Tài liệu Research " WHO’S INFLUENCING WHOM? A STUDY OF THE INFLUENCE OF THE CEO AND THE BOARD OF DIRECTORS ON ORGANIZATIONAL STRATEGY " pdf

Inherent in the description of for-profit organizations are certain assumptions about claims on residual earning, the risk preferences of the owners, and the board of directors.. CHARACT

CEO AND THE BOARD OF DIRECTORS

ON ORGANIZATIONAL STRATEGY

By Myleen M Leary

A dissertation submitted in partial fulfillment of

the requirements for the degree of Doctor of Philosophy (Business)

at the

UNIVERSITY OF WISCONSIN — MADISON

2003

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Who's influencing whom?

A study of the influence of the CEO and the Board of Directors on Organizational Strategy

submitted to the Graduate School of the University of Wisconsin-Madison

in partial fulfillment of the requirements for the

degree of Doctor of Philosophy

by

Myleen M Leary

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THEORY DEVELOPMENT AND HYPOTHESES -. Á 1S H HH HH Hit 37 Hypothesis Development: Board-CEO Relationship - nà Ssehere 37 Boardl DDV€FSHẨJ 2à LH HH TH ng KT TT HT TH ng ren 38 Board Presid€HIE TIHLITC tt TH T H TT HT HH TH 43 Interaction of Board Diversity and Boardl Presid€Ht T€HUT€ .- ăn 45

Hypothesis Development: Exfension of the Board-CEO Relationship 47

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Bureau of Labor and StatÏS(ÍCS SH HH HH HH HH ng c 61 M0 O© 61

Dependent Variabile€s -ó - s1 ng TH HH nu TH HH it 61 Diversity Of fUnding HT HH HH TH Tà TT TH TH HT cà TH 62 @FÍOTHIQHCÔ HH HH TT TT TH HT ngàn 63 Independent Variables 2.000.000 64

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CHAPTER 6

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Bi 0y v01 82

Using characteristics to imply monitoring funefions - nàn senseerieriec 82 Focus on affiliates of one non-profÏt organÌZafÏon - - c cv ng reo 83 Hindsight bias for surVey r€SUÏ(S - LH ng TH HH TH KH 84 l6i0)-328 49329.106.001 84

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R.EFERENCES LG SH HH HH HH nh TT TT và 89 TABLES Table 1: Exchange Relationship «2.0.0.0 98

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Table 3: A Model of Organizational Adaptation to Environmental Constraints 99

Table 4: Data/Variable na 100

Table 5: Summary of Hypotheses, Predicted Relationships, and Results 101

Table 6: Descriptive Statistics and Correlation Table .0 0.0.0 ccc ceccscceeteeetteeneeeeees 103 Table 7: Predicting Total Ïncome - - - <5 HH TH HH ngờ 104 Table 8: Predicting Eunding Divyersify SH HH ng ng kg key 105 (VD Cá: (0 240i nh hố 106

APPENDICES Appendix 1: Interview Protocol for Board Members of Local Organizations 107

Appendix 2: Interview Protocol for Executive at Boys and Girls Club National Office HH1 TT TT Họ KT TH Họ TT TT TT TH 19018115111 108 Appendix 4: Survey sent to CEOs and Board Presidents in the Boys and Girls Clubs109 Appendix 4: Letter sent requesting participation in the research study 115

A STUDY OF THE INFLUENCE OF THE CEO AND THE BOARD OF DIRECTORS

ON ORGANIZATIONAL STRATEGY

Myleen M Leary Under the supervision of Associate Professor Mason A Carpenter

at the University of Wisconsin-Madison

ABSTRACT

This dissertation is motivated by the opportunity to examine the fundamental attributes

of principals and agents beyond an economically defined view to gain a deeper understanding

of the mechanisms that influence the exchange relationship between CEOs and boards of directors | While existing research has relied on the ownership structure to determine principals and agents in organizations, this dissertation will suggest that the interdependent nature of the relationship between the CEO and the Board of Directors can result in situations where both actors could fill either role Within the framework of exchange theory, agency theory and resource dependence are used to provide a theoretical foundation for this research

As an exchange relationship develops as individuals interact over a period of time, the independence of the CEO and the composition of the Board of Directors will be used as proxies for characteristics of the relationship between the actors These characteristics are hypothesized to influence the strategies pursued by the organizations as well as the organizational performance Hypotheses were tested on a sample of Boys and Girls Clubs in the Midwest region and the results from the study extend our practical and theoretical

knowledge of the relationship between the CEO and the board of directors in non-profit and for-profit organizations.

ACKNOWLEDGEMENTS

There are many people who have contributed to the completion of this study First, I would like

to thank the members of my dissertation committee: Ted Baker, Tim Pollock, Mark Suchman, Jim Wade and my advisor, Mason Carpenter Their feedback and assistance was instrumental through the many iterations of this study I would especially like to thank Mason for his support while I was in the PhD program He has been an excellent mentor who provided guidance yet encouraged independence

Another thank you is in order for my friends at the University of Wisconsin and from the annual Academy of Management meetings Linda, Helen, and Davina have been wonderful sources of encouragement and support throughout the last few years Mike is a great friend for listening, sharing, and helping me muddle through ’'m so glad you got here first!

I would also like to thank my family and friends who boldly stood behind me at every turn in the doctoral student process—class work, preliminary exams, dissertation proposal, and dissertation defense I especially want to thank Jay, for simply being my favorite brother, and Lauren who always have the time to ask how things are going I was lucky that Val got her degree just ahead of me so I had

an expert who had “been there, done that.” What an amazing trip since the summer of le Chateau des Enfants! I could always count on Lisa for her perfectly timed surprises and excellent conversations Katie and Thom are such gracious hosts and have given me wonderful reasons to travel to Connecticut and New York over the last few years

Finally, none of this would have been possible if my parents hadn’t believed in me so strongly They listened and made me laugh no matter what time I called

Over the last few years, my dad’s favorite question has been “So, how’s the thesis going?” Thanks

to all of you, I can finally and definitively say “It’s done.”

INTRODUCTION

Overview

Recent corporate scandals have reinvigorated the discussion of the role of the CEO versus that of the board of directors in the management and oversight of for-profit organizations The lavish perks earned by CEOs and approved by the boards of directors, sometimes to the detriment of shareholder wealth and the financial health of the organization, have put the spotlight back on the role of boards of directors Whose interest are they protecting? How do the Chairman of the Board and the CEO influence the approval of strategies? Can board members truly represent the interests of the shareholders in whose name they serve? What role does the Chairman of the Board or the CEO play to ensure an active and participating board?

The view of boards of directors as monitors of managerial actions on behalf of tlie shareholders is based in the economics literature (Jensen and Meckling, 1976; Fama and Jensen, 1983) Individuals are assumed to be self-interested and to act in their own best interests without any external incentives to act for the common good Within the framework of public, for-profit organizations, there is inherently a conflict between the interests of the managers and those of the owners; what may be in the best interests of the managers may not

be in the best interests of the owners and vice versa Implicit in this view is the assumption that the relationships between the actors are independent, non-recurring events The impact of personal ties and social ends on the actions of either the CEO or the board members are

However, this view does not adequately recognize the role of managers in the dissemination of information and control over the day-to-day activities of an organization To counter the view of the preeminence of boards of directors in the control of organizations and

to sufficiently recognize the role of managers in policy development and implementation, researchers have emphasized the proactive role managers play in using strategy to manage the internal and external environment constraints facing their organizations With an emphasis on the role of managers, the board of directors’ role is to approve managerial policies and programs rather than to provide a monitoring and control function The underlying assumption

in this view is the expectation that managers have a deeper understanding of the organization and are in a better position to evaluate and select strategic actions for the organization than board members who serve in a part-time role do

The economic-based and managerial-based views of strategy implementation appear to

be at odds with each other; either the CEO or the board is in the best position to evaluate and implement the appropriate strategy for the organization However, if we view the relationship between the CEO and the board as an interdependent set of transactions, we can move away from the ‘either-or’ mentality and gain a broader perspective on the relationship between the actors This view implies “a two-sided, mutually contingent, and mutually rewarding process involving “transactions” or simply “exchange” (Emerson, 1976: 336) The CEO pursues strategies which he expects will result in his continued employment with the organization while

rewarded with the status, privilege, access, and possibly financial reward that comes with their position on the board Unlike an economic transaction, “the process of interactive exchange between independent actors is referred to an exchange relation” (Emerson, 1976: 251)

The motivation for the dissertation is presented in the next section of this chapter The chapter concludes by outlining the format for the dissertation

Motivation of the Study

This dissertation is motivated by the opportunity to examine the fundamental attributes

of principals and agents beyond an economically defined view to gain a deeper understanding

of the mechanisms that influence the exchange relationship between CEOs and boards of directors Using a research setting of non-profit organizations, the assumption of financial ownership as the guiding force to describe the relationship between CEOs and boards of directors can be relaxed As the exchange approach provides the framework for an “economic analysis of noneconomic social situations” (Emerson, 1976:336), this dissertation relies on complementary theories of exchange, agency theory and resource dependence, to provide a theoretical foundation for this research

Agency theory developed through the work of economists (Spence and Zeckhauser, 1971; Ross, 1973; Jensen and Meckling, 1976; Fama, 1980; Fama and Jensen, 1983) The theory has traditionally focused on the agreement or contracts between principal and agents in situations where the separation of ownership and control is easily observable Theoretically it can be tested in any type of organization based on the idea that “ most organizations are

the expectations and responsibilities of the principal and agent, agency theory can be viewed as

a theory of information and its acquisition and it can be applied to any exchange relationship (Fama, 1980)

Not surprisingly, there is a large body of empirical support for agency theory in the context of for-profit, public corporations (i.e.: Amihud & Lev, 1981; Argawal & Mandelker, 1987; Kosnik, 1987; Singh and Harianto, 1989; Wade, Porac, and Pollock, 1997) This research has been focused on evaluating the contracts as a source of information about the degree of alignment between the goals of the managers (agents) and the owners (principals) In these organizations, the board of directors is conceived as an independent third party to act on behalf of the owners.! Acting on behalf of the principal, boards of directors are expected to monitor and ratify decisions while managers as the principals’ agents are expected to initiate and implement them (Fama and Jensen, 1983a)

In this context, the principal and agent roles have been filled by owners and managers respectively based upon the separation of ownership and control; owners have delegated control of their financial investment in the organization to the managers When the ownership structure is changed such that the organization does not have any residual earnings claimants, the roles of principal and agent between the CEO and the board of directors are not as easily

' The term ‘board’ has been used to convey the idea of a group of individuals serving in an advisory capacity since the 16" century when William Shakespeare’s Henry VIII referred to ‘a board of council;’ in the 18" century documents referring to the East India Trading Company mentioned ‘directors’ acting in the capacity of overseeing the activities of the organization (Oxford English Dictionary, 2"! edition) The Oxford English Dictionary provides definitions of words as well as quotes to demonstrate the first time the word was used in that context ‘Board of Directors’ is found as part of definition (8) (b) of the word ‘board.’

ratify those decisions but managers may also monitor the board to ensure the board members are meeting their responsibilities and actively participating on behalf of the organization

To understand how managers would take a proactive role in managing the organization and its environment, we must now turn to resource dependence Resource dependence was developed by sociologists in the context of non-profit organizations to study the influence of environmental constraints on the actions of organizations (i.e.: Randall, 1973, Pfeffer, 1973; Pfeffer and Salancik, 1974; Salancik and Pfeffer, 1974; Pfeffer and Leong, 1977); results from these initial studies were generalized to for-profit organizations The theory focuses on

“*,.decision and power and influence relationships that affect organizational actions (Aldrich and Pfeffer, 1976: 101) From this perspective, managers pursue actions that enable the organization to adapt to the external environment (Pfeffer, 1982) For example, as a third party that provides access to resources in the external environment, actively managing and monitoring the Board of Directors is one way managers can deal with the organization’s external dependencies

While existing research has relied on the ownership structure to determine principals and agents in organizations, this dissertation will suggest that the interdependent nature of the relationship between the CEO and the Board of Directors can result in situations where both actors could fill either role As an exchange relationship has “emergent” or developmental attributes (Blaud, 1964) due to the fact that social exchange assumes that individuals interact over a period of time, the independence of the CEO and the composition of the Board of

Salancik, 1978; Pennings, 1980; Boyd, 1990; Gales and Kesner, 1994) and agency theory (i.e.: Baysinger and Butler, 1985; Pearce and Zahra, 1992; Ezzamel and Watson, 1993) but they have not explicitly been used to identify the roles of principal and agent This research is not suggesting that the definitions of the principal and agent be changed but it does suggest that there may be situations where who fulfills each role may be different than previously studied

Format of the Paper

This chapter introduced a theoretical argument that the roles assumed by the CEO and the Board of Directors in their exchange relationship will be influenced by the independence of the CEO and the composition of the Board of Directors These characteristics are predicted to influence organizational strategies and performance This study is motivated by an opportunity

to make a contribution to our understanding of the exchange relationship between CEOs and Boards of Directors as well as the study of corporate governance In addition, the research offers insight into the practical problems faced by managers and board members of non-profit organizations Specifically, this dissertation applies theory developed and tested in for-profit organizations to the interesting and unique context of non-profit social service organizations

To understand the differences between for-profit and non-profit organizations, Chapter 2 will begin by reviewing the characteristics of for-profit organizations as compared with non-profit organizations and it will provide contextual information about the Boys and Girls Clubs that will be used to test the hypotheses developed in this dissertation Chapter 3 will provide a

hypotheses consistent with the existing view of the exchange relationship between the CEO and the board of directors as well as hypotheses that support an extension to the current literature to suggest that the CEO may in fact act on behalf of the principal in the exchange relationship with the board of directors

After the theory and hypotheses development sections, Chapter 5 will outline the research method used, including a description of the sample, the process for acquiring data, and

a discussion of the data analysis and results Finally, the Chapter 6 will conclude with limitations to this study as well as areas of future research

Inherent in the description of for-profit organizations are certain assumptions about claims on residual earning, the risk preferences of the owners, and the board of directors These characteristics have influenced theory development and shaped the general view of how organizations operate Explicitly identifying these characteristics and understanding how they influence our conceptualization of the relationship between the CEOs and boards of directors is

a preliminary step in understanding where differences could be expected when looking at the same relationship in a non-profit setting

Residual earnings and risk preferences

In for-profit organizations, owners have claims on residual earnings due to the use of debt and outside equity to finance the organization’s operations (Jensen and Meckling, 1976)

As a result of these claims, the risk preferences are said to be different between owners and managers of organizations There are two views of the risk preferences of owners and managers The first is that owners are risk neutral (Wiseman and Gomez-Mejia, 1998) and managers are risk averse (Jensen and Meckling, 1976; Fama, 1980; Baysinger and Hoskisson, 1990) due to the fact that owners can diversify their risks through a portfolio of investments while the managers’ risk is concentrated in the organization in which they are employed

Another view of the risk preferences is that managers are risk neutral while owners are risk-seeking These risk preferences may be most salient in organizations that are inherently

actively seek out ways of managing their risk through compensation packages that emphasize stable forms of compensation rather than riskier components such as stock options (Beatty and Zajac, 1994) Investors in these organizations are said to be risk seeking due to their desire to extract the greatest return for their investments

While there is theoretical support for both view points, there are two important conclusions that can be drawn First, an agency problem exists between owners and managers when the risk aversion of the managers is greater than the risk owners are willing to bear (Carpenter, Pollock & Leary, 2003) Second, owners and managers have different risk preferences and managers are expected to be less willing to accept risks than owners

Composition of the Board of Directors

In for-profit organizations, boards of directors are characterized as a source of labor, information, and resources (see Finkelstein and Hambrick, 1996; Dalton, Daily, Ellstrand, and Johnson, 1998; Dalton, Daily, Johnson and Ellstrand, 1999 for excellent reviews of the existing research) Boards of directors are expected to act on behalf of the owners of the organization and may themselves be owners of the organization Among the many roles performed by the board of directors, including co-opting influence and providing legitimacy for the organization, the board of directors is a means to access resources that are not part of the organization’s internal resource base (Pfeffer and Salancik, 1978; Zahra and Pearce, 1989) or it is a third party

to monitor and ratify managerial decisions on behalf of the organization’s stakeholders (Jensen

and Meckling, 1976; Fama and Jensen, 1983) How well the board of directors can fulfill these roles is influenced by the size, composition, and independence of the board

Larger boards of directors provide greater links to the environment (Price, 1963) but are also difficult to manage (Gladstein, 1984) The larger the board, the greater the heterogeneity (Alexander, Fennell, and Halpern, 1993) and the more difficult it can be to reach consensus (Shaw, 1981) Conversely, smaller boards are more likely to fulfill a managerial and administrative oversight function in the organization (Zald, 1969) but their information processing may be limited (Haleblian and Finkelstein, 1993) In for-profit organizations, small and large boards refer to groups of two to 20 members For example, in a study of the influence of boards of directors on the degree of internationalization in new ventures, the board size ranged from 2-12 members (Carpenter, Pollock, and Leary, 2003) In the United States, boards of publicly-traded companies typically range in size from 4 to 35 members (Davis and Useem, 2002)

In addition to the size of the board, the proportion of inside and outside board members influences strategy (Baysinger and Hoskisson, 1990), diversification (Hill and Snell, 1988), and performance (Baysinger and Butler, 1985; Baysinger and Hoskisson, 1990; Pearce and Zahra, 1992; Ezzamel and Watson, 1993) Outside directors are expected to provide access to necessary resources (Hillman, Canella, and Paetzold, 2000) and an independent evaluation of the CEO The proportion of insiders and outsiders has been studied as a means to assess the independence of the board of directors from the CEO and their ability to monitor the actions of management to ensure they act in the best interest of shareholders

The effect of the ratio of insiders and outsiders on organizational strategies and performance has been mixed Researchers have found positive relationships between outside directors and firm performance (Baysinger and Butler, 1985; Pearce and Zahra, 1992; Ezzamel and Watson, 1993) as well as with a higher proportion of insiders (Baysinger and Hoskisson, 1990) Furthermore, the causal effect of boards on diversification strategies is mixed Peace and Zahra (1992) found that outsiders bring information and expertise to diversified organizations while boards dominated by outside directors have also been linked to a greater level diversification by organizations (Hill and Snell, 1988; Baysinger and Hoskisson, 1990)

A further measure of board independence is CEO duality When a CEO is also the chairman of the board of directors the independence of the board may be compromised or CEO duality may create a situation of strong leadership (Finkelstein and D’Aveni, 1994) While some researchers call for the separation of the two positions (Lorsch, 1989), others suggest that

in poorly performing firms where strong leadership is required, duality is beneficial (Finkelstein and D’Aveni, 1994) In for-profit organizations, CEO/Chair duality and the proportion of outsiders on the board of directors have been used as proxies to measure the board’s independence and its effect on organizations

In for-profit organizations, the board of directors represents the interests of the shareholders, is more risk-seeking than managers, and would benefit from an independent relationship from the CEO to be in a better position to monitor his actions These underlying characteristics have informed research on the relationship between the CEO, board of directors, and their influence on organizational strategy and performance As we will see, these

characteristics do not provide the same information in the analysis of corporate governance in non-profit organizations

CHARACTERISTICS OF NON-PROFIT ORGANIZATIONS

Having identified some of the characteristics of for-profit organizations, this section will discuss the characteristics of non-profit organizations with regard to ownership, risk, and the board of directors In addition, the following sections will discuss some of the unique characteristics of non-profit organizations including (1) the implications of tax-exempt status

on income generating activities for non-profit organizations and (2) the relationship between donors, customers, and the organization Finally the structure of the organizations in this study will be discussed

Ownership and risk preferences

The fundamental difference between non-profit and for-profit organizations is the distribution of residual earning A non-profit organization should not be classified as an organization that does not or can’t make a profit but rather one that can’t share the profit In non-profit organizations, the non-distributions constraint dictates that there are no owners of the organization and any residual earning must be used to pursue projects that are consistent with the organization’s mission Without claims on residual earnings, the risk preferences of the CEO and the board members are not dictated by ownership What those risk preferences may be or how they might change in this setting hasn’t been studied, but the important point is that their preferences are not based on financial ownership of the organization

The CEO of a non-profit bears the same employment risk as a CEO in a for-profit organization as the manager’s risk is concentrated in the organization in which he is employed Managers of non-profits are rewarded with a base salary but not the incentive compensation packages associated with CEOs of for-profit organizations The employment risk the manager

of a non-profit organization must bear is not in the form of risky compensation packages but rather is derived from the perceived riskiness of the organization itself Therefore, the risk preference of a manager of a non-profit organization may be influenced by the strength and reputation of the organization The stronger the organization and its parent company, the more likely it will survive and the CEO would continue to be employed

Similarly, the risk preferences of the boards of directors are not dictated by ownership, even for those board members who are financial donors Board members of non-profit

organizations are typically volunteers who do not expect a financial return on their investment

of time, money, or resources in the organization Instead, they may expect their commitment to the organization to enhance their reputations (Fama and Jensen, 1983) or to meet an internal need for altruism (Finkelstein and Hambrick, 1996) Their willingness to expend their time and money and the expected personal reward may be motivated by public perception of the non- profit organization Affiliation with an established non-profit organization that enjoys a good reputation will offer more predictable status rewards than affiliation with a less well-known organization The risk that an individual bears as a board member is a reputational rather than financial one

Similar to a for-profit organization, the riskiness of the return expected by the CEO and board of directors in non-profit organizations is reduced at an organization with a good

reputation The key difference between the two kinds of organizations is that both the CEO and the board of directors can expect a financial return for their affiliation with a well-known for-profit organization’ but in a non-profit setting, only the CEO can have a financial benefit from her affiliation with the organization through her compensation package However, in both settings the CEO and the board of directors can enjoy reputational returns as a result of their commitment to the organization As the board members are not faced with risk associated with financial returns based on the performance of the organization, board members may still be less risk adverse (or more risk-seeking) than the managers Therefore, the risk preferences of the board members and the managers may the same as in for-profit organizations but the causes of the preferences may not be the same

Composition of the Boards of Directors

As with for-profit organizations, the board of directors in a non-profit organization is a source of labor and information as well as access to required resources The size of the boards

of directors in non-profit organizations can vary greatly as compared with for-profit organizations Generally boards of directors in this setting have a large number of members (i.e.: Golden and Zajac, 2001) As a provider of labor, information, and access to resources, this characteristic is consistent with the fact that non-profit organizations represent the classic example of the external control felt by organizations (Pfeffer and Leong, 1977) due to the fact

? This assertion based on the assumption that the board members are compensated for their time on the board of directors

that they operate in environment influenced by donors, regulators, beneficiaries, support organizations, competing organizations, and clients (Herman and Heimovics, 1991)

In addition to larger boards of directors, there are also differences in the composition of the boards in non-profit and for-profit organizations In non-profit organizations there is a much larger proportion of outsiders on boards of directors, to the point where all of the board members are outsiders with the sole exception of the CEO Fama and Jensen (1983) suggest this extreme form of independence between the board of directors and the CEO exists to reduce

or eliminate insider voting rights as a result of the lack of an external takeover threat or the discipline imposed by residual claimants Furthermore, the situation of CEO duality in non- profit organizations is highly unlikely None of the organizations in this study share that trait The combination of a high proportion of outsiders with the lack of CEO duality suggests that boards of directors in non-profit organizations have the theoretically maximum amount of independence possible from the CEO

This independence is mitigated somewhat by the fact that boards of directors in non- profit organizations are generally more operationally focused There is an expectation that board members will donate their skills to the organization and provide substantial support in terms of strategy development and implementation For example, the marketing committee of one of the organizations in this study was responsible for publishing the organization’s quarterly newsletter However, the degree of board involvement in the management of the organization in may vary depending upon the size of the organization Larger non-profit organizations are in many ways similar to large established for-profit organizations There is a

professional staff responsible for running the organization and a program staff responsible for implementing programs consistent with the organization’s mission Conversely, smaller non- profit social service organizations are more akin to entrepreneurial for-profit organizations as they rely extensively on their board of directors to make up for the limited financial and human capital resource available in the organization While the boards of directors for larger and smaller organizations include different committees to deal with the various management issues facing the organization (i.e.: human resources, legal, finance), the members of the committees for the smaller organizations are called upon to participate in tasks that may be assigned to the professional staff in a larger organization

Tax exempt status, income-producing activities, and donors

Organizations receive a non-profit designation when they fulfill a social role for which the government provides an indirect subsidy through their tax-exempt status (Weisbrod, 1998) Non-profit organizations are permitted to engage in income-producing activities without a tax obligation when the activities are related to the organization’s mission For example, membership fees or dues can be levied and are a source of revenue that isn’t taxed However nonprofit organizations are faced with a tension between the pursuit of commercial activities and their donations, as managers of non-profit organizations are aware of how the organization appears to its potential donors If the nonprofit organization pursues commercial activities successfully, it may appear self-supporting and therefore in less need of funds from donors There is the fear among non-profit managers that an increase in revenue from commercial activities will drive away donors (James, 1998)

Relationship between funding sources, non-profit organizations, and customers

Unlike organizations that rely on a revenue stream from the sale of goods or services, certain types of non-profit organizations rely on external funding sources that engage the organization on their behalf to provide a service to the organization’s customers.’ Traditionally, the relationship between an organization and its customers is reciprocal: the customer exchanges money for a good or service produced by the organization In this situation, the customer is both the purchaser as well as the beneficiary of the product However, in an organization that relies on donations, the organization acts as an intermediary

on behalf of the donors Donors engage a non-profit organization to provide a service on their behalf to a target population Donations can be unrestricted where the organization can decide the best way to use the money to achieve its mission or the funds can be restricted to a specific activity (i.e.: to support victims of the September 11" terrorist attacks or to purchase new computers) Jn the former situation, the donors are delegating a greater amount of decision- making latitude to the managers of the organization than in the latter situation However no matter what the nature of the donation, the donors have engaged in an agency relationship with the organization for the organization to act on their behalf The donors give the money to the organization, but instead of expecting to receive a good or service for their own benefit, the donors expect the organization to provide the benefit to the members or users of the organization’s programs

> For example, HMOs, hospital, and universities are non-profit organizations that operate under a fee for service structure Non-profit organizations that rely on donations are considered public charities.

The three-party relationship that exists between the organization, its donors, and the customers results also limits how much power the customers have to dictate changes in the organization’s mission or strategy When customers pay for a service or a good, they can exercise their displeasure in their purchase by withholding future purchases In this manner the organization is disciplined through the actions of consumers (Newman and Wallender, 1978) However, in organizations that rely on donations to subsidize services to their clients, the consumers do not have the same ability to influence organizational strategy Instead, the individuals, government agencies, corporations, and foundations that provide the organization’s funding have the opportunity to encourage or discipline the organization with the promise to give or the threat to withhold future funding While the organization’s mission is to provide a public good, the ability of the organization in the long-term will depend upon how well it manages the demands and expectations of its funding sources

In addition, when an organization 1s part of a federation it must answer to the demands and expectations of the Federation Management Organization (FMO) As outlined by Provan (1983), federations make up three of the five possible interorganizational linkage networks When there is interdependence among a large number of organizations, the organizations can join or form a federation in exchange for relinquishing a degree of their autonomy to a management organization The federation management organization offers affiliated organizations greater access to resources and in exchange the mission of the federation can be spread to different locations and communities

CEOs and boards of directors in non-profit organizations that are part of a federation management organization are working to further their own interests, those of the organization, and those of the federation CEOs and boards of directors can be motivated by their own agendas or status-seeking goals but in a non-profit organization, only the CEOs will be directly rewarded financially as a result of their affiliation with the non-profit In addition to these motivations, CEOs and boards of directors are also working to meet the demands specified in the organization’s mission as well as the requirements of the national organization to ensure the organization’s continued membership in the federation

In a for-profit, public organization, managers and board members must manage the organization to ensure the continued financial support of the organization’s owners and other financial stakeholders If the owners do not feel that they are receiving the return on their financial investment they expected, they have the opportunity to sell their shares In doing so, they are withdrawing their support of the organization Similarly, in organizations that are part

of a federation management structure, the affiliates work to ensure on-going support by the federation management organization It can be said that the actions of the managers and board members of non-profit, affiliated organizations are scrutinized not by shareholders but by a national office to ensure compliance with stated goals and objectives Therefore, in addition to working to meet their own goals, to fulfill the organization’s mission, and to meet the demands

of the donors, managers and board members work to represent the interests of the federation management organization These interests are not inherently mutually exclusive but neither are they automatically mutually inclusive It is the responsibility of the organization’s managers to

address these important but potentially competing interests without jeopardizing the stability and performance of the organization

Structure of the organizations in this study

Boys and Girls Clubs are the non-profit social service organizations that will be considered in this study All of the organizations are part of the Midwest region, one of the five regional offices as defined by the national office in Atlanta, and as members of an independent voluntary federation, they are semi-autonomous affiliates of the national organization

The organizations in the Midwest region vary in size according to the number centers or sites that each organization operates For a given geographical area, there is an umbrella organization with one board of directors and a chief professional officer (CPO) The chief professional officer in these organizations is comparable to a chief executive officer (CEO) in for-profit organizations with similar responsibilities for long-term strategic planning and ensuring the organization has the necessary financial, human capital, and physical resources necessary for its continued survival In this paper, hypothesized actions taken by a manager are proxies for actions taken by a CPO

The umbrella organization in each area can be responsible for as many sites as it can support Managers interviewed suggest that there is a correlation between the age of the organization and the number of centers supported by the organization While the number of sites may increase in a particular geographic area, there will still only be one board of directors for the umbrella organization and all of the centers will fall under its jurisdiction Two practical examples come from organizations in the Midwest One organization is well-

established with many different centers while the other organization was founded in 1999 and has just one center The former organization has a separate administrative headquarters for the staff and activities related to managing the operations of all of the centers while all of the administrative and program activities for the latter organization are to be found in one location

In this paper, centers refer to the specific locations where programs are offered to the customers and organizations refer to the umbrella organizations to which the board of directors is affiliated

SUPPORT FOR NON-PROFIT SETTING

The characteristics of for-profit organizations have lead to the development of a typology that explains the relationship between the CEO and the board of directors The board

of directors represents the interests of the shareholders, is willing to take more risk than the managers, and prefers an independent relationship from the CEO to be in a better position to monitor his actions Consistent with agency theory, the board of directors monitors organizational strategies the CEO has initiated and implemented (Fama and Jensen, 1983)

However, the structural and governance differences between non-profit and for-profit organizations suggest that there is an opportunity to extend our theoretical and practical knowledge of the relationship between CEOs and boards of directors In their survey of the literature on TMTs and Boards of Directors, Finkelstein and Hambrick (1996) suggest that

“while directors may be appointed to enhance access to needed resources, they may also be fulfilling their own instrumental needs” (1996: 215) Research done by Aldrich (1979), Mizruchi (1982), and Mizruchi and Brewster-Stearns (1988) supports this assertion This view

suggests that when we think about the exchange relationship between boards of directors and CEOs, we can extend our thinking beyond what the board is providing to the CEO but also to include what the CEO is providing to the board members The table shows that both sides can act on behalf of the principal to ensure the organization’s financial stability and success The two sides of the exchange relationship are shown in Table 1

***Tnsert Table 1 about here***

Unlike prior studies of the relationship between the CEO and the board of directors, Table 1 suggests that the CEO can act as a monitor of the board of directors to ensure that they are contributing to the success of the organization As the job security and future income of the CEO are tied up with the strength of the organization, the CEO has an incentive to monitor the activities of board of directors Board members may be motivated to serve in name-only; their contribution to the organization may be minimal but they are able to claim increased status through their affiliation with the organization Therefore, to maximize the contribution of the board of directors to the strength of the organization, the CEO identifies requirements about the financial or labor contributions expected of the board and provides the board members access

to resources and information within the organization

While the CEO is concerned with job-security and the long-term stability of the organization, board members do not have the same financial considerations In non-profit organizations the ownership constraint has been relaxed and board members are not assumed to

be protecting the financial investments of shareholders They may view the organization as means through which they can fulfill their own goals (Aldrich, 1979; Mizruchi, 1982; Mizruchi

and Brewster-Stearns, 1988; Finkelstein and Hambrick, 1996) As board members, directors have a forum through which they may pursue their individual policy agendas, fulfill affinity goals, take advantage of networking and agenda-setting opportunities, and receive status through their affiliation with the organization With access to these resources and opportunities, board members may shirk their responsibilities or implement decisions that in their own best interests but not those of the organization This too is an incentive for CEOs to monitor the decisions of boards of directors

By identifying where the differences are between the for-profit and non-profit organizations and eliminating the assumption that risk preferences and responsibilities are derived from financial ownership, non-profit organizations offer a unique context within which

to study how CEOs and boards of directors influence strategy as well as to determine what characteristics of the exchange relationship between the CEO and the board would be necessary for the CEO to act on behalf of the principal To address these research questions, this study will focus on agency theory and resource dependence, two theories of exchange A literature review of these theories as well as a discussion of their applicability to non-profit organizations follows in the next chapter

CHAPTER 3

AGENCY THEORY

Agency theory was developed by economists to explain how the separation of ownership and control led to agency costs due to the asymmetric access to information faced by the managers and owners of organizations (Jensen and Meckling, 1976; Fama, 1980; Fama and Jensen, 1983) An agency relationship exists when “one or more person(s) (the principal(s)) engage another person (the agent) to perform some service on their behalf which involves delegating some decision-making authority to the agent” (Jensen and Meckling, 1976: 308) As a result of the delegation of decision-making authority, the issue of separation of ownership and control has also been characterized in terms of the separation of decision management from residual risk bearing (Fama and Jensen, 1983a) To manage this separation, organizations have as governance structures a decision system where the initiation and implementation of decisions is separate from the ratification and monitoring of decisions (Fama and Jensen, 1983a) For example, shareholders have the right to vote on new board members proposed by the existing management Under this scenario, the agent is responsible for implementing the decisions while the principal is responsible for ratifying and monitoring them

Agency theory suggests that the relationship between principals and agents should be constructed so that there is efficient access to information and distribution of risk-bearing costs (Jensen and Murphy, 1990) As it is impossible at zero cost to ensure the agent will make an optimal decision from the principal’s viewpoint, the principal can encourage a convergence of

the agent’s interests with his or her interests by incurring monitoring costs and by establishing appropriate incentives through contracts (Jensen & Meckling, 1976) Agency theory assumes information is a purchasable commodity (Eisenhardt, 1989) through the contracts entered into between the principals and agents The contract between the principal and agent can be explicit

or implicit An employment contract is an example of an explicit contract while membership

on a team is an implicit contract where an equal contribution to the team’s effort is exchanged for an equal share of the outcome However, the contracts are not perfect as the contracting parties can encounter problems of moral hazard, adverse selection, and issues about the appropriate risk sharing arrangements (Perrow, 1986; Eisenhardt, 1989)

Agency theory has had a well-developed history of theoretical development and testing, especially in for-profit organizations “The agency theory ideas on risk, outcome uncertainty, incentives, and information systems are novel contributions to organizational thinking, and the empirical evidence is supporting of the theory, particularly when coupled with complementary theoretical perspectives” (Eisenhardt, 1989: 58) Supporting this view, Finkelstein and Hambrick (1996: 259) suggest that “research that relies solely on an agency theory perspective

to explain board behavior may be neglecting an important alternative theory, one consequence

of which may the inconsistent results reported in the literature.” After discussing prior empirical research of agency theory in the field of management and the applicability of agency theory to the domain of non-profit organizations, this chapter will heed Eisenhardt’s suggestion and introduce the background and empirical support for resource dependence These two

theories of exchange provide the theoretical framework for the hypotheses to be developed in the subsequent chapter

Empirical evidence

The two major streams of literature in agency theory have been the positivistic and principal-agent approaches Researchers interested in how governance mechanisms are used to alleviate conflicts between the principals and agents are in the positivistic research stream (Jensen and Meckling, 1976; Fama and Jensen, 1983; Fama, 1980; Oviatt, 1988; Eisenhardt, 1989) Much of the research in this area has been concentrated on the relationship between owners and managers in the context of for-profit public corporations (Berle, 1932; Eisenhardt, 1989) The principal-agent research stream 1s a complementary one to the positivistic approach (Eisenhardt, 1989) Instead of focusing on contract alternatives, principal-agent research puts the emphasis on identifying the most efficient contract the efficiency of the contract under different levels of risk preferences and uncertainty (Eisenhardt, 1989)

Support for the positivistic research stream of agency theory suggests that governance mechanisms employed by firms provides information as to the degree of alignment between the goals of managers and stockholders Argawal and Mandelker (1987) found that when executives held stock in their organization, acquisition and financing decisions were consistent with stockholder interests; similar results were found by Walking and Long (1984) in their study of managerial resistance to takeover bids between 1972 and 1977 Further empirical support was found by Singh and Harianto (1989) in their study of Fortune 500 firms Their results suggest there is a higher probability of a takeover attempt when the interests of

executives and stockholders were aligned through the use of golden parachutes (Singh and Harianto, 1989) The cumulative results of this research suggest that the use of outcome-based contracts among executives in for-profit public organizations can provide information to potential stakeholders outside of the organization

As representatives of the organization’s shareholders, the board of directors can also provide information to external stakeholders The composition of the board of directors is an indicator of its ability to independently monitor management’s activities The number or proportion of outsiders as well as CEO duality are common measures of the board’s independence Researchers have found positive relationships between outside directors and firm performance (Baysinger and Butler, 1985; Pearce and Zahra, 1992; Ezzamel and Watson, 1993) These results support an agency theory perspective as outside board members are believed to be less influenced by the CEO and, therefore, in a better position to objectively review and monitor proposed organizational strategies However, researchers have found similar effects on firm performance when there have been a higher proportion of insiders on the board of directors (Baysinger and Hoskisson, 1990) These results are consistent with stewardship theory and the concept that inside directors are better evaluators of the actions and strategies of top managers

A second measure of board independence is the separation of the CEO and Chairman positions This separation (or lack of CEO duality) reflects the agency theory perspective that the board of directors must maintain its independence to effectively monitor managers In support of this perspective, Finkelstein and D’Aveni (1994) found that CEO duality was less

likely when organizational performance was poor, suggesting that boards of directors increase monitoring activities when necessary to protect the interests of stakeholders

The empirical research outlined above has been done in on samples of for-profit organizations As will be described in the next section, agency theory is not theoretically constrained to for-profit organizations The following section will present how agency theory

is applicable to the study of non-profit organizations

Applicability to non-profit organizations

Agency theory is typically conceptualized around the separation of ownership and control In for-profit organizations ownership is viewed in terms of financial ownership characterized by claims on residual earnings while control is vested in the professional management team hired to run the organization Fama and Jensen (1983a, 1983b) addressed the unique context of non-profit organization in two articles published in the Journal of Law and Economics In both of these articles, they argue that the absence of residual claim in non- profits avoids the donor-residual claimant agency problem and explains the dominance of the non-profit structure in donor-financed organizations

Theoretically agency theory can be tested in the context of non-profit organizations based on the idea that “ most organizations are simply legal fictions which serve as a nexus for a set of contracting relationships among individuals This includes firms, non-profit institutions such as universities, hospitals and foundations, mutual organizations such as mutual savings bank and insurance companies, and co-operative, some private clubs, and even governmental bodies such as cities, states, and the Federal government, government enterprises

such as TVA, the Post Office, transit systems, etc.” (Jensen and Meckling, 1976:290) Ownership of an organization is frequently determined based upon the ownership of capital or the claims on residual earnings “However, ownership of capital should not be confused with ownership of the firm Each factor in a firm is owned by somebody The firm is just a set of contracts covering the way inputs are joined to create outputs and the way receipts from outputs are shared among inputs In this ‘nexus of contracts’ perspective, ownership of the firm is an irrelevant concept” (Fama, 1980: 290) As non-profit organizations cannot sell stock or ownership of the organization they represent the archetype of ownerless organizations but they are still required to enter into agreements with the factors of production necessary to produce the services mandated under their charters

In one of the few studies testing agency theory in non-profit organizations, Olson (2000) examined relationships between boards of trustees, college president characteristics, and institutional performance Using data from a survey of the members of the Council of Independent Colleges, Olson’s study tested hypotheses on a sample of 43 respondents He found that board size, average board tenure, and the level of business executive experience among the board members had a positive impact on the performance of the universities as did the tenure of the university’s president The results of the relationship between the board of directors and organizational performance are consistent with a traditional application of agency theory Olson suggested that a long-tenured president may have a greater sense of ownership

of the organization and this ‘psychological’ ownership would result in the president feel more like a principal than an agent However, in his discussion of the results, Olson suggested that

the mixed pattern of results for the board diversity hypotheses may suggest the relationships were indicative of support for resource dependence rather than agency theory He found that a more ethnically heterogeneous board of directors led to more gift income presumably by using the board of directors to open itself to a new source of donors This study will build on that suggestion by developing hypotheses based in agency theory and resource dependence

RESOURCE DEPENDENCE

Resource dependence has its origins in the social exchange literature Unlike economic theories of exchange that assume exchanges between actors are unique, independent events, social exchange theory assumes the existence of recurring and, therefore interdependent, interactions between actors over time (Blau, 1964) These interactions result in a social structure that defines the parameters under which the exchange occurs However, the reoccurring nature of the exchange means that the established structure is susceptible to change

as a result of the on-going exchange process For example, changes in the environment may alter the degree of dependence between actors from the time the exchange is initiated and as the relationship continues This change in dependence may alter the parameters of the exchange without ending the relationship Building on this perspective, resource dependence focuses on how to manage exchange relationships between actors by altering or reducing dependencies

To understand how the recurring nature of exchange with the actors from the external environment for critical resources influences the internal structure of organizations, resource dependence began by proposing a process by which the influence occurs [see Table 2 for Aldrich and Pfeffer’s process (1976)] Pfeffer and Salancik (1978) extended Aldrich and

Pfeffer’s (1976) process by identifying a model of organizational adaptation to environmental constraints Pfeffer (1982) amended the model to include a feedback loop from the last stage in the model back to the first step (see Table 3 for the 1982 version of the model)

As an open systems theory that acknowledges the influence of the environment on the strategic decisions made by managers, resource dependence implies that managers will work to manage their organizations and environments due to the power and control possibilities inherent in dependent relationships (Aldrich and Pfeffer, 1976; Pfeffer and Salancik, 1978) The theory suggests managerial actions “reflects the constraints of the external elements Action results from the pattern of constraints, contingencies, or demands confronting the social unit” (Pfeffer, 1982: 8) At best managers will proactively pursue actions that will enable the organization to adapt to or alter the external environment (Pfeffer, 1982) “Top managements are especially concerned with (a) scanning the environment to find out what is happening and what may happen, (b) loosening dependencies so that the organization does not become too dependent on any one or few others, and (c) managing conflicting external demands” (Pugh and Hickson, 1997, page 65)

Managers can use interlocks through the board of directors as one tactic to establish links with the environment and bring previously unavailable information and resources into the organization “Any board member who is primarily affiliated with another firm automatically

established through interlocking directorates are meant to keep the managers of the