Organizational Transitions and the Consequences of Governance: an Analysis of Start-up and Adolescent High Technology Ventures Shaker A. Zahra Babson 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 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 Ventures START-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 > < > <

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. +

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. +

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 > n.s. < Yes

New Products Entre.R&D Findings Related to Innovative 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 + ????

ROAROE 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 + ??????

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?