Outside Director Tenure as a Source of Interpersonal
Trust Inside the Boardroom
Jesse Wouda
University of Groningen, Faculty of Economics and Business
20-06-2016 – Amsterdam
This study addresses the nature and the development of competence trust and affective trust within relationships between outside directors. Based on a unique multilevel data set composed of 412 individual peer ratings obtained from outside directors from Dutch not-for-profit organisations, this research provides new insights about interpersonal trust in the context of actual board behaviour. The author states that outside director tenure positively influences affective trust among outside directors, however, this relation decreases in strength and even declines after a certain period of time. Competence trust is not influenced by the time that an outside director is in office, which assumes that outside directors are believed to be competent in doing their job from the early years in office. Consequently, participative leadership style of the chairman of the board positively moderates the relationship between competence trust and affective trust. The findings suggest that a participative leadership style of the chairman plays a dominant role in the development process of competence trust to affective trust, by facilitating a social exchange process that allows outside directors to share their own ideas, which consequently contributes to a joint decision-making culture in the boardroom. This study highlights the importance of interpersonal trust, and affective trust in particular, within the regulated corporate governance mechanisms.
Jesse Wouda S-2799685
Field of study: MSc Accountancy
Supervisor: Dhr. dr. Dennis B. Veltrop Co-assessor: Mevr. Irene Mostert Word count: 10,109
E-mail: j.wouda.7@student.rug.nl
Keywords: board of directors; outside director tenure; trust; cognitive trust;
2
Introduction
In response to the corporate financial reporting scandals in the beginning of this century and with the introduction of the Sarbanes-Oxley Act (SOX) in the United States and the Code Tabaksblat in the Netherlands, stakeholders are demanding enhanced oversight of management’s activities with the help of a strict governance mechanism, in order to ensure that their value is protected. Outside directors play an important role in this respect as they are expected to scrutinise management activities through monitoring and to support the management with valuable advice (Daily, Dalton & Cannella, 2003; Finkelstein & Mooney, 2003). The effectiveness of enterprise’s board of directors1 plays a critical role in the corporate governance mechanism and therefore has
been a popular topic for researchers (Huse 2005; Ees, Garbielsson & Huse 2009).
In the governance literature, many scientists focus on the structure and composition of the board as a measure to determine the board’s effectiveness (Huse, 2005). This trend in the literature has been fused together with governance regulation and therefore has created new recommendations for firms and boards in particular. A recent call from the ‘Monitoring Commission Corporate Governance Code’ advocates to limit the tenure of outside directors with a maximum tenure in office of two times a period of four years (Monitoring Commission Corporate Governance Code, 2016), taking in mind that longer tenured outside directors are less inclined to evaluate management’s decisions critically (Veltrop, Molleman, Hooghiemstra, & Van Ees, 2015) and are more likely to become entrenched (Hillman et al., 2011; Kor & Sundaramurthy, 2009).
However, despite the increasing popularity of scientific focus on the regulated board environment, previous studies have paid surprisingly little attention to examining the impact of tenure of outside directors in relation to what actually happens inside the boardroom (Johnson, Schnatterly, & Hill, 2013). This is not a trivial matter. Whereas scholars claim that much is unclear about the actual internal processes in the boardroom, because these internal processes are scantly investigated (Ees et al., 2009; Dalton, et al. 1992; Hermalin & Weisbach, 2003; Roberts, McNulty & Stiles, 2005), regulators remain strict in limiting outside director tenure. This is surprising, since limiting outside director tenure may very well have unintended consequences without a fundamental micro-level understanding of how boards function. Indeed, scientists argue that extended research should give us more insight in behavioural processes and dynamics in and
3 around the boardroom to understand the concept of actual board behaviour, including interpersonal relations and trust, that could potentially be influenced by directors’ tenure (Gabrielsson & Huse, 2005; Huse, 2005; Pye & Pettigrew, 2005; Migliore & DeClouette, 2011). This study answers that call and goes one level deeper by examining actual behaviour in the boardroom.
Boards of directors function only episodically and therefore can be classified as a unique group of people compared to many other workgroups (Forbes & Milliken, 1999). Generally, outside directors have different work-related backgrounds, cultural values and personalities (Migliore & DeClouette, 2011). Taking these personal elements in mind and assuming that office meetings take place a limited times a year, the need for an effective collaboration in this specific social group is evident. That is where the importance of trust comes in. Many scholars have argued that a high level of trust among members of a social group encourages proper cooperation, more interaction and superior levels of performance (Jones & George, 1998; Kramer & Tyler, 1996; Mayer, Davis & Schoorman, 1995; McAllister, 1995). Additionally, the presence of trust inside the boardroom is considered to have essential benefits for an effective collaboration among outside directors (Oortmerssen, Woerkum & Aarts, 2014) and increases board effectiveness (Huse, 1998; Huse & Zattoni, 2008).
However, despite the enormous amount of studies that acknowledge the importance of trust in the interpersonal relationships between outside directors, the development of trust in the boardroom is still scarcely investigated (Migliore & DeClouette, 2011). Welch et al. (2005) state that real trust is not to be taken for granted, and denote that trust involves a dynamic development process and is not something that is always available in interpersonal relationships in the early stages. As soon as outside directors stay in office for a longer time, they build up a history with each other and are more likely to have a homogeneous set of understandings (Katz, 1982; Lewicki & Bunker, 1996). Some scholars argue that frequent interactions in (small) teams encourages building social ties and friendships which, under certain conditions, enhance interpersonal trust (Zand, 1972; Westphal, 1999; Kramer & Tyler, 1996; McAllister, 1995) and ultimately increases board effectiveness (Migliore & DeClouette, 2011). Indeed, this study provides evidence that outside directors’ tenure does effect the level of trust among colleague outside directors.
It is important to realise that the episodic part-time nature of boards results in a development process of trust that differs from other social groups (Forbes & Milliken, 1999). Given the limited interaction between outside directors, the author expects that the chairman of the board plays a
4 crucial role for the evolvement of trust in the boardroom. Indeed, the main responsibility of the chairman is to encourage healthy participative dialogues among outside directors and is often seen as essential for board effectiveness (Kakabadse & Kakabadse, 2007a). In particular, given the episodic nature of boards the author expects that the participative leadership style of the chairman2
plays an important role in the development of trust. Previous studies have exposed the positive relationship between a participative leadership style and its contribution to trust (Dirks & Ferrin, 2002; Miao, Newman & Huang, 2014). Under the condition of a participative leadership style of the chairman this study expects trust among outside directors is more likely to develop in participative boards, whereas trust may not develop in non-participative boards.
The objective of this study is twofold: (1) to give us greater insight in the development of trust among outside directors; (2) to provide a peek inside of the proverbial ‘black box’. Taking a social behavioural point of view, this study explorers the underlying interpersonal dynamics between outside directors. There are four theoretical aspects through which this study contributes to the current literature. To the best of my knowledge, this study provides the first micro-level analysis of the impact of individual tenure of outside directors on interpersonal trust among them. Secondly, in examining this theoretical construct, this study provides insight into the development of the different stages within interpersonal trust over time, where other scientists measure trust from a unidimensional perspective (Lewicki, Tomlinson, & Gillespie, 2006). The third contribution is made through providing more insight into the actual behavioural processes and dynamics in the boardroom, which is frequently called the ‘black box’ (Roberts et al., 2005). Finally, the data is based on a unique comprehensive dataset comprised of survey data from (outside) directors of not-for-profit Dutch firms. This method enables direct investigation of board behaviour and sheds new light on the way in which scholars can investigate actual board behaviour in future studies.
This paper is structured in five sections and starts with an extended review of the existing theories in the literature with respect to outside director tenure and the foundations of trust. Next, the methodology model is explained in more detail. Furthermore, in section three the data and results are presented which will be discussed in section four. Also, in section four the limitations of this research and new perspectives for future research will be revealed. In the last section the author will present the final conclusions.
5
Theory and Hypotheses
UNDERSTANDING OF BOARD PROCESSES
For decades the role of the board of directors in the corporate governance literature has been a subject of research in different contexts. The majority of board research is based on the agency theory perspective (Jensen & Meckling, 1976; Fama & Jensen, 1983) considering the formal separation of the manager (agent) and the shareholder (principal) and with an emphasis on how boards fulfil their monitoring task within the corporate governance mechanism, referring to the protection of shareholders’ interest from opportunistic and self-serving behaviour of managers (Ees et al. 2009). Another important task of the board is providing the day-to-day management with valuable advice about complex dilemmas (Forbes & Milliken, 1999).
An effective fulfilment of these complicated tasks requires outstanding teamwork between outside directors, which directly underlines the importance of examining the behavioural processes and dynamics – including interpersonal relationships and trust – inside the boardroom. Interpersonal trust in the context of actual board behaviour is widely investigated and proved to cause high cooperative behaviour among outside directors, and effective corporate governance, to boost team performance and to reduces complexity (Jones & George, 1998; Mayer et al., 1995; Lewis & Weigert, 1985; Luhmann, 1979; Camerer, 2003). Additionally, McAllister (1995) states that interpersonal trust between managers is an essential element in facilitating effective cooperation in organisations. From another perspective, Lencioni (2002) states that the main reason why management teams fail, is owing to the absence of trust, referring to work situations where managers with a low level of trust are less committed and more reticent. Additionally, trust increases individuals’ job satisfaction, organisational commitment and job performance (Lewicki et al., 2006). In sum, trust is likely to be a core ingredient of having effective interpersonal relationships between outside directors and to provides conditions in which a high level of collaboration, outstanding team performance and firm value creation are likely to occur (Kramer & Tyler, 1996; Migliore & DeClouette, 2011).
TRUST AND ITS FOUNDATIONS
Although trust has gained high attention from researchers in the sociologic, the psychologic and the management literature, there is still no universally accepted definition (Rousseau, Sitkin, Burt, & Camerer, 1998; Colquitt, Scott, & LePine, 2007; Mayer et al., 1995). One of the first
6 approaches to define the concept of trust came from Deutsch (1958) who claimed that the concept of trust contains a non-rational choice of a person in an uncertain event and where the expected negative consequences are greater than the expected positive consequences (Hosmer, 1995). Other scholars support the idea that trust is a synonym for trustworthiness, referring to personal characteristics of the trustee, such as ability, benevolence and integrity (Colquitt et al., 2007). Some prominent studies treat trust as a source that conveys risk taking, because the trustor does not have the complete picture of the trustee and therefore no action of that particular person grants complete certainty (Lewis & Weigert, 1985; Zand, 1972).
However, despite their great contribution these scientists have made to the literature, this study suggests that trust is not simply a relational choice and involves a deeper understanding of the development of interpersonal trust over time (Lewicki et al., 2006). Rousseau et al. (1998) made a great effort with their cross-discipline review and formulated the following definition of trust: “the psychological state comprising the intention to accept vulnerability based upon positive
expectations of the intentions or behaviour of another” (p. 395). Referring to this definition,
‘psychological state’ entails two interrelated cognitive processes (Lewicki et al., 2006). The first cognitive process involves a certain willingness to accept vulnerability to the actions of the other person. Secondly, the psychological state should entail positive expectations regarding someone’s motivation, intentions and behaviour. This is in line with the definition of trust of Deutsch in the early years.
McAllister (1995) introduced a two-dimensional model of trust, in which trust can be distinguished into cognitive-based and affective-based trust. Cognitive trust, which is similar to competence trust3, is based on relational choices in which the level of interactions depends on
economic exchange between parties (Lewicki et al., 2006). This type of trust refers to “trust that
is based on performance-relevant cognitions such as competence, responsibility, reliability, and dependability” (Schaubroeck, Lam, & Peng, 2011, p. 864). Competence trust is also seen as “trust from the head” (Chua, Ingram, & Morris, 2008, p. 436). Indeed, a crucial ingredient of competence
trust is an appropriate level of competence, which mostly entails technical know-how and skills, and is often gained by education and work experience (Kor & Sundaramurthy, 2009). Additionally, Zucker (1986) argues that individuals with professional qualifications or extensive work experience receive a higher level of trustworthiness from their colleagues. The core characteristics
7 of competence trust, such as competence and responsibility, can be relative easily accessed and “a
simple utilitarian calculation” (p. 1013) can be applied in order to determine the benefits derived
from that competence trust in a relationship with someone (Lewicki et al., 2006).
Affective trust refers to “the emotional bonds between individuals” (Lewis & Weigert, 1985). It is also labelled as “trust from the heart” (Chua et al., 2008). A state of great affective trust emerges from repeated positive interactions, risk taking, and successful fulfilment of positive expectations (Rousseau et al., 1998). McAllister (1995) argues that relationships become more emotional when parties have frequent and long-term interaction based on reciprocated interpersonal care. Some researchers argue that trust emerges when there is a considerable amount of person’s knowledge, that usually is acquired through repeated interactions and appreciated meetings in the past (Zucker, 1986; Kramer,1996b; Lewicki & Bunker, 1996). This is supported by the study of Gabarro (1978) that finds a positive relationship between trust among employees and day-to-day interactions with each other. He states that “trust, like mutual expectations,
developed over time and the nature of the trust became more concrete and differentiated as people came to know one another better” (Gabarro 1978, p. 295). This results in an interactive process in
which shared meanings emerge, people become more attached to each other and a higher level of faith in the intentions of the other person exists (Hardy, Phillips, & Lawrence, 1998; Rousseau et al., 1998).
Trust evolves over time. Some scholars argue that trust is a dynamic psychological state wherein the composition of competence trust and affective trust develops and differs over time. This dynamic process is frequently called a ‘transformational model’ of trust development (Rousseau et al., 1998; Lewicki & Bunker, 1996; Shapiro, Sheppard, & Cheraskin, 1992). The development of trust starts at a certain level of competence trust, since parties first evaluate the possible derived losses and gains of that relationship, which involves an expectation of the parties’ knowledge, skills, identity and shared values (Lewicki et al., 2006). This cost/benefit analysis appears in the first stage of an interpersonal relationship and will change over time. According to Rousseau et al. (1998) “trust takes different forms in different relationships — from a calculated
weighting of gains and losses (competence trust) to an emotional response based on interpersonal attachment and identification (affective trust)” (p. 398). These authors propose that a baseline of
competence trust is required which serves as a fundamental condition for the development of affective trust over time (Lewicki & Bunker, 1996). In more detail McAllister (1995) argues that
8 competence trust precedes affective trust and that individuals are more willing to invest and develop dense relations (affective trust) when the professional qualifications (competence trust) of the other party are considered to be high (Newman, Rose, & Teo, 2016). As mentioned above, affective trust increases when parties have repeated positive interaction wherein they can share their emotions. Even though the overall level of trust will increase over time, the proportion of affective and competence trust will change as the time of the relationship increases.
OUTSIDE DIRECTOR TENURE AND TRUST FROM THE HEAD
The board of directors consists of talented people with considerable widespread know-how which they have built up during their extensive career (Forbes & Milliken, 1999). In all these years, outside directors have obtained explicit knowledge with regard to business markets, overall management skills and specific job-related proceedings, and are supposed to bring these specific resources to the firm in order to provide the day-to-day management with valuable advice (Forbes & Milliken, 1999; Hillman, Withers, & Collins, 2009). Further extending this line of reasoning, outside directors with a broad scale of knowledge about the market and firm’s peers have more input at their disposal to provide valuable advice to the management with respect to strategic decisions (Kor & Sundaramurthy, 2009). Indeed, newly appointed outside directors do not have the required firm-specific knowledge about internal processes, procedures and culture and therefore start with a monitoring deficit in comparison with longer tenured outside directors (Kor & Sundaramurthy, 2009; Veltrop et al., 2015).
An expected level of outside director’s abilities, education, skills and business knowledge forms a condition for the development of competence trust (Nooteboom, 2002) and is correlated to the frequency of interaction (Oortmerssen et al., 2014; Edelenbos & Klijn, 2007; McAllister, 1995) and the quality of meetings in the past (Kramer & Tyler, 1996; Katz, 1982). Additionally, competence trust in an outside director is also related to someone’s reliability towards colleagues, responsibility for the job and the collaboration with other outside directors in the boardroom, which is most likely to become apparent when outside directors have worked together for some time (Nooteboom, 2002; Schaubroeck et al., 2011). However, outside director tenure will have a positive effect on competence trust, especially in the early years in office of an outside directors. Given that, outside directors need to use their broad competences in a relatively short timeframe, referring to the limited amount of meetings in a year, and work situations wherein evidence of
9 failure of performance is easily visible, the focus on capabilities and competences of outside directors increases (Rousseau et al., 1998; Lewicki et al., 2006). This effect is strongest in the early years of tenure of an outside director, because at that time interpersonal contact is mainly based on complex multifaceted tasks (competences) and outside directors have not built up emotional ties yet. Additionally, in this particular period, outside directors face the most intensive learning about the entire firm and that will narrow the knowledge gap between long tenured outside directors and short tenured outside directors in a relatively short time period (Veltrop et al., 2015). At this point outside directors’ competences and abilities become abundantly clear, because extensive capabilities are required to learn all the internal processes of the firm. In sum, we may assume that outside director tenure has a positive effect on competence trust and this effect is strongest in the first years of tenure because at that point the level of trust is mainly determined on outside directors’ competences, responsibility, reliability, and dependability. Thus,
Hypothesis 1a: Outside director tenure is positively related to competence trust, this effect is
stronger at lower levels of tenure.
OUTSIDE DIRECTOR TENURE AND TRUST FROM THE HEART
As in all other social groups, members come to know each other better when they have had a certain amount of interactions in the past. Lewicki et al., (2006) state the following “relationships
mature with interaction frequency, duration, and the diversity of challenges that relationship partners encounter and face together” (p. 1005). After a considerable time in office, outside
directors have built up a rich history of (positive) interactions, feelings and experiences with each other, which results in a proper insight in the different personalities, norms and values and shared interests of colleague outside directors. Also, confident interactions in the past have a positive effect on the quantity and quality of current interactions (Kramer & Tyler, 1996). All these exchanges allow outside directors to gain deeper-level information about psychological similarities or dissimilarities with respect to other board members (Harrison, Price, & Bell, 1998). Furthermore, longer tenured outside directors have developed internal social capital4, have evolved
problem-solving abilities and established a shared understanding among other outside directors in the boardroom (Fischer & Pollock, 2004; Katz, 1982). Hence, the emotional ties become even
4 Internal social capital refers to interpersonal connections within an organisation that develop cohesiveness in
10 stronger in situations where outside directors face highly interrelated tasks, such as strategic related issues (Harrison et al., 1998). All these elements together encourages the feeling of solidarity among board members and ultimately provide a valuable condition for the development of affective trust, also known as trust from the heart (Hardy et al., 1998; Jones & George, 1998; Zand, 1972; Lewicki & Bunker, 1996; Chua et al., 2008). Therefore the author argues that, particularly at a higher level of tenure, affective trust is most likely to develop, because at that time outside directors will have built up internal social capital with their colleague outside directors through repeated deeper-level exchanges. Thus,
Hypothesis 1b: Outside director tenure is positively related to affective trust, this effect is
stronger at higher levels of tenure.
THE COMPOSITION OF COMPETENCE TRUST AND AFFECTIVE TRUST
The previous sections advocate that competence trust will emerge especially in the early years of tenure, where affective trust will principally develop at a higher stage of tenure. Indeed, Rousseau et al. (1998) state that the composition of trust within work relationships differs over time whereby competence trust among outside directors will emerge in the early stages and affective trust will develop at a later stage. McAllister (1995) states that competence trust serves as a necessary foundation for the development of affective trust, especially in settings where the amount of interaction is limited, such as boards (Schaubroeck et al., 2011; Forbes & Milliken, 1999). The degree of someone’s competence, reliability and responsibility in the working field plays an important factor in the determination of trust in general, especially in the early years. Additionally, a certain base of competence trust is an appropriate condition for having frequent interaction and provides the opportunity to learn deeper-level information of other outside directors, such as norms and values, motivation, goals and beliefs, and therefore increases the likelihood that affective trust will arise (McAllister, 1995; Kramer & Tyler, 1996; Harrison et al., 1998; Brickham, Becker, & Castle, 1979; Fukuyama, 1995; Nooteboom, 2002). This is acknowledged by Rempel, Holmes, & Zanna, (1985) who argue that social interaction relies on expectations that are partially based on competence trust, which is generated from past experiences (Jones & George, 1998). We may assume that the degree of competence trust that someone is achieving in the beginning of a work relationship highly influences the progression of the development process of emotional ties with his or her colleague outside director in a later stage.
11 In sum, the author expects that longer tenured outside directors have proven to meet the expectations that is involved with competence trust, which automatically creates a more reliable basis to gain deeper-level personal information which forms the antecedents of affective trust later on. Thus,
Hypothesis 2: Competence trust will mediate the relation between the tenure of an outside
director and affective trust
THE INFLUENCE OF PARTICIPATIVE LEADERSHIP
Since the board of directors forms a specific group of experienced and talented people who scantly see each other around the table, the importance of the way the chairman of the board cooperates within this social group in order to make thoughtful decisions about the firm’s specific matters is evident (Forbes & Milliken, 1999). Many scholars acknowledge that the chairman of the board of directors fulfils a pivotal role in the boardroom, referring to the task of managing complex and sensitive dialogues among board members in order to attain meaningful consensus on firm wide issues (Roberts et al., 2005; Kakabadse & Kakabadse, 2007a). This is recognised by the ‘Monitoring Commission Corporate Governance Code’ who clearly state that the chairman of the board shall ensure the proper functioning of the board of directors (Monitoring Commission Corporate Governance Code, 2016). Hence, the way the chairman of the board of directors manages (leadership style) is decisive for the evolution of an effective decision-making culture in the boardroom (Huse, 2005).
In this light, a participative leadership style of the chairman of the board of directors contributes to an effective decision-making culture, in which the chairman encourages the sharing of problem solving and advocates for a harmonious consensus (Kahai, Sosik, & Avolio , 1997; Somech, 2003). In this participative environment, outside directors perceive a certain amount of responsibility in the boardroom (Sauer, 2011). This leadership style is characterised by joint decision-making and involves a balanced cooperation between board members (Somech, 2006). Participative chairmen express their willingness to achieve a process of social exchange by establishing a joint decision-making culture in the boardroom where self-efficacy among outside directors is encouraged and where conditions that could create a feeling of bureaucracy are removed (Arnold, Arad, Rhoades, & Drasgow, 2000). As a result, outside directors feel comfortable to offer suggestions and opinions that get them truly involved in a harmonious
12 decision-making process (Huang, Lun, Liu, & Gong, 2010; Newman et al., 2016). For instance, a participative chairman is committed to create a working culture wherein outside directors feel free to express their ideas and opinions about firm-specific matters in order to collect valuable input from all the board members and, all together, reach consensus.
Consequently, outside directors will exchange their opinions and ideas with their colleague board members frequently, which in return – in combination with the ‘feeling of self-efficacy’ that encourage the development of emotional ties between outside directors – could ultimately elicit affective trust (Huang et al., 2010; Kramer & Tyler, 1996; Lewicki et al., 2005). Hence, a participative chairman aspires to have a healthy collaboration in the boardroom, which is the reason why the chairman facilitates the social exchange process by giving outside directors time to share their own ideas and by establishing a joint decision-making culture. In sum, the author supposes that participative leadership of the chairman of the board of directors positively influences the transformation from competence-based trust to a more affective-based trust, given that a high degree of participative leadership leads to complete disclosure of abilities and personalities of outside directors, which encourage social collaborations in the boardroom. Thus,
Hypothesis 3: Participative leadership style of the chairman of the board of directors
positively moderates the transformation from competence trust between an outside director and other directors to affective trust between an outside director and other directors.
Figure 1: Conceptual model
Outside director tenure Competence trust Participative leadership Affective trust
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13
Research Method
Research Setting
Many researchers in the board literature acknowledge the difficulty of getting access to data about actual board behaviour and agree that gaining access is one of the most challenging aspects of board research (Daily et al., 2003; Leblanc & Schwartz, 2007; Huse, 2005). Migliore & DeClouette (2011) argue that surveys and questionnaires could be used to determine the perception of trust among outside directors. In line with the statements of the researchers above, this research is based on survey-based data gathered from boards of directors of Dutch school communities, housing agencies, private health institutions and other not-for-profit organisations, taking in mind that outside directors of listed firms would probably be restrained from disclosing crucial board- specific information due to the fear of negative publicity. The majority of these Dutch not-for-profit firms have a two-tier board structure, which involves a formal separation of the day-to-day management and the supervisory board (Bezemer, Peij, Maassen, & Halder, 2012). The tasks of outside directors within a two-tier structure are very similar to the tasks of outside directors within an one-tier structure. The survey data is gathered by using a web-based tool, which involves an online survey that is conducted by the outside directors of these not-for-profit organisations. The data is gathered in the period between May 2013 and February 2016. The outside directors of the boards that participated, voluntarily contributed to this survey.
Sample and Procedure
One of the advantages of this survey study is that actual board behaviour can be measured directly by interviewing the outside directors about their perception of competence trust and affective based trust between their board colleagues. However, the validity of the online survey instrument cannot always be assured and should always be taken into account. The incentive for boards of directors to participate in this survey was stimulated by the fact that participating boards will receive a benchmark report after completing the survey.
451 outside directors from the 85 participating boards of directors received a personal access code for the web site; 433 outside directors (96%) completed the questionnaire. 34% of the participating outside directors were female. To all directors partaking in this survey, an absolute confidentially in the rating of their fellow directors was assured, which involves that none of the answers given will be available to other directors under any circumstances.
14
Measures
Outside director tenure. I define outside director tenure as the length of an outside director’s
tenure in the board of directors of a particular organisation. The participating organisations were legally obliged to disclose information about their board of directors in their annual report. The information regarding tenure of an outside director was obtained from the most relevant annual report of the organisation. Outside director tenure is measured in years before standardisation.
Competence trust. Competence trust in outside directors is directly derived from the online
questionnaire. The following two items of the questionnaire measured competence trust; “I can trust that [name] will performs the job carefully” and “I can trust that [name] will perform his/her tasks professionally and with devotion”. Drawing from the literature, I used a ‘round robin’ model with a response model based on a 7-point Likert scale (1 = strongly disagree, 7 = strongly agree) to measure competence trust between outside directors (McAllister, 1995). The interpersonal results, derived from the items of the questionnaire, are aggregated to an individual level.
Affective trust. Affective trust in outside directors is also directly derived from the online
questionnaire and includes two items. Affective trust is measured on the basis of the following two items; “I can freely share my ideas, feelings and expectations with [name]” and “I can freely speak with [name] about difficulties that I could face when performing my tasks as a director”. Outside directors rated their affective trust in their peers in the form of a ‘round robin’ model on a 7-point Likert scale (1 = strongly disagree, 7 = strongly agree), which is similar to the scale that McAllister (1995) has used. The interpersonal results, derived from the items of the questionnaire, are aggregated to an individual level.
Participative leadership. Participative leadership style of the chairman refers to the chairman’s
use of the information and opinions from all outside directors in making decisions (Arnold et al., 2000). This is measured on the basis of six items from the online questionnaire, which are based on the interview items of the study of Arnold et al. (2000). This scale focuses on the extent to which the supervisor assists the progress of a joint decision-making, and listens to opinions and ideas from his or her subordinates (Newman et al., 2016). Two sample items being; “The chairman of the board of directors listens to ideas and suggestions of outside directors” and “The chairman of the board of directors give all outside directors a chance to share their opinions”. Outside directors responded their perception of participative leadership of the chairman on a 7-point Likert
15 scale (1 = small degree, 7 = high degree). The Cronbach’s alpha was .85. The interpersonal results, derived from the items of the questionnaire, are aggregated to an individual level.
Control variables. Before testing the hypotheses, I excluded all directors who were involved
in the day-to-day management, which resulted in a dataset of outside directors who only operate in the board of that particular firm. Additionally, I added a chairperson dummy in order to distinguish the position of the chairperson in the board for testing the effect of participative leadership on the relationship between competence trust and affective trust. At individual director level, I checked for gender diversity within boards. Since women care more about maintaining emotional ties than men and are therefore less likely to lose trust, I expect that gender could potentially have an impact on the results (Haselhuhn, Kennedy, Kray, Van Zant, & Schweitzer, 2015). Also, I controlled for age in all models. Trust comes with time, and since older outside directors would probably have greater experience and skills accumulated over time, age would blur the relationship between outside director tenure and competence trust between them (Lewicki et al., 2006). Board size is not included as a control variable, since the effect of board size on the results is covered by the method of testing.
Analytical Methodology
A random intercept multilevel analysis is used to test the hypotheses of this research. This multilevel model controls for unobserved heterogeneity and is widely used for data that are clustered, such as board of directors. It estimates separate intercepts and slopes for each participating board of directors, and models all observations simultaneously within the same model (Kreft & De Leeuw, 1998). As mentioned earlier, the board of directors is considered as a social group, and within each specific board of directors across the sample the level of competence trust and affective trust among outside directors is influenced by different factors. Larger boards are likely to have more knowledge and skills at their disposal, and could potentially enhance competence trust. However, a larger board may have difficulty building interpersonal relationship among board member, which could hamper the development of affective trust (Forbes & Milliken, 1999). Therefore the random intercept model contributes to the validity of the results of this study, because this model takes into account the variation of parameters across the boards. To test whether the effect of tenure of an outside director for competence trust is exponential in the early years and the effect of affective trust is more visible in the later stage, the author included a squared term for
16 both dependent variables to the model. The R-square is not included in the models. The random intercept multilevel analysis does not produce the R-square, since it gives different values in computing the correlation between observed and predicted values. It is considered to be difficult to compute the R-square manually and does not provide any contribution to the model in this case.
All hypotheses in this study are measured on individual level by using peer ratings, which means that each director rated all colleague directors individually. The peer ratings are aggregated to the mean for each individual outside director. Before testing the hypothesis all variables in the models are standardised. An interaction term is added to the model in order to test the moderating effect of participative leadership on the relationship between competence trust and affective trust. The data is tested for observations that distant from other observations (outliers), which resulted in the exclusion of seven observations with regard to the outside director tenure variable. All the data, including results from the survey, were controlled for possible errors or empty fields, that derived in a final sample of 412 outside directors’ observations. The observations that were not complete filled in by outside directors that partook on the survey, are excluded from the database. Additionally, the reliability of the survey questions with respect to the level of participative leadership is tested by the Cronbach’s Alpha method and resulted in a score of .85, which is considered reliable. The survey questions regarding participative leadership are combined into one standardised variable and that variable is used to test the third hypothesis.
Results
The Pearson correlation among all the study variables is presented in table 1. As expected, there is a clear positive relationship between age and outside director tenure. The results learn us that both age and outside director tenure are positively correlated to the chairman of the board which indicates that, in general, the chairman of the board is older and has a longer tenure in office in comparison with his or her colleague outside directors. Also, generally we can assume that the chairman of the board is a male. That comes as no surprise, since almost 34% of the outside directors are females. However, female outside directors are positively related to the level of affective trust received from other outside directors. Next to that, affective trust has a positive correlation with the chairman of the board and, as hypothesised, affective trust is significantly positively correlated with outside director tenure. Even more interesting, affective trust is highly correlated with competence trust, referring to the highly significant correlation coefficient of .62.
17
Table 1
Correlations Among Study Variables
Variables 1 2 3 4 5 6
1. Gender
2. Age -.23 **
3. Chairman dummy -.17 ** .27 **
4. Outside director tenure -0.9 .24 ** .16 **
5. Competence trust .04 -.04 .01 .05 6. Affective trust .10 * -.02 .10 * .19 ** .62 ** 7. Participative leadership .03 -.11 * -.01 -.05 .18 ** .12 * Note: N = 412. *p < .05. **p < .01.
Additionally, participative leadership is positively correlated to both competence trust and affective trust, which indicates that participative leadership influences both the level of competence trust and affective trust between outside directors. Another interesting figure involves the negative correlation between participative leadership style and age. This implies that relative younger outside directors embrace a participative leadership style.
The results of the random intercept analyses with respect to the main effects of outside director tenure on competence trust and affective trust are presented in table 2, including the control variables and the squared term of outside director tenure. The first and the fourth model is dedicated to the control variables, whereas model 2 and 5 illustrate the effect of outside director tenure on both competence trust and affective trust. The squared term is added to model 3 and 6. The results with regard to the moderator is shown in table 3. The author started with competence trust and added participative leadership as a separate variable in model 2. Model 3 presents the interaction effect between competence trust and participative leadership.
It was hypothesised that outside director tenure is positively related to competence trust, especially in the early years of tenure. The results from table 2 shows that the coefficient of outside director tenure is slightly positive but insignificant (Model 2, b = 0.09). This relation is also tested with the squared term in order to test the curvilinear effect of the tenure in relation of competence trust. The results showed no significant effect. Thus, findings do not support hypothesis 1a.
18 Hypothesis 1b, however, is partially supported. Although the findings lend support to the assumption that outside director tenure has a positive effect on affective trust, the effect is, in contrast to what was expected, not stronger at higher level of tenure. Table 2 shows a significant positive relation between outside director tenure and affective trust (Model 5, b = 0.24, p < .01), however, as stated above this relation is also tested for a curvilinear effect, and these results show a negative significant squared term (Model 6, b = -0.16, p < .05). This means that affective trust is positively related to outside director tenure but this evolution becomes less positive and eventually negative at a certain point in time, which was, however, not expected. In sum, findings are only consistent with the hypotheses that tenure has a positive effect on affective trust.
Table 2
Main Effect Results of Random Effect Analysis for Competence Trust and Affective Trust
Main effect Competence trust Affective trust
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6
Gender 0.04 0.04 0.04 0.10* 0.11* 0.11*
Age -0.03 -0.04 -0.05 -0.02 -0.05 -0.06
Chairman dummy 0.02 0.02 0.02 0.10* 0.09* 0.09*
Outside director tenure 0.09 0.09 0.24** 0.26**
Outside director tenure squared -0.03 -0.16*
Intercept 0.03 0.05 0.06 0.11* 0.14** 0.23**
Observations 412 412 412 412 412 412
Number of boards 85 85 85 85 85 85
Note:standardised estimates are reported.
*p < .05. **p < .01.
Moreover, hypothesis 2 addresses the mediation of competence trust between outside director tenure and affective trust. The hypothesis is tested by conducting the four step approach of Baron & Kenny (1986), which involves a regression analysis for each step that is linked to a path in the full mediation model (figure 2). Paths were drawn from outside director tenure to both competence trust (mediator) and affective trust, and directly from competence trust to affective trust. Outside
19 director tenure is tested without the squared term, which means that the results in the mediation model show a linear effect. As figure 2 illustrates, outside director tenure was statistically significantly related to affective trust (b = .24, p < .01), as was the relationship between competence trust and affective trust (b = .53, p < .01). However, the relationship between outside director tenure and competence trust fell statistically out of the significance range (b = .09). A significant path between outside director tenure and competence trust is required to support the mediation effect of competence trust. I also conducted a regression analysis and added outside director tenure and competence trust as a predicted variable and affective trust as an outcome variable, which resulted in an estimate of 0.19 (p < .01). However, in sum the findings indicate that there is not enough evidence to argue that affective trust is partially or fully mediated by competence trust because of the insignificant relationship between outside director tenure and competence trust, and therefore hypothesis 2 is rejected.
Table 3
Moderator Effect Results of Random Effect Analysis for Affective Trust
Moderator Affective trust
Model 1 Model 2 Model 3
Gender 0.09* 0.09* 0.08*
Age -0.03 -0.03 -0.03
Chairman dummy 0.08* 0.08* 0.08*
Outside director tenure 0.19** 0.19** 0.19**
Competence trust 0.53** 0.53** 0.54**
Participative leadership 0.01 0.03
Competence trust × Participative leadership 0.09*
Intercept 0.12** 0.12** 0.11*
Observations 412 412 412
Number of boards 85 85 85
Note:standardised estimates are reported.
*p < .05. **p < .01.
20
Figure 2: Full mediation model
Outside director tenure Competence trust Affective trust 0.09 0.24** 0.53**
With regard to hypothesis 3, the results in table 3 indicate that a participative leadership style of the chairman of the board plays a significantly moderating role in the relationship between competence trust and affective trust among outside directors (Model 3, b = 0.09, p < .05). As illustrated in figure 3, a higher degree of participative leadership of the chairman of the board will enhance the evolution of affective trust. The difference in level of affective trust between high- and low participative leadership will increase further in times of a high level of competence trust among outside directors, and therefore we can state that participative leadership of the chairman definitely influences the degree of affective trust, given a certain amount of competence trust. In sum, findings support hypothesis 3.
Figure 3: Interaction plot of participative leadership of the chairman
2 2,5 3 3,5 4
Low Competence Trust High Competence Trust
Affective trust Low Participative Leadership High Participative Leadership
21
Discussion
The goal of this research was to open up the proverbial ‘black box’ of actual board behaviour. The foregoing studies have paid surprisingly little attention to what actually happens inside the boardroom, keeping scientists still unaware about the antecedent and development process of competence trust and affective trust among outside directors (Roberts et al., 2005). Accordingly, this study provides, by using a multilevel analysis based on individual peer ratings from outside directors, new insights in the understanding of the relationship between outside director tenure and competence trust and affective trust, including the influence of the leadership style of the chairman of the board on the development process of affective trust among outside directors. In line with the findings of the studies of McAllister (1995) and Rousseau et al. (1998) the author hypothesised that outside director tenure would have a positive impact on affective trust and competence trust, whereby the effect on affective trust is the strongest in the later stage, and the effect on competence trust is supposed to be more likely in the beginning of time of service. In addition, the author explored whether competence trust mediates the primary relationship between outside director tenure and affective trust referring to the theory that the development of affective trust depends on a certain elementary level of competence trust in that particular person. The relationship between outside director tenure and affective trust is supposed to be positively moderated by the participative leadership style of the chairman and concerns the last hypothesis. Overall, the results support that outside director tenure has an inverted U-shaped relationship with affective trust, whereby the level of affective trust increases in the first years of tenure and decrease after a considerable time in office. The results indicate that participative leadership style of the chairman plays an important role in the development of affective trust.
This research has several theoretical and practical contributions. First, the primary theoretical contribution of this study to board research is the assessment of the foundations of actual board behaviour within organisations. This contribution is important since scientists are still unaware of the internal processes within the boardroom, frequently called the ‘black box’, and its effects (Huse, 2005; Roberts et al., 2005; Huse & Zattoni, 2008). Starting from there, this research includes new insights to the current corporate governance literature in the field of the antecedents of interpersonal trust between outside directors in this specific episodically environment, and more generally, highlights the need for additional research in the field of actual board behaviour.
22 Secondly, in this study trust is reasoned from a two-dimensional theoretic model whereby affective trust and competence trust are measured interdependently, and is consequently linked to the transformational model, by which the type and nature of trust transforms over time (Lewicki et al., 2006). With regard to affective trust, the findings of this study indicate that outside director tenure is positively related to the level of affective trust, which means that longer tenured outside directors have built up emotional ties with their colleague board members, since they have a longer history of working together (Lewicki et al., 2006). As stated earlier, affective trust is based on personal contact and good faith, which is only attainable after a history of interaction. On the other hand, the results show a curvilinear relationship. While affective trust increases at lower levels of tenure, it decreases at higher levels of tenure, that is, in contrast to what was hypothesized. The results that affective trust declines as tenure increases seems to be inconsistent with the theory of McAllister (1995) and Rousseau et al. (1998). On the other hand, affective trust is very fragile because trust is hard to gain but easy to lose (Lewicki & Bunker, 1996). Also, there are different levels within affective trust, meaning that outside directors experience different levels of emotional ties with colleague outside directors. Even when a basic level of affective trust is met, outside director should endeavour to retain the emotional bonds in the future. This could be considered as a serious challenge, since long outside directors – with a considerable perceived level of affective trust – experience relative high expectations from other outside directors (Deutsch, 1958). Hence, such high expectations might be hard to achieve due to the episodically nature of boards. Lewicki & Bunker (1996) state that trust (competence trust and affective trust) could decline due to the failure of meeting predefined expectations. Altogether, long tenured outside directors must make a great effort to retain emotional ties, which is considered difficult in this episodically environment and could lead to an decrease in affective trust.
However, the relationship between outside director tenure and competence trust is rejected, which implies that competence trust is not influenced by the frequency of interaction and the know-how gained in the early years of service, which is in line with the findings of Dunn (2000). However, the results could be argued by the fact that outside directors are contracted on the basis of their competences and knowledge for that specific task within the board in order to bring those resources to the firm (Hillman et al., 2009; Johnson et al., 2013). In this way (new) outside directors are considered to be fully competent, even in the early years of tenure, because they are hired to bring those competences into the boardroom. In a similar vein, the level of competence trust could
23 also be affected by the fact that outside directors have gained prior knowledge of the competences of other outside directors over the last years, and that they trust in the competences of the new outside director even not knowing his or her competences very well (Lewis & Weigert, 1985). In this situation it might occur that we “trust in trust” (Welch et al., 2005). Also, the insignificant relation between outside director tenure and competence trust causes also the unsupported indirect effect of the mediator since the other paths of the mediator were supported (see figure 2). As the results illustrated, competence trust is highly significantly correlated to affective trust, which is consistent with the understanding that a certain level of competence trust is necessary for the development of affective trust and is consistent with the transformational model (McAllister, 1995; Rousseau et al., 1998). Summarised, the findings provide additional insights in the evolution of affective trust and competence trust among outside directors. In line with the results of McAllister’s study, the author has proven that having frequent interaction, or long tenure in office, positively influences affective trust between outside directors. On the other side, this effect is lower at higher levels of tenure. In contrast with affective trust, competence trust is not influenced by outside director tenure. These findings are an interestingly eye-opener. Although outside director tenure has a greater impact on the level of affective trust in comparison with competence trust, corporate governance research is mainly focused on the impact of outside director tenure on the cognitive dynamics in the boardroom. In contrast to studies that investigate the impact of outside director tenure on the level of know-how (Vafeas, 2003) or entrenchment (Kor & Sundaramurthy, 2009), this research highlights the fact that affective elements of board behaviour should not be underestimated in future board studies.
The third theoretical contribution of this study involves the impact of the leadership style of the chairman of the board on actual board behaviour. The findings regarding the moderation effect of a participative leadership style of the chairman on competence trust and affective trust which is consistent with the results of Blau (1964) and Miao et al. (2014), who stated that a participative leadership style and its emphasis on social exchange, enhance the level of affective interaction between parties. This understanding teaches us that in a setting where a high level of specific knowledge is obligatory and sets the tone, the chairman of the board plays a prominent role in the development process of competence trust to a higher quality of trust (affective trust), which finally enhances the board’s effectiveness. This underlying mechanism is important for the understanding of actual board behaviour, and trust in particular, and therefore contributes to the board literature.
24 The last theoretical contribution involves the research method that is used for this study. Migliore & DeClouette (2011) proposed in their review that board studies should use interviews and surveys to determine the perceptions of trust among outside directors. This research gives an answer on that statement and uses a unique comprehensive dataset comprised of survey data. Indeed, methods like these should be used more often in board literature in order to obtain such hard collectable personal data. This study might increase the awareness of the methodological possibilities for future research.
This study contains practical implications as well. By the request of the Monitoring Commission Corporate Governance Code (2016), the tenure of an outside director in office should be limited to two times a period of four years. They propose that long tenured outside directors become entrenched with the organisation and may become “stale in the saddle”, which makes them less capable to monitor the management strictly (Hillman et al., 2011; Kor & Sundaramurthy, 2009). According to Katz (1982) entrenchment involves a reduction in the amount of outside communication and an increase in rigidity in decision making. However, the results indicate that longer tenured outside directors experience a higher quality of trust (affective trust), which is considered as an essential element of an effective supervisory board mechanism (Jones & George, 1998; Mayer et al., 1995). Nevertheless, while scholars and regulators chiefly focus on the impact of outside director tenure on cognitive elements in the boardroom, this study shows a contrary point of view for two reasons. First, this study provides evidence that emotional elements should not be ignored in setting up new regulations, since affective trust is significantly affected by outside director tenure. Secondly, the findings show no single effect regarding the cognitive elements, because competence trust is not related to outside director tenure.
The second practical implications contains the leadership style of the chairman of the board. As Lencioni (2002) stated earlier, a lack of decent trust in the board of directors increases the likelihood that the team will fail. In board of directors wherein the level of trust is considered to be critical, it would be wise that the board is served by a chairman who is willing to adopt a participative leadership style in the boardroom. In this circumstance, the chairman of the board of directors is prompt to give attention to the development process starting from a competence-based trust to a more affective-based trust among outside directors, which results in a higher state of the overall trust in the boardroom. This higher state of trust is expected to boost collaboration and decision-making within the board of directors and reduces the likelihood of failure.
25
Limitations and Future Recommendations
A number of limitations of this research should be acknowledged. This study is based on data that are measured at a single point in time. This so called static ‘snapshot’ limits the ability to draw conclusions about whether the level of trust will increase or decrease over time. In addition, this cross-sectional design of outside director tenure is not always identical to frequency of interaction. For example, it may occur that a newly hired outside director comes into the board of directors and assesses the trustworthiness of a long tenured outside director. This reflects the fact that the amount of interaction is not always similar to tenure. Since the study is cross-sectional in nature, we should not underestimate the inferences of the causality with regard to the relationship between competence trust and affective trust. Future research should focus on repeated measurements of trust with a reliable timeframe and determine whether competence trust precedes affective trust in the causal order. However, the ability to gather such personal information will remain a serious challenge in future research.
Another limitation of this research relates to the likelihood of the well-known common method variance problem (Campbell & Fiske, 1959). The findings of this study could be biased by the use of a common source (outside director) in determining the perception of competence trust and affective trust, which could potentially hamper the validity of the relationships (Podsakoff, MacKenzie, Lee, & Podsakoff, 2003). However, by specific wording and format of the questions in the survey it was endeavoured to guarantee the validity of the measurement with regard to the variable. Future studies that examine actual board behaviour could use a different set of sources to obtain measures of the construct.
Furthermore, the sample consists of organisations with a two-tier board structure. Although there is a formal difference in structure between a one-tier and a two-tier board structure, the tasks of the outside directors of both structures are similar (Bezemer, Peij, Maassen, & Halder, 2012). Additionally, the sample of the research only includes not-for-profit organisations, which could potentially affect the results of this research. According to Forbes & Milliken (1999), boards of directors differ in terms of diversity, tasks and commitment. They argue that outside directors of not-for-profit boards experience a strong commitment to the organisational objectives and may be associated with a high level of cohesiveness, which in turn could potentially enhance the level of trust among outside directors. Furthermore, board of directors of not-for-profit organisations generally include a higher level of female outside directors in comparison with profit
26 organisations. More female outside directors might positively influence the degree of affective trust within the boardroom (Haselhuhn et al., 2015). Therefore, future studies should investigate whether the degree of competence trust and affective trust among outside directors differs between profit- and not-for-profit organisations.
Moreover, future research could add institutional-based trust to the model. Institutional-based trust involves factors that support the development of competence trust and affective trust (Rousseau et al., 1998), such as societal norms and values (Miles & Creed, 1995) and legal forms (Fukuyama, 1995). This information was unfortunately not available, but could obtained in future survey or experimental studies. In addition, within the trust literature there is much unclear about the understanding of the elements that cause a reduction in affective trust in interpersonal relationships between outside directors. This is surprising since trust has been a widely used topic in the sociologic and management literature. However, future studies may include a broader investigation about the antecedents of the decrease in affective trust after a considerable time in the office. In this respect, examining the effects of outside director tenure among outside directors on interpersonal level could lead to a deeper understanding of the different levels of affective trust between two individuals. At times that individuals have a comparable tenure in office, they have probably shared the same experiences and therefore gained a higher level of affective trust in comparison with colleagues outside directors with non-comparable outside director tenure (Kramer & Tyler, 1996). Furthermore, the practical and work-related inferences of affective trust between outside directors in this episodically environment could be an interesting subject in future studies.
Conclusion
The rising attention of scientists for board literature in the context of corporate governance has spread out over various streams. Probably one of the most challenging direction in this perspective is the research on actual board behaviour, which is still considered as a proverbial ‘black box’. Prominent scholars advocate for more research in this field of board literature, and this study answers that call with examining factors that influence the evolution of interpersonal trust among outside directors (Huse, 2005). By integrating the two-dimensional model of trust of McAllister (1995), the author has found support that outside directors tenure has an inverted U-shaped relationship with affective trust. While affective trust increases at lower levels of tenure, it
27 decreases at higher levels of tenure. On the other hand, the level of competence trust is not driven by the time that an outside director serves in the boardroom. Furthermore, participative leadership style of the chairman of the board positively moderates the development process of affective trust, that is, build up on a certain level of competence trust. This is with the reason that participative leadership style is characterised by emphasising social exchanges among outside directors, which ultimately enhances affective trust. These findings emphasise the importance of the leadership style of the chairman of the board in times when a decent quality of trust is required. Overall, the results of this study highlight the importance of the understanding of interpersonal trust – and affective trust in particular – among outside directors in setting new board regulations within the corporate governance theme.
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