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The Impact of Outside Board Members on Decision Making in Family Firms

The Impact of Outside Board Members on Decision Making in Family Firms. Jeremy A. Woods. Doctoral Student University of Cincinnati. Paper Overview. Why study family businesses?

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The Impact of Outside Board Members on Decision Making in Family Firms

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  1. The Impact of Outside Board Members on Decision Making in Family Firms Jeremy A. Woods Doctoral Student University of Cincinnati

  2. Paper Overview • Why study family businesses? • Studies suggest that over 80 percent of all businesses in the U.S. are closely held family businesses, and that these companies employ over 60 percent of the U.S. workforce and generate over 60 percent of the nation’s Gross Domestic Product (Astrachan & Shanker, 2003). • Family-owned businesses are the dominant business type in many countries around the world, including Australia, Brazil, Canada, Chile, Finland, Germany, Italy, Sweden, and the United Kingdom (Family Firm Institute, 2005).

  3. Paper Overview • Why study boards of directors/boards of advisors? • Debate exists in family business scholarship about the appropriate role of the board in family businesses. • Why study outside board member impact on decision making in family firms? • Input from outsiders can improve environmental scanning and questioning of assumptions, which can positively impact firm performance.

  4. Mainstream Theories on the Role of the Board • Agency Theory (Jensen & Meckling, 1976; Fama & Jensen, 1983) – the board protects interests of principals and minority shareholders. • Often less relevant in owner-managed, closely-held family businesses with no real minority shareholders. • Resource Dependence Theory (Pfeffer & Salancik, 1978) – the board provides access to resources, including advice and information (Hillman & Dalziel, 2003; Forbes & Milliken, 1999; Westphal, 1999; Daily & Dalton, 1992, 1993). • Closely held, owner-managed family businesses often use a board for this purpose (Blumentritt, 2006).

  5. Types of Board Members • Boards are often divided by scholars into inside members and outside members (Hillman & Dalziel, 2003; Forbes & Milliken, 1999; Westphal, 1999; Daily & Dalton, 1992, 1993). • Inside Board Members – board members who also work in the firm. Often share similar knowledge and perspectives. Common in closely held, owner-managed family firms. • Outside Board Members – board members who do not work in the firm. Often have heterogeneous knowledge and perspectives from inside board members. Not as common in closely held, owner-managed family firms.

  6. Boards in Family Businesses • There has been a good deal of family business scholarship focused on defining the proper structural forms and roles of boards in family businesses. • High owner-manager goal alignment (i.e., the goals of the owner and the goals of the manager are the same – often because the same person plays both roles) often leads to the absence of a board in a family business (Jaskiewicz & Klein, 2007; Lane, Astrachan, Keyt, & McMillan, 2006). • If a family business does have a board, high owner-manager desire for control often leads to the absence of outsiders on the board (Bammens, Voordeckers, & Van Gils, 2008; Fiegener, Brown, Derux, & Dennis, 2000). • If a family business does have a board, the family firm CEO often also serves as the chairman of the board (Braun & Sharma, 2007) and functions as the firm’s key decision-maker (Feltham, Feltham, & Barnett, 2005).

  7. Board Impact on Decision Making in Family Firms • Some scholars have examined the role of the board in decision making in family firms. • Board members’ social capital (i.e., their relationships with other individuals or organizations) influences decision making activities in family firms (Jones, Makri, & Gomez-Mejia, 2008; Lester & Cannella, 2006). • Board members’ human capital (i.e., their knowledge, abilities, and other personal traits) influences decision making activities in family firms (Calabrò, Mussolino, & Huse, 2009; Chen, Mahoney, & Tan, 2009; Ding & Pukthuanthong, 2009). • Outside board members tend to have heterogeneous social capital and human capital to that of inside board members (Lester & Cannella, 2006; Hillman & Dalziel, 2003).

  8. Decision Making Challenge: Concentration of Control • One key decision making challenge facing family businesses is the high concentration of control common in closely held, owner-managed family firms. • Individual human decision makers are prone to faulty evaluation of information (Levitt & March, 1988), incorrect estimation of risk (Khaneman & Tversky, 1979), and escalation of commitment (Barton, Duchon, & Dunnegan, 1989; Staw & Ross, 1978; Staw, 1976). • Goals are often based on the maximization of socio-emotional wealth, rather than the maximization of financial wealth (Gomez-Mejia, Haynes, Nez-Nickel, Jacobson, & Moyano-Fuentes, 2007). • Decision making in family businesses, made by a limited number of individuals in conditions of high control concentration, is prone to incomplete information, faulty reasoning, and escalation of commitment (Barton 1990, 2010; Ensley, 2006).

  9. P1 P2 Board with Outside Members Effective Decision Making • Environmental Scanning • Questioning of Assumptions Firm Performance Outcomes • Opportunity Recognition Theoretical Framework and Propositions Proposition 1: The presence of a board with outside members in a family firm will improve the effectiveness of environmental scanning and questioning of assumptions in the firm’s decision making process. Proposition 2: The improved decision making activities in proposition 3 will lead to improved family firm performance outcomes – in particular better opportunity recognition.

  10. Proposition 1 • The presence of a board with outside members in a family firm will improve the effectiveness of environmental scanning and questioning of assumptions in the firm’s decision making process. • Outside board members’ social capital and human capital, which is heterogeneous to that of inside board members (Hillman & Dalziel, 2003), often bring additional access to information from the external environment, and different perspectives, to the decision making process. • This helps family firms to question underlying assumptions, identify more and better opportunities, and avoid the escalation of commitment problems common to firms with high control concentration (Barton, Duchon, & Dunegan, 1989; Staw & Ross, 1987; Staw, 1981).

  11. Proposition 2 • The improved strategic planning activities in proposition 2 will lead to improved family firm performance outcomes – in particular, better opportunity recognition. • Effective strategic planning has been shown to affect opportunity recognition in family firms (Kellermanns & Eddleston, 2006)

  12. Next Steps • Quantitative research – Goering Center member firms. • Independent variable: board with outside members. • Dependent variables: product markets, profitability per product market. • Controls: industry, size, generation of family. • Interviews – Goering Center member firms. • Proxies for outside board member impact on decision-making process.

  13. Cognitive Abilities Effective Decision Making • Environmental Scanning • Questioning of Assumptions Firm Performance Outcomes • Opportunity Recognition Alternative Theoretical Framework Informal Network of Advisors Decision Making Process ???

  14. Questions/Comments?

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