from the CEO to the TMT and therefore provides a broader view on how a collision at the top management level can enhance the pursuit of certain strategic decisions.

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Finally, previous scholars have argued that TMT diversity influences the strategic choices a firm makes (Li, 2013; Knight et al., 1999). Testing the moderating effect of TMT diversity on the relationship between external and internal TMT alignment on organizational ambidexterity extended this notion.

6.3. Practical Implications

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