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Keywords:

  • Board Structure;
  • Board Processes;
  • Social Capital;
  • Research Dependence Theory;
  • Stewardship Theory

ABSTRACT

  1. Top of page
  2. ABSTRACT
  3. INTRODUCTION
  4. THE CONCEPT OF SOCIAL CAPITAL
  5. TWO TYPES OF SOCIAL CAPITAL: INTERNAL VS. EXTERNAL
  6. SOCIAL CAPITAL, DIRECTOR SELECTION, AND BOARD EFFECTIVENESS
  7. METHODOLOGICAL ISSUES
  8. CONCLUSION
  9. ACKNOWLEDGEMENTS
  10. REFERENCES

Manuscript Type: Conceptual

Research Question/Issue: Our study evaluates the role of social capital in new director selection, board composition, and board effectiveness.

Research Findings/Insights: We take steps toward a theory of director selection, explaining how social capital at the individual-level influences director selection and at the group level influences board effectiveness. At the individual level, social capital is defined as the interpersonal linkages that director candidates have to others, both inside and outside the firm. At the group level, board social capital is an asset that includes both relations of directors and potential resources arising from the relations.

Theoretical/Academic Implications: We argue that: 1) social capital can be divided into internal and external dimensions according to its locus and function; 2) both internal and external social capital are associated with board composition through director selection, although the causal logic differs considerably; 3) the influences of social capital on director selection vary according to the context; and 4) both internal social capital and external social capital generate unique resources that are important to board effectiveness.

Practitioner/Policy Implications: Our study informs practicing managers, because we describe how and why most research and public discussion has emphasized the role of directors as monitors of managers and this has significantly downplayed the role of directors in providing advice, counsel, and other resources to their organizations. We provide a strong logic for seeking directors with specific types of social capital (internal or external) under specific contexts.


INTRODUCTION

  1. Top of page
  2. ABSTRACT
  3. INTRODUCTION
  4. THE CONCEPT OF SOCIAL CAPITAL
  5. TWO TYPES OF SOCIAL CAPITAL: INTERNAL VS. EXTERNAL
  6. SOCIAL CAPITAL, DIRECTOR SELECTION, AND BOARD EFFECTIVENESS
  7. METHODOLOGICAL ISSUES
  8. CONCLUSION
  9. ACKNOWLEDGEMENTS
  10. REFERENCES

Much has been written about boards of directors as an important governance mechanism. Whereas numerous studies have focused on the relationship between board composition and firm performance, fewer scholars have focused on the autecedents of board composition and attempted to link those autecedents to effective governance (Hillman and Dalziel, 2003; Lynall, Golden, and Hillman, 2003). Our study is designed to further understanding of corporate governance through a better understanding of the director selection process.

The popular news media is replete with examples of what boards of directors should not be. Finkelstein and Mooney (2003) refer to the factors inherent in these examples as the “usual suspects,” including relatively few outside (independent) directors, little or no share ownership by directors, boards that are too large, and CEOs who also serve as board chairs (i.e., CEO duality). However, rigorous research on board effectiveness has not yielded much evidence that these “usual suspects” have any meaningful connection to firm performance. For example, in a meta-analysis of 54 studies on board composition, Dalton, Daily, Ellstrand, and Johnson (1998) found no substantive relationship between board composition and firm performance. In another meta-analysis of 37 studies on board composition, Rhoades, Rechner, and Sundaramurthy (2000) found only an inconsequential relationship between outside directors and firm performance. Finally, Finkelstein and Mooney (2003) found no significant differences between high-performing companies and low-performing companies in terms of number of outside directors, director shareholdings, board size, and CEO duality.

Noting the lack of empirical support and other challenges to the traditional agency theory predictions about board effectiveness, Ghoshal (2005) suggested a fundamental rethinking of corporate governance issues, particularly those surrounding board composition and independence. In response, we strive to go beyond the “usual suspects” in exploring boards of directors. In that regard our manuscript aligns with the work of Forbes and Milliken (1999), Finkelstein and Mooney (2003), and Huse (2005, 2007). Forbes and Milliken (1999) focused on various aspects of board culture through concepts like cognitive conflict, cohesiveness, creativity, commitment, criticality, and consensus. Similarly, Finkelstein and Mooney (2003) focused on how board process is linked to board effectiveness. Huse (2005, 2007) emphasized the need to balance external perspectives (the control tasks) and internal perspectives (the service tasks) on board behavior. While all these studies have adopted behavioral approaches to the study of boards, our manuscript moves toward a theory of director selection and its impacts on board effectiveness by adopting a social capital perspective.

We define “social capital” as the interpersonal linkages between individuals, both inside and outside the firm, that are important to boards. We note that social capital is embodied in board composition. At the aggregate level, board social capital is a group-level asset that represents both the relations and the potential resources arising from the relations of directors. By board effectiveness, we mean 1) the board's ability to perform its service tasks effectively; 2) the board's ability to work effectively as a group, as evidenced by its cohesiveness (Forbes and Milliken, 1999; Finkelstein and Mooney, 2003); and 3) the board's ability to perform resource dependence and boundary spanning tasks, defined as the board's ability to provide (to the firm) valuable resources or information from the external environment.

We use social capital theory to make predictions about new director selection (i.e., which candidates for directorship are more likely to be chosen). We also theorize about how board-level social capital impacts board effectiveness. In that way, our approach differs markedly from prior research, as we do not make predictions about selection (or board composition) in terms of “insiders” versus “outsiders,” but rather consider the social capital profiles of candidates. Once we understand the social capital that new directors bring to the board, we can better understand how the board's overall social capital impacts its effectiveness, as reflected in firm performance. Kim and Cannella (2007) offer a somewhat parallel approach, but for executive promotion decisions, not for corporate directors.

In this paper we first briefly review the concept of social capital. Then we describe two types of social capital that are particularly relevant to boards and the potential “main effect” outcomes associated with each type. Finally, we discuss three likely moderators of the association between social capital and board composition, and develop propositions about how each influences the social capital–director selection relationship, and ultimately board effectiveness.

THE CONCEPT OF SOCIAL CAPITAL

  1. Top of page
  2. ABSTRACT
  3. INTRODUCTION
  4. THE CONCEPT OF SOCIAL CAPITAL
  5. TWO TYPES OF SOCIAL CAPITAL: INTERNAL VS. EXTERNAL
  6. SOCIAL CAPITAL, DIRECTOR SELECTION, AND BOARD EFFECTIVENESS
  7. METHODOLOGICAL ISSUES
  8. CONCLUSION
  9. ACKNOWLEDGEMENTS
  10. REFERENCES

Although the concept of social capital originated in the nineteenth century classics of sociology, three American sociologists – Ronald Burt, James Coleman, and Robert Putnam – have made large contributions to the recent development of the construct. Each of these scholars has offered a slightly different definition of social capital. Coleman argued that social capital must be defined by its function and that social capital is created “when the relations among persons change in ways that facilitate action” (Coleman, 1990: 304). Burt defined social capital as relationships with others –“friends, colleagues, and more general contacts through whom you receive opportunities to use your financial and human capital” (Burt, 1992: 9). Finally, Putnam construed social capital as a property of groups or communities (or even nations), rather than of individuals, and defined it as “features of social organization, such as trust, norms, and networks that can improve the efficiency of society by facilitating coordinating actions” (Putnam, 1993: 167).

While Burt's approach characterizes social capital as relations or networks of relations per se, Coleman's approach characterizes it as the combination of relations and resources, and Putnam's approach goes beyond Coleman's by including such moral resources as trust and norms. Drawing on these definitions, our notion of social capital has several prominent characteristics. First, it is both an individual-level and a group-level asset that includes both relations and potential resources arising from the relations. By including both relations and resources, our concept of social capital includes not only social networks but also the content of social relations such as trust, liking, obligation, and respect, as well as the outcomes from social relations such as information, influence, and solidarity.

Second, our notion of board social capital includes the individual director's personal ties, but also his or her social similarity with others, or homophily. Homophily is the degree to which pairs of individuals who interact are similar in identity or group affiliation (Ruef, Aldrich, and Carter, 2003). Homophily plays an important role in creating trust by making reciprocal relationships more predictable (Bacharach, Bamberger, and Vashdi, 2005; Marsden, 1988), while direct, personal ties can provide access to information (Granovetter, 1973), and influence (Bian, 1997; D’Aveni, 1990; D’Aveni and Kesner, 1993).

Third, both Coleman (1990) and Burt (1992) have argued that social capital is located not in the actors themselves but in links to other actors. For example, Burt argues, “No one player has exclusive ownership rights to social capital. If you or your partner in a relationship withdraws, the connection dissolves with whatever social capital it contained” (1992: 58). While we agree, we also argue that social capital can be considered an individual resource. Additionally, even though a tie that connects two players is jointly owned by the two, the actual value of the tie for each player differs according to his or her position, ability, and power. For example, suppose there is a candidate for a director position who has a close relationship with the CEO. Whereas the relationship is jointly owned by the candidate and the CEO, the value of the relationship is probably much greater for the candidate than for the CEO. Thus, while no one player has exclusive ownership rights to a tie, social capital can be analyzed as an individual resource, and a resource that is not equally valuable to all parties to the tie.

Finally, social capital can have more costs than benefits under certain circumstances (for a discussion of the costs and downsides of social capital, see Portes, 1998, and Portes and Landolt, 1996). For example, Woolcock (1998) described how, upon arriving at a new country, immigrants’ entry to a given ethnic community (e.g., Koreans in south-central Los Angeles or Puerto Ricans in New York) provides them with access to financial and social support that enables them to successfully create new businesses. When the businesses grow in size and complexity, the immigrant entrepreneurs need larger and more heterogeneous markets, and therefore, they often wish to extend the networks beyond their ethic community. However, this is very difficult because of highly demanding intra-community obligations. The stronger the commitment to the focal ethnic group, the harder it is to expand beyond that group. Similarly, if an individual is too strongly committed to any particular group, it is difficult to expand his or her network beyond that group due to the high maintenance costs for the existing network.

Based on the above points, our study assumes 1) individuals can possess too much or too little social capital; 2) there are different types of social capital, depending upon to whom a person is linked and how; and 3) individuals often can increase one type of social capital only at the expense of another. In the following section, we discuss two types of social capital to shed light on the following two questions. First, how should relationships be described (i.e., relationship to whom and how) to further our understanding of the role of social capital in director selection? Second, what are the roles of social capital in the context of boards of directors?

TWO TYPES OF SOCIAL CAPITAL: INTERNAL VS. EXTERNAL

  1. Top of page
  2. ABSTRACT
  3. INTRODUCTION
  4. THE CONCEPT OF SOCIAL CAPITAL
  5. TWO TYPES OF SOCIAL CAPITAL: INTERNAL VS. EXTERNAL
  6. SOCIAL CAPITAL, DIRECTOR SELECTION, AND BOARD EFFECTIVENESS
  7. METHODOLOGICAL ISSUES
  8. CONCLUSION
  9. ACKNOWLEDGEMENTS
  10. REFERENCES

We find it most useful to divide social capital into interpersonal linkages that involve others already in the focal organization, the board of directors in particular, and linkages that involve others outside the organization. Among incumbent directors there are those who can directly influence (or even control) new director selections, including the CEO, chairperson of the board, the company founder, or other senior executives and/or directors. On the other hand, there are influential stakeholders outside the organization, and director candidates who can bring strong linkages to those stakeholders may be particularly valuable. We label the ties to those inside the organization as internal social capital, and the ties to those outside the organization as external social capital.

A key reason for dividing social capital into these two categories is that each draws upon different types of network linkages and provides different resources to the board. Additionally, neither category alone can provide a complete explanation of the effects of social capital on director selection. Internal social capital influences director selection because those deciding whom to select will naturally favor and trust others like themselves and others to whom they have close interpersonal relationships. External social capital influences director selection because those with diverse ties to external stakeholders can provide more, newer, and potentially more valuable information from outside the firm. For external social capital, both the prestige of contacts and the diversity of contacts are important. Table 1 outlines the differences between internal and external social capital in terms of their sources, their characteristics and costs, and their functions.

Table 1.  Two types of social capital
Type of social capitalSourcesNetwork profilesCosts/characteristicsFunctions
Internal social capitalTies and relations with other people within the firm, mainly the other directorsDense and small network with few structural holes• High maintenance costs • Very firm-specific • Once the important contacts (such as CEO) leave the firm or lose power, the value of social capital decreasesBonding: facilitating trust and collaboration among network members, enhancing Teamwork, impacting the director selection decision
External social capitalTies and relations with various outside contacts, including investors, customers, suppliers, legal authorities, politicians, etc.Sparse and large networks with many structural holes• Individuals with high external social capital will be distant from other dominant coalition members • Not firm specificBridging: providing additive information, and cooptation benefits to the holder and the organization

We should note that external and internal social capital are not necessarily mutually exclusive (i.e., a person with high external social capital may also have high internal social capital and vice versa). Considering the maintenance costs of social capital, however, a person or a group with a large stock of one type of social capital is likely to lack the other type (McFadyen and Cannella, 2004). Individuals with high external social capital often function as boundary spanners, linking their organizations to critical resources or information in the environment. Boundary role spanners tend to be distant, psychologically and organizationally, from other members of the organization, and this distance makes those with high external social capital tend to relatively lack internal social capital (Adams, 1976). On the other hand, those with high stocks of internal social capital have probably not been able to develop and maintain a broad and sparse external network. As indicated by the immigrant entrepreneurs’ example, intra-network obligations are very demanding, so expanding the external network will be relatively difficult and costly to those with high internal social capital. Therefore, while having some optimal level of both types of social capital may be ideal, we expect that most individuals will tend to have much more of one type of social capital and much less of the other.

Figure 1 illustrates two individuals with different combinations of social capital. Person A has high internal social capital and low external social capital, as indicated by the bold lines (i.e., strong ties) to others in the dominant coalition of Organization X. Strong demands from constituents inside the dominant coalition prevent Person A from building a diverse external network. Person B, on the other hand, has high external social capital and low internal social capital. Here, many outside players are linked to the person, but there are few strong ties to the dominant coalition members inside Organization Y.

image

Figure 1. Board Members with Different Types of Social Capital Bold lines reflect strong ties while lighter lines reflect weak ties.

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SOCIAL CAPITAL, DIRECTOR SELECTION, AND BOARD EFFECTIVENESS

  1. Top of page
  2. ABSTRACT
  3. INTRODUCTION
  4. THE CONCEPT OF SOCIAL CAPITAL
  5. TWO TYPES OF SOCIAL CAPITAL: INTERNAL VS. EXTERNAL
  6. SOCIAL CAPITAL, DIRECTOR SELECTION, AND BOARD EFFECTIVENESS
  7. METHODOLOGICAL ISSUES
  8. CONCLUSION
  9. ACKNOWLEDGEMENTS
  10. REFERENCES

Any discussion of director selection and board effectiveness must begin with a consideration of what directors do. While Huse (2005, 2007) recently classified the roles of the board into six categories (i.e., behavioral control, output control, strategic control, advice and counsel, networking and lobbying, and strategic participation), the broader literature on boards generally discusses three tasks: monitoring management (control tasks); providing advice and counsel to management (service tasks); and providing resources from the external environment (resource dependence tasks). Of particular relevance to this manuscript are the latter two tasks.

The service tasks of directors, which are partly based on stewardship theory, entail providing advice and counsel to the CEO and top managers. While agency theory assumes managerial opportunism, leading to a strong need to monitor and control management (c.f., Jensen and Meckling, 1976), stewardship theory is based on the assumption that managers strive to be stewards of shareholder interests (c.f., Donaldson, 1990). Stewardship theory promotes boards as collaborative and mentoring, and as actively participating in strategy formulation and implementation.

The resource dependence tasks entail directors acting as boundary spanners who link the organization and its environment. Resource dependence theory suggests that organizations are not autonomous, but rather are constrained by their institutional environments including such societal institutions as governments, financial institutions, and other important external stakeholders (Pfeffer and Salancik, 1978). According to resource dependence theory, directors often perform externally-oriented functions, such as lobbying, that may generate income for the firm.

Both internal and external social capital are important for director selection decisions, but they are important for different reasons because directors perform multiple tasks. Figure 2 illustrates the main effects and moderators of internal and external social capital on director selection decisions and board effectiveness. One of the central arguments of our study is that the aggregate social capital of the board is a firm-specific intangible resource, critical to the firm's acquisition and maintenance of sustainable competitive advantage. We argue that: 1) both internal social capital and external social capital generate unique competitive advantages thereby influencing board effectiveness; and 2) contextual factors impact which kind of social capital is needed and thus, most sought-after from director candidates.

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Figure 2. Social Capital as a Determinant of Director Selection and Board Effectiveness

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Internal Social Capital

The benefits of internal social capital, in terms of board tasks, can be summarized as follows. First, internal social capital among directors reduces various economic costs associated with communication and cooperation at the board level. A primary function of social capital is to enhance trust between those who share it. According to Coleman, “if A does something for B and trusts B to reciprocate in the future, this establishes an expectation in A and an obligation on the part of B” (1988: 102). Coleman asserts that these expectations and obligations are a form of social capital that depends on two factors – trust and the actual extent of obligation held. Trust can significantly reduce transaction costs (Williamson, 1975) and coordination costs (Pfeffer, 1983). Boards with high trust among directors also find it easier to communicate and cooperate.

Forbes and Milliken (1999) emphasized effort norms as a key determinant of board effectiveness. Effort norms are a group-level construct defined as the group's shared belief regarding the level of effort each individual is expected to put forth toward a task (Wageman, 1995). It has long been known that organization members do not all share selfless devotion to the same objectives (Barnard, 1938). Because most directors face competing demands and must keep carefully planned schedules (Lorsch and MacIver, 1989; Mace, 1986), their time is very valuable and not all of them will be devoted to the same objectives and “do the homework” necessary for understanding the company's various business issues (Mace, 1986: 107). High levels of internal social capital lead to strong, board-level effort norms, thereby increasing the effort that directors invest in their service. Also, by enhancing trust, internal social capital increases effective collaboration and communication inside the boardroom.

Second, internal social capital facilitates the exchange of valuable information and knowledge. By facilitating the flow of information, internal social capital accelerates knowledge transfer (Hansen, Podolny, and Pfeffer, 1999), and creates intellectual capital within the organization (Nahapiet and Ghoshal, 1998). Resource-based theory suggests that firm-specific culture can be a source of competitive advantage (Barney, 1986; Wernerfelt, 1989). For example, Barney (1986) suggests that unique organizational skills and abilities, involving combinations of firm resources, form the foundation for competitive advantage. Forbes and Milliken (1999) noted that potentially income-generating cultural resources and organizational skills and abilities seldom emerge without an effective board of directors, and an effective board of directors seldom arises without effective communication and cooperation (i.e., strong internal social capital) among directors.

The third benefit from board internal social capital is teamwork deriving from cohesiveness among directors (Forbes and Milliken, 1999). Because agency theory, which emphasizes board independence, continues to dominate academic research on corporate governance (Daily, Dalton, and Cannella, 2003), boards consisting of directors who are close to each other and close to the CEO have been perceived as troublesome. However, Finkelstein and Mooney (2003), after conducting 32 structured interviews with directors, pointed out that directors work hard to provide advice and counsel to management and other resources to the firm, but also to balance that resource provision with effective monitoring of managers. This tension in director roles and responsibilities increases the importance of team-level resources such as cohesiveness. Put differently, effective director service is much more likely when the board functions as a cohesive team.

It is important to recognize that “teamness” (Hambrick, 1994) should not be automatically assumed for boards because they meet only occasionally and director service is a part-time responsibility (Finkelstein and Mooney, 2003). However, a lack of “teamness” reduces the ability of directors to work together effectively (Kim, 2005). We argue that a board's ability to function as a team will be greatly improved when directors have high levels of internal social capital. Internal social capital helps to resolve the problems associated with the lack of team spirit, trust, and collaboration which are critical to fulfilling the board's service tasks. For these reasons, director candidates with more internal social capital will be preferred to those with less, and boards with high levels of internal social capital will function effectively as a group. Therefore, we propose:

Proposition 1a: The internal social capital of director candidates will be positively associated with new director selection because it indicates the extent to which a given candidate is known, liked, and trusted by incumbent directors.

Proposition 1b: Board-level internal social capital will be positively associated with board effectiveness, because internal social capital leads to increased trust and teamwork, thereby increasing collaboration and cohesiveness.

External Social Capital

As shown in Table 1, the primary function of external social capital is bridging (i.e., linking the firm to outside constituents). External social capital, which derives from a person's contacts with such external stakeholders as suppliers and clients, investors, political elites, and other business leaders, can also play a significant role in director selection decisions. Pfeffer (1973) posits that there are two distinct strategies that organizations can pursue to ensure survival and growth. The first is an internal strategy, by which organizations concentrate on improving the efficiency of the internal transformation process, thereby reducing transaction costs and enabling more effective internal resource allocation. The second is an external strategy, by which organizations attempt to ensure favorable exchanges with other organizations through actions taken vis-à-vis these organizations.

In a parallel argument, strategic leadership theories suggest that boards of directors operate at the boundary between the environment and the organization (Barnard, 1938; Mintzberg, 1973; Kotter, 1982; Thompson, 1967). The environment encompasses key suppliers, buyers, regulatory agencies, governments, and rival organizations that produce similar services and products (DiMaggio and Powell, 1983). The organization benefits from the external social capital of its directors in two ways. First, using their external social capital, directors gather information from outside and take actions accordingly to align the organization with the environment. Second, directors may be able to modify the environment by cooptation (Selznick, 1949) – defined as the absorption of potentially disruptive elements into an organization's decision making structure. For example, individuals with powerful outside contacts can lobby the government to change laws or can influence important external parties to create more favorable environmental contexts. These external activities are expected to increase the organization-environment fit, thereby increasing firm performance. Given that external activities are important aspects of board work, director candidates with more external social capital are more likely to be selected than comparable others with less external social capital.

Organizations can also use their board's external social capital as a vehicle through which they deliver information on their behalf to important institutional actors such as government officials, regulators, media, and investors. Corporate directors are frequently called upon to counsel government, govern universities, and raise campaign funds. They are also favorite topics for the business press (Useem, 1984). These various factors create opportunities for directors to meet important decision makers in the institutional environment, thereby intervening in matters that are critical to their companies’ interests. Boards whose members have a large stock of external social capital are more likely to have these opportunities, and therefore, more likely to be effective in co-optation. Therefore, we propose:

Proposition 2a: The external social capital of director candidates will be positively associated with new director selection because it indicates the candidates’ ability to achieve effective organizational performance through linkages to the external environment.

Proposition 2b: Board-level external social capital will be positively associated with board effectiveness, because external social capital provides organizations with links to the external environment through which the firm can gain information, resources and legitimacy.

Contextual Factors

We believe that the effect of social capital on director selection will vary according to the organization's context. In other words, different contexts lead to different board role expectations. Our study highlights the notion that while there may be a natural tendency, especially among cohesive boards, to select others to whom the current directors are already closely connected (e.g., Westphal and Stern, 2006; Westphal and Stern, 2007; Stafsudd, 2003), at the same time there may be considerable external pressure to select new directors who can best achieve the desired organizational outcomes by locating and securing resources from outside the organization. Put another way, while the incumbent directors may desire to select candidates who are closely linked to them, contextual factors may lead them to select those who are best suited to the particular context in which the firm is embedded.

Figure 2 illustrates several contingent factors that moderate the effects of social capital in director selection decisions. We identified three factors that characterize organizational and environmental context. These are: the level of environmental dependency; the age of the organization; and organizational performance. The discussion of each of these contingent factors follows.

The Level of Environmental Dependency.  Organizations are dependent on a resource environment that can sometimes impose powerful constraints. Thompson (1967) pointed out that one way to respond to constraints caused by environmental dependence is to control the source of that dependence. The most extreme way to control the source of the dependence is to absorb it through merger or acquisition. Organizations also use less extreme strategies for managing their dependence by modifying the environment through lobbying, associations, or consortia (Finkelstein and Hambrick, 1996). Given that directors may be called upon to serve as boundary spanners that link the organization and its environment when there are strong external forces in the business environment, directors must engage in more external activities.

For example, in an environment where political and legal forces are strong, directors may have to deal with authorities such as local and federal governments, or international policy formulators such as the World Trade Organization (Burns and Wholey, 1993) or the Organization for Economic Cooperation and Development (OECD). By selecting directors with ties to important institutional players, firms can deliver information to influence exogenous decisions, thereby helping to create favorable environmental contexts. The need for external financial capital is a widely noted factor that can affect the relationship between board social capital and firm performance. Use of outside financing, either debt or equity, involves relationships between those inside the organization and others outside. Corporations frequently invite onto their boards of directors representatives of banks to which they are heavily indebted (Mizruchi, 1996; Pfeffer and Salancik, 1978). Director candidates who have powerful outside contacts can more effectively provide needed financial capital to organizations than others who do not have such contacts (D’Aveni, 1990). Thus, we expect the following:

Proposition 3: When there are powerful external forces in the environment, the importance of external social capital as a determinant of director selection will increase.

Firm Age.  External social capital is probably of more value to young organizations, because young organizations tend to lack legitimacy. Firm age is importantly associated with organizational mortality and the liability of newness is one of the most widely known hypotheses in organization theory. Stinchcombe (1965) argued that there are both internal and external reasons for the liability of newness. On the internal side, new organizations have to learn new roles as social actors, and a considerable amount of time and effort is required to learn these new roles. On the external side, when new organizations deal with external clients they have to compete with well-established organizations that are familiar with the clients’ tastes, needs and demands. In such situations, existing organizations that have high levels of reliability and accountability tend to be favored by forces in the environment (Scott, 1995).

Fichman and Levinthal (1991) suggested that such forms of resources as interorganizational linkages, favorable prior beliefs, trust, goodwill, financial resources, social ties, or psychological commitment can be buffers that affect organizational failure. Younger organizations are more vulnerable because they have fewer such buffers. In a similar vein, Miner and her colleagues found that organizations are more likely to survive even severe environmental change if they have good interorganizational linkages (Miner, Amburgey, and Stearns, 1990). We argue that directors’ external social capital can provide such resource buffers and help the firm weather the storms associated with environmental pressures and the liability of newness (c.f., Johannisson and Huse, 2000). Directors with rich external social capital may facilitate access to financial capital through their social ties, they can capitalize on their relationships with powerful external players by lobbying, or they can simply bring in clients or customers through their extensive external networks. Similar arguments are found in the entrepreneurship literature (Nohria, 1992).

Because younger organizations tend to have fewer established relationships with important external players than older organizations, they are more likely to rely on directors who can build such relationships quickly or who already have such relationships. Given that corporate boards are major links to the external environment director candidates with extensive external social capital are more likely to be selected for director positions in younger firms. Therefore, we propose:

Proposition 4: As the organization ages, the importance of external social capital as a determinant of director selection will decrease.

Firm Performance.  The level of current organizational performance is a key contextual factor in CEO selection decisions (Kesner and Sebora, 1994; Cannella and Lubatkin, 1993; Vancil, 1987). It is well known those in power tend to surround themselves with others similar in terms of functional background or demography (Byrne, 1969; Zajac and Westphal, 1996). This effect may be particularly strong when organizational performance is good, because observers often conclude that if the current leaders and directors are good, more of the same is desirable.

On the other hand, decision-makers may intentionally select candidates who have characteristics that are different from their own. This is more likely when firm performance is poor, because poor firm performance signals lack of fit for incumbent leaders (and directors), and new directors differ importantly from incumbent directors, but can initiate and facilitate organizational change (Datta and Guthrie, 1994; Schwartz and Menon, 1985). When critical problems facing the organization are not effectively resolved by the incumbent board, decision-makers will come under pressure to select new directors who are capable of coping with the critical problems, and those individuals are likely to differ considerably from incumbent directors (Gouldner, 1954).

The logic above fits neatly with the divergent motives behind internal and external social capital. While internal social capital provides a motivation to select those who are trusted friends and confidants of incumbent directors, external social capital provides a motive to select those who are able to improve organization-environment fit. Survival pressures are low when performance is good, so incumbent directors can follow their natural inclinations and select their friends. When performance is poor, however, incumbent directors will come under increasing pressure to select new directors who are linked to powerful stakeholders outside the firm. Accordingly, we expect the following:

Proposition 5: When organizational performance is good, the importance of internal social capital as a determinant of new director selection will increase.

Proposition 6: When organizational performance is poor, the importance of external social capital as a determinant of new director selection will increase.

METHODOLOGICAL ISSUES

  1. Top of page
  2. ABSTRACT
  3. INTRODUCTION
  4. THE CONCEPT OF SOCIAL CAPITAL
  5. TWO TYPES OF SOCIAL CAPITAL: INTERNAL VS. EXTERNAL
  6. SOCIAL CAPITAL, DIRECTOR SELECTION, AND BOARD EFFECTIVENESS
  7. METHODOLOGICAL ISSUES
  8. CONCLUSION
  9. ACKNOWLEDGEMENTS
  10. REFERENCES

Our framework suggests a research agenda with various research themes and questions. Many of our propositions require data that are not readily available. In this section we discuss these issues and provide suggestions for their resolution. Table 2 provides some suggestions for measuring board social capital and board effectiveness with surveys of incumbent directors. We developed the items by adapting ideas from Finkelstein and Mooney (2003), Forbes and Milliken (1999), Hillman and Dalziel (2003), and Huse (2005). To perhaps overgeneralize a bit, board social capital can be measured by identifying who incumbent directors know (e.g., whether each is connected to important clients of the company or other powerful outside constituents) and board effectiveness can be measured by considering what directors do (e.g., the extent to which they are actively involved in the selection of new directors as well as capturing the level communication and cohesiveness among directors). A board's social capital and effectiveness could be operationalized through the questions in Table 2, using Likert-type psychometric response scales.

Table 2.  Example Checklist for Board Social Capital and Board Effectiveness
BOARD SOCIAL CAPITALBOARD EFFECTIVENESS
Internal Social CapitalService Task Performance
Do outside directors have good relationships with the CEO?Is the board actively involved in the selection of new directors?
Do directors possess firm specific knowledge?Does the board have criteria for strategic decisions?
Do directors share beliefs regarding the level of effort each individual is expected to put toward a task?Do directors carefully scrutinize information provided by the firm prior to the meeting?
Is each director aware of other directors’ areas of expertise?Do directors research issues relevant to the company?
Do directors have the time to serve?
Teamwork Performance
Does a board meet regularly with the CEO?
Do directors communicate well with each other and with the CEO?
External Social CapitalResource Dependence Task Performance
Does the board appoint a lead outside director?Does the board use outside contacts actively for the company?
Does the board have members who know important suppliers of the company?Does the board provide additive information secured from outside contacts?
Does the board have members who know important customers of the company?Does the board help to provide outside financing?
Does the board have members who know important bank officials in the company's local business community?Does the board contribute to company reputation or legitimacy?
Does the board consist of members with diverse industry backgrounds? 

To avoid common method biases, board effectiveness and board social capital should be assessed with different respondents. For example, board effectiveness could be assessed by surveying CEOs or outside consultants (Forbes and Milliken, 1999), while board social capital could be assessed by surveying directors other than the CEO. Environmental dependence could be measured with the Keats and Hitt (1988) approach to capturing munificence and dynamism, as well as through volatility in industry net sales (Keats and Hitt, 1988; Tosi, Aldag, and Storey, 1973). The firm's age could be calculated by the number of years since the firm was founded. Finally, firm performance could be measured by such accounting-based indicators as return on assets, return on equity, or market-based indicators like shareholder returns or market-to-book ratio.

CONCLUSION

  1. Top of page
  2. ABSTRACT
  3. INTRODUCTION
  4. THE CONCEPT OF SOCIAL CAPITAL
  5. TWO TYPES OF SOCIAL CAPITAL: INTERNAL VS. EXTERNAL
  6. SOCIAL CAPITAL, DIRECTOR SELECTION, AND BOARD EFFECTIVENESS
  7. METHODOLOGICAL ISSUES
  8. CONCLUSION
  9. ACKNOWLEDGEMENTS
  10. REFERENCES

Our paper makes several contributions to research on boards of directors and corporate governance. First, we emphasize the role of social resources for director candidates as well as incumbent directors. Previous research on board composition has primarily focused on directors’ economic or non-social resources such as knowledge, skills, abilities, and capabilities (e.g., Castanias and Helfat, 1991; Hambrick, 1987) or their demographic characteristics such as age, gender, firm and industry tenures, functional background, and formal education (e.g., Glick, Miller, and Huber, 1993; Hambrick and D’Aveni, 1992; Hitt and Tyler, 1991; O’Reilly, Snyder, and Boothe, 1993; Wiersema and Bantel, 1992). However, research needs to take into account the role of personal relations and structures (or networks) of such relations when predicting or explaining human behavior (Granovetter, 1973). Social capital theory thus contributes to the study of boards of directors by adding a stronger social dimension to the corporate governance literature. Our study analyzes the determinants of new director selection by focusing on social capital as a key resource that influences board effectiveness.

Second, social capital theory fits the context of director work very well. As pointed out by Selznick's (1949) study of the TVA, and Pfeffer's (1973) and Pfeffer and Salancik's (1978) seminal works on boards of directors and network building within and outside organizations is one of the most important jobs of directors. Further, members of the upper echelons spend much of their time building communication and influence networks through which they acquire and deliver information and knowledge, and exert influence to extract valuable resources from the external environment (Barnard, 1938; Kim and Cannella, 2007; Kotter, 1982). Our study argues that the social capital of directors is a vehicle through which organizations build such communication networks and influence important decision making processes. We explain how these networks impact director selection and through director selection, board composition, and effectiveness.

Third, by focusing on external and internal social capital of top executives as determinants of director selection, our study examines how different types of social ties can provide different resources to those possessing the ties. Previous studies on social capital have tended to focus exclusively on either internal social capital (e.g., Burt, 1992, 2000; Hansen et al., 1999) or external social capital (Pennings, Lee, and van Witteloostuijn, 1998; Useem and Karabel, 1986). Our study integrates both dimensions, providing a richer explanation of their origins and benefits.

Our study has a limitation that deserves comment. Notably, we assume that our propositions are applicable to different settings with different governance environments. However, our propositions are probably more appropriate to a subset of governance environments. For example, Millar, Eldomiaty, Choi, and Hilton (2005) categorize global business systems into three types –”the Anglo-American,”“the Communitarian,” and “the Emerging.” In emerging economies such as Indonesia, the Philippines, some parts of China, and Thailand, selection of new directors is almost entirely determined by the families who own the companies. Millar et al. (2005) also point out that in such emerging economies, it is not the financial markets but various government ministries that control financial allocations. In such societies, social capital may be a more important determinant of director selection decisions than in the Anglo-American sector. Thus, the generalizability of our propositions should be evaluated with samples from multiple nations so that they encompass a variety of business systems. The extent to which our propositions hold under alternative governance environments is an important issue for future research.

Our study has several implications for governance practice. By developing a theory of the effects of social capital on new director selection decisions and board effectiveness, our paper provides a fine-grained picture of the implications of social capital among corporate directors. Prior work has been dominated by the agency theory perspective, which views boards as monitors of managers, and not much else. We have argued, along with a number of others (e.g., Ghoshal, 2005; Hillman and Dalziel, 2003; Hillman, Cannella, and Paetzold, 2000; Huse, 2005, 2007) that the roles of directors go well beyond monitoring, and indeed, if the boards are perceived to be primarily a monitoring device, their effectiveness could be substantially weakened. We are not blind to the excesses of some managers, but simply recognize that an overemphasis on monitoring is also costly to firms. Similarly, our work echoes the call of Finkelstein and Mooney (2003) to move beyond “the usual suspects” in understanding boards – a call that is as important for practitioners as for researchers. To move beyond the “usual suspects” we must abandon simplistic indicators of board effectiveness, like the proportion of outside directors. Our study emphasizes that who directors are connected to is far more important than whether or not they are employed by the firm.

Our social capital lens also helps practitioners gain a better understanding of how boards come to be structured as they are. Additionally, our work can inform those who are seeking outside directors, as well as those who seek to serve as outside directors. Our conclusions are that the firm should seek directors who have network contacts outside those of incumbent directors, but not so far outside that the new director is unable to function as part of an effective team. Further, overlapping networks are essential to internal social capital, but are harmful to external social capital. Put another way, new directors who offer essentially identical external social capital to incumbent directors are not likely to enhance firm performance. Finally, we note that external social capital is especially important for young firms or those that operate in unstable environments. Therefore, practitioners must consider the environmental context in which their organizations operate when they make (or draw conclusions about) new director selections, because a given configuration of board social capital will not yield identical effects on firm performance in all environmental conditions.

ACKNOWLEDGEMENTS

  1. Top of page
  2. ABSTRACT
  3. INTRODUCTION
  4. THE CONCEPT OF SOCIAL CAPITAL
  5. TWO TYPES OF SOCIAL CAPITAL: INTERNAL VS. EXTERNAL
  6. SOCIAL CAPITAL, DIRECTOR SELECTION, AND BOARD EFFECTIVENESS
  7. METHODOLOGICAL ISSUES
  8. CONCLUSION
  9. ACKNOWLEDGEMENTS
  10. REFERENCES

This research was supported by a Sogang University Research Grant. The authors gratefully acknowledge the helpful comments of Maura Belliveau, Ann McFadyen, and participants in the Texas A&M brown-bag series on earlier drafts of this manuscript.

REFERENCES

  1. Top of page
  2. ABSTRACT
  3. INTRODUCTION
  4. THE CONCEPT OF SOCIAL CAPITAL
  5. TWO TYPES OF SOCIAL CAPITAL: INTERNAL VS. EXTERNAL
  6. SOCIAL CAPITAL, DIRECTOR SELECTION, AND BOARD EFFECTIVENESS
  7. METHODOLOGICAL ISSUES
  8. CONCLUSION
  9. ACKNOWLEDGEMENTS
  10. REFERENCES
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Yangmin Kim is an Associate Professor of Organization and Strategy in the School of Business Administration at Sogang University in Seoul, Korea. He received his Ph.D. in business from Texas A&M University, with a major in strategic management. Before joining Sogang University, he was an assistant professor at the Faculty of Management, Marquette University. His research area includes strategic leadership, corporate governance, social capital, and entrepreneurship in a global economy.

Albert A. Cannella Jr. (acannell@tulane.edu) is the Koerner Chair in Strategy and Entrepreneurship at Tulane University and has held positions at Arizona State University and Texas A&M University. He received his Ph.D. from Columbia University in 1991. He was President of the Business Policy and Strategy division of the Academy of Management in 2001 and Associate Editor of Academy of Management Review from 1999–2002. He currently serves on the editorial review boards of Academy of Management Journal, Journal of Management, and Administrative Science Quarterly. His research interests focus on executives, entrepreneurship, knowledge, and competitive dynamics.