Organizational Transitions and the Consequences of Governance: an Analysis of

Start-up and Adolescent High Technology Ventures

Shaker A. ZahraBabson College

&James C. Hayton

Utah State University

What we know Governance through boards of directors is

important for

…firm performance (Zahra & Pearce, 1989)

…recognizing and acquiring resources (e.g., Shane & Cable, 2002)

…signaling firm capabilities (e.g., Certo et al., 2001)

Little research has been done on the composition, decision making processes and contributions of boards to the performance of new ventures (companies 8 years or younger).

This gap is surprising given that new ventures are important for the growth of national economies and the fact that boards can contribute in meaningful ways to these companies success.

Boards and New Ventures

Boards and New Ventures

Boards can play a major role in determining the success (if not the survival) of new firms. Examples include:

Obtain resources Identify potential sources of capital

Connect firm to external stakeholders Help gain legitimacy Guide the strategy development process Oversee implementation Monitor CEOs who may mix business and personal

goals.

What we don’t know Need to address governance in

emerging ventures.

Need a more dynamic (life-cycle) perspective (e.g., Zahra & Pearce, 1989)

Need to understand impact on innovative performance (e.g., Zahra, Neubaum & Huse, 2000)

In This Study We Use….

Organizational life cycle (OLC) Theory

Tells us that companies face different challenges over time.

Resource Dependence Theory

Helps to delineate the potential contribution of the board over the course of the OLC.

Organizational Life Cycle:Challenges for New

VenturesSTART-UP (Years 1-5)

Legitimacy Access to resources Owner control Centralized Simple & Organic Innovation/

engineering Smaller

ADOLESCENT (Years 6-8)

Growth Product line

expansion Professionalization Role differentiation Formalization Marketing/Admin. Larger

Our Model

Board Composition

New Venture Performance

•Innovative•Financial

Start-Up vs. Adolescent

We Focus on Board Composition because

It influences the decision making process on the board.

It also captures the skills directors possess.

Research has yielded contradictory findings regarding the effect of composition variables on performance.

Most existing evidence comes from well established companies.

Most of past research fails to capture the effect of composition at different stages of the OLC

Board Composition Variables We Examine Include

CEO is also chair (duality) Presence of Founder on the board. Size of Top Management Team and Board Representation of Outsiders/Board Venture Capitalists (VCs) on the board. Functional Diversity of Board Members Educational Diversity.

Our Predictions Regarding Changes in Board Composition

Variables

CEO is founder……………………………………… Size of Top Management Team ………………….. Board size……………………………………………. Proportion of Outsiders/Board …………………... Proportion of Venture Capitalists (VCs) on the

board………………………………………………….. Functional Diversity of Board Members………… Educational Diversity of Board Members……….

Start ups vs. Adolescents

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In our Model We Focus on Two Dimensions of

Performance Financial

Determines survival of the ventures.

Source of wealth creation.

Provides slack resources for innovation and expansion

Innovative

Source of product differentiation

Shift from innovation to commercialization as we move from the start up to the adolescent stages.

Our Predictions Regarding Effect of Board Composition On Innovative

Performance

CEO duality Founder(s) on the board. Outsiders/Board VCs on the board. Functional Diversity of Board Educational Diversity.

Start UPs

++++++

Adolescents

n.s.n.s.+

n.s.++

Our Predictions Regarding Effect of Board Composition On Financial

Performance

CEO duality Founder(s) on the board. Outsiders/Board VCs on the board. Functional Diversity of Board Educational Diversity.

Start UPs

++++++

Adolescents

n.s.n.s.+

n.s.++

Method: Sample and Data Collection

Mail survey; 2 mailings. Targeted 1700 companies in 11

industries. 419 responded, for a response rate of

24.6%

Sample attributes:

Company age=4.2, sd=2.8 Employees=29; sd=44.67

Validation

Pre-tested some of the items on a smaller sample of 41.

Collected data from a second group of respondents in the same companies (n=103) and examined inter-rater agreement on key measures

Measures: Independent Variables

CEO is founder (1= if CEO is also founder; 0 otherwise)

CEO Duality (1= CEO is also chair; 0 if not ) Founding team on board (%) Size of top management team (# of VPs and

higher) Size of Board (total #) Outsiders on board (%)= (outsiders/size) * 100 VCs on board (%)= (VC/size)* 100 Functional diversity of board = Blau’s (1977)

index Educational diversity of board= Blau’s (1977)

index

Measures: Dependent Variables

R&D/Sales (%) [from survey and secondary sources]

New Products (# of announcements from Lexis.Nexus; also data provided by managers).

Entrepreneurship (Survey measure, 8 items taken from Danny Miller, 1983)

Return on Assets (ROA) [ from secondary sources]

Return on Equity (ROE) [from secondary sources]

Measures: Control Variables

Company related

Size Past performance

Industry Related

SIC

Classification of OLC

Companies 5 years or younger= Start ups: 73% of the sample [n=306].

Older companies = Adolescent: 27% of the sample [n=113].

We used information from the survey to validate this classification.

Findings Regarding Changes in Board Composition Variables

CEO is Founder………………………………………. Size of of Top Management Team………………… Size of Board………………………………………….. Outsiders/Board……………………………………… Venture Capitalists (VCs) on the board…………... Functional Diversity of Board Members…………. Educational Diversity………………………………..

Start ups vs.

Adolescents

> Yes

< Yes

< Yes

< Yes

> n.s.

< Yes

< Yes

New Product

sEntre.R&D

Findings Related to Innovative Performance

CEO Duality Founders on

board Outsiders/

Board VCs/Board Functional

Diversity Educational

Diversity

n/s

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n/s

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n/s

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n/s

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n/s

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n/s

n/sn/sn/s

+

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ROA ROE

Findings Related to Financial Performance

CEO Duality Founders on board Outsiders/Board VCs/Board Functional Diversity Educational Diversity

-

+

n/s

n/s

n/s

n/s

-

+

n/s

+

+

n/s

+

n/s

n/s

+

+

n/s

n/s

+

n/s

n/s

+

+

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Implications for Practice

Board composition should be revised over time to reflect strategic and structural changes

Founders continue to make a positive contribution to innovative and financial performance.

Board diversity has positive influence on innovative and financial performance, even though the effect is not universal.

CEO duality is a double edged sword – positive early but threatens performance as firm develops

Implications for Theory

Our results are consistent with OLC and resource dependence theories. We need to apply both perspectives more

frequently in future research.

Consider different types of entrepreneurial firms and the impact of strategy and context on governance

How do board processes change over the course of a firm’s life cycle?

Implications for Theory

How does ownership structure influence board composition – e.g., institutional investors?

Do these findings generalize beyond the U.S. in the 1990s?