The Effects of Board Size and Diversity on Strategic Change

Author(s): Jerry Goodstein, Kanak Gautam and Warren Boeker

Source: Strategic Management Journal , Mar., 1994, Vol. 15, No. 3 (Mar., 1994), pp. 241-
250
Published by: Wiley

Stable URL: https://www.jstor.org/stable/2486969

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 Strategic Management Journal, Vol. 15, 241-250 (1994)

RESEARCH NOTES AND COMMUNICATIONS

THE EFFECTS OF BOARD SIZE AND DIVERSITY ON

STRATEGIC CHANGE
JERRY GOODSTEIN
Department of Management and Systems, Washington State University, Vancouver,
Vancouver, Washington, U.S.A.

KANAK GAUTAM
School of Business and Administration, St. Louis University, St. Louis, Missouri,
U.S.A.

WARREN BOEKER
Graduate School of Business, Columbia University, New York, New York U.S.A.

This study examines an important potential conflict between the institutional, governance,
and strategic fuinctions of boards. We specifically test how higher levels of board size and
diversity, traditionally associated with optimal institutional and governance performance of
boards, affect the board's ability to initiate strategic changes during periods of environmental
turbulence. Our findings suggest that board diversity, in particular, may be a significant
constraint on strategic change.

INTRODUCTION his seminal studies, Pfeffer (1972, 1973) found

Research on the board of directors has been one
of the most prolific research domains in the
organizational literature in the last two decades.
As boards have evolved from small homogeneous
units to large representative entities, a primary
focus of scholars has been the structure of boards
and its effects on the performance of significant
board functions. Studies have adopted one of
two perspectives, each emphasizing different
functional duties of the board.
Resource dependence theorists have empha-
sized the institutional function of board structure,
arguing that by increasing in size and diversity,
boards help to link the organization to its external
environment and secure critical resources, includ-
ing prestige and legitimacy (Mintzberg, 1983;
Pearce and Zahra, 1992; Pfeffer, 1972, 1973). In
Key words: Board of directors, strategic change
that organizational responsiveness to resource
dependencies and regulatory pressures led to the
creation of boards that were comparatively larger,
and composed of members of diverse occupational
and professional groups.
Later, the emphasis shifted away from the
resource-acquisition or institutional function of
the board to its governance function. The board
of directors was viewed as a critical mechanism
for checking managerial opportunism and ensur-
ing that organizational actions accord with stake-
holder interests (Williamson, 1975; Kosnik, 1987,
1990).Researchers have focused on the effects of
outsiders on corporate governance decisions,
arguing that outside board members are more
likely to be objective and independent, and more
capable of resisting self-interested efforts by
inside managers to influence board decisions
(Kosnik, 1987; Singh and Harianto, 1989). Kosnik
(1987), for example, found that corporate boards

CCC 0143-2095/94/030241-10 Received 20 November 1992

(C 1994 by John Wiley & Sons, Ltd. Final revision received 17 September 1993

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242 Research Notes and Communications
with a higher proportion of outsiders were more
likely to resist the payment of greenmail.
A third function of the board that has
historically been neglected, but is receiving
greater attention, is the effect of board structure
on the strategic function of the board (Judge
and Zeithaml, 1992; Pearce and Zahra, 1991,
1992). The strategic role of the board, beyond
acquiring resources or representing stakeholder
interests, involves taking important decisions on
strategic change that help the organization adapt
to important environmental changes (Mintzberg,
1983; Pearce and Zahra, 1991, 1992; Zald, 1969).
The strategic function of the board is particularly
important during critical periods of environmental
turbulence or declines in organizational perform-
ance (Boulton, 1978; Mintzberg, 1983; Zald,
1969). Such events provide significant opportuni-
ties for maximum mobilization of board power
and the initiation of strategic change.
The increased interest in the board's strategic
role raises the issue of potential conflict between
the strategic function of the board and its
institutional and governance functions. Such
conflicts are rooted in the structure of the board.
Specifically, as boards increase in size and
diversity to fulfill their institutional and govern-
ance functions, they may not be ideally suited
to taking timely strategic action in response to
critical environmental changes.
To a great extent this potential conflict has
not been emphasized by strategy researchers.
Researchers have generally argued that larger
and more diverse boards of directors reduce
uncertainty surrounding strategy development
and enhance company performance (Pearce and
Zahra, 1992). Therefore, we develop and test
propositions below that specify how board size
and diversity affects the ability of the board of
directors to initiate strategic changes in turbulent
environments.
BOARD STRUCTURE AND STRATEGIC
CHANGE
The effects of board size on strategic change
Researchers have pointed to a number of ways
in which board size enhances the institutional and
governance functions of the board. Expanding the
size of the board has been shown to provide an
increased pool of expertise and resources for the
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organization (Pfeffer, 1972, 1973). In addition,
it has been suggested that larger boards might
enhance corporate governance by reducing CEO
domination and making it more difficult for the
CEO to build a broad consensus within the
board to take actions, such as the adoption of
golden parachute contracts, that might not be in
shareholder interests (Singh and Harianto, 1989).
Finally large boards may permit the inclusion of
a variety of perspectives on corporate strategy
(Pearce and Zahra, 1992).
However, increased size can significantly
inhibit the board's ability to initiate strategic
actions. Large boards may face a number of
barriers in reaching a consensus on important
decisions. These barriers may be a function of a
number of factors. First, larger decision-making
groups are less cohesive (Shaw, 1981) and
experience decreased levels of motivation and
satisfaction due to the lack of participation that
often characterizes larger decision-making groups
(Jewell and Reitz, 1981). Judge and Zeithaml
(1992) found that larger boards were less likely
to become involved in strategic decision making.
Second, larger groups are more difficult to
coordinate due to the large number of potential
interactions among group members (Gladstein,
1984). Finally, larger groups are more likely to
develop factions and coalitions that can increase
group conflict (O'Reilly, Caldwell, and Barnett,
1989) and increase the difficulty of reaching a
consensus on critical decisions.
The nature and context of decisions considered
by the board also exacerbates the potential group
dynamics problems associated with large groups.
Decisions that involve complex and ambiguous
tasks, as most issues involving strategic change
invariably do (Eisenhardt, 1989; Wiersema and
Bantel, 1992), are apt to be more unfavorably
affected by large group dynamics (Olson, 1982).
As complexity and ambiguity increase, groups
may become factionalized into special interests.
These special interests may attempt to promote
their own agenda, rather than working to fulfill
the goals of the collective group. Olson (1982)
argues that this can limit important changes such
as the adoption of new technologies within an
organization.
Larger boards may also hinder the board's
effectiveness in ensuring that the organization is
responsive to environmental change. This may
be particularly true during major environmental

jolts or shifts (Meyer, 1982), when environmental
change is turbulent and complex and initiating
critical strategic changes in a timely manner
becomes a critical contingency for the organiza-
tion. The poor quality of internal dynamics
within larger boards (Harrison, 1987; Herman,
1981) may potentially slow down the strategic
decision making process and limit the board's
ability to direct critical strategic changes.
The arguments outlined above suggest an
inverse relation between board size and the
board's ability to initiate strategic changes that
help the organization adapt to its environment.
HI: Organizations with larger boards of
directors will be less likely to initiate strategic
changes during periods of environmental turbu-
lence.
The effects of board diversity on strategic
change
Past studies on boards have emphasized the
benefits of greater board diversity. In particular,
resource dependence theorists have argued that
the incorporation of diverse constituencies and
stakeholders into the board facilitates the
acquisition of critical resources for the organiza-
tion (Pfeffer, 1972, 1973; Pfeffer and Salancik,
1978). Corporate governance theorists have
also suggested that board diversity can indirectly
or directly benefit organizations (Kosnik, 1990).
Drawing an important distinction between the
proportion of outside board members and
the diversity of board membership, Kosnik
(1990: 138) specifically argued that diversity
among board member backgrounds '...may
promote the airing of different perspectives
and reduce the probability of complacency and
narrow-mindedness in a board's evaluation of
executive proposals.' This argument is consist-
ent with others who have posited that the
promotion of diverse perspectives can produce
a wider range of solutions and decision-
criteria for strategic decisions (Eisenhardt and
Bourgeois, 1988; Schweiger, Sandberg, and
Ragan, 1986).
However, diversity within a group may
significantly constrain a group's efforts to take
decisive action, especially in the context of the
board and their efforts to initiate strategic
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Research Notes and Communications 243
change in times of environmental turbulence.
Board members bring their individual and
constituencies' interests and commitments to
the board (Baysinger and Butler, 1985; Kosnik,
1990). Differences among these interests,
especially those that are based on occupational
and professional affiliations (Powell, 1991;
Thompson, 1967) are likely to lead to varying
conceptions about proposed strategic changes.
The greater the diversity of board interests,
the greater the potential for conflict and factions
to develop based on divergent definitions of
organizational goals and policies (Clegg, 1990;
Mintzberg, 1983; Powell, 1991).
Once again, these considerations may become
particularly salient when the board of directors
confronts the complex and ambiguous issues
that surround strategic decisions. Proposals for
strategic change can create a high degree of
uncertainty and conflict (Mintzberg, 1983) and
intensify differences between diverse individuals
or coalitions. As a result, it may become
increasingly difficult to develop a consensus
on strategic changes (Walsh, Henderson, and
Deighton, 1988).
In summary, diverse boards may fail to
initiate strategic changes during critical periods
of environmental turbulence.
H2: Organizations with more diverse boards
of directors are less likely to initiate strategic
changes during periods of environmental turbu-
lence.
METHODS
We explored these issues by focusing on the health
care industry and examining the relationship
between hospital boards and strategic changes in
medical services during the period 1980-85.
This period was characterized by unprecedented
environmental turbulence and discontinuous
change in the health care industry (Meyer,
Brooks and Goes, 1990; Shortell, Morrison and
Friedman, 1990). Industry-wide innovations in
healthcare delivery lead to intense competition
from new organizational forms such as health
maintenance organizations (HMOs), preferred
provider organizations (PPOs) and ambulatory
surgical centers (Shortell et al., 1990). In addition,
244 Research Notes and Communications
major reforms in state and federal reimbursement
policies such as the implementation of the
Medicare Prospective Payment System (PPS)
created unprecedented resouirce scarcity in the
industry (Meyer et al., 1990). This provided an
appropriate setting for examining board decisions
requiring strategic adaptation to a turbulent and
uncertain environment.
Another advantage of using the health care
industry as a research site was the increasd
involvement of hospital boards in strategic
decisions. Writers have argued that hospital
boards, in order to cope with uncertain regulatory
and competitive environments, need to become
more strategically-oriented (Alexander, Morlock
and Gifford, 1988; Delbecq, 1988; Shortell,
1989). A number of empirical studies confirm
the increased involvement of the board in
strategic decision processes. For exmple, Judge
and Zeithaml (1992) found that hospital boards
were significantly more likely than corporate
boards to be involved in the formulation of
strategic decision making.
Sample
The two hypotheses of the study were specifically
tested on a panel of 334 hospitals in the
State of California. Hospitals in California were
particularly affected over the period 1980-85 by
heightened competition from new health care
organizations, excess capacity among hospitals
and the introduction of important state (in
addition to federal) regulatory actions designed
to constrain hospital costs (Meyer et al., 1990;
Shortell et al., 1990).
The data on hospitals were obtained from the
Calfornia Health Facilities Commission (CHFC)
annual disclosure survey. The CHFC surveys
hospitals in California with regard to hospital
organization and management, service provision
and utilization, and financial performance. Data
on hospital environments were collected from
the Area Resource File, a widely used data base
providing a broad range of data on hospital
environments. We directed attention to hospitals
within Standard Metropolitan Statistical Areas
(SMSA) in order to explore strategic change
within a hospital market context (Fennell, 1980).
The sample included for-profit, not-for-profit,
and governmental (nonfederal) hospitals. The
average hospital size was 150 beds.
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Measures
Dependent variable
Strategic change. We examined three distinct
types of strategic changes in medical services:
service additions, service divestitures and service
reorganizations. Changes in the scope and organi-
zation of services represent one of the most
fundamental strategic responses to environmental
contingencies (D'Aveni, 1989; Ginsberg, 1988).
In addition, because changes in medical services
may differentially affect both internal and external
constituencies, the potential for conflicting values
and interests within the hospital board is likely
to be high.
1. Service additions. Additions were noted when
a hospital indicated the availability of a service
not provided in the previous year. A service
addition occurred either by the hospital
directly providing the new service or by
establishing a contractual relationship with
another provider. For each year we determined
the number of new services added by the
hospital and summed these services to create
the dependent variable.
2. Service divestitures. In a similar manner,
divestitures were noted when the survey
indicated that a service previously provided
(either by the hospital or by an external
provider) was no longer provided by the
hospital. A summary measure of total service
divestitures was computed.
3. Service reorganizations. Reorganizations were
determined based on changes in the govern-
ance of a given service. A reorganization was
coded when services previously provided in-
house were presently contracted out, or
services previously contracted out were cur-
rently provided in-house. A summary measure
of total service reorganizations was also
computed.
Independent variables
We used data on hospital board structure and
composition to develop measures of board size
and board diversity. In addition to these variables,

we included a measure of the total proportion
of outsiders on the board. Including this measure
allowed for differentiating the effects of board
diversity and outsider representation on strategic
change (Kosnik, 1990).
Board size. We determined the total number
of directors listed as active members on the
board of directors.
Board diversity. We developed a measure of
board diversity that reflects differences in occu-
pational or professional backgrounds (Kosnik,
1990). We first created 11 occupational groupings
for board members based on previous research
on hospital boards (Pfeffer, 1972, 1973). These
groups (e.g., physicians, hospital administrators,
corporate executives, etc.) reflect important
constituencies likely to influence hospital oper-
ations. We then computed a Gibbs-Martin Index
of diversity based on the distribution of board
members within these groups.
The Gibbs-Martin Index is defined as:
n
1 - , Pi2
where Pi represents the proportion of a board
accounted for by the ith group. This measure
indicates the extent of concentration of board
members, ranging from high concentration with
a single group (index of 0 indicating complete
homogeneity) to extremely low concentration,
based on an equal distribution of members across
a very large number of groups (index of 1).
Board outside representation. We computed the
proportion of total board membership held by
outsiders. We distinguished between hospital
management and physicians (insiders) and all
other board members (outsiders).
Control variables
A number of other important control variables
were included in the research design, based
on prior research on the organizational and
environmental determinants of strategic change
(Tushman and Romanelli, 1985).
Competitive environment. Two separate meas-
ures of hospital competition were incorporated.
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Research Notes and Comnmnunications 245
We first computed the number of hospitals per
capita for all SMSA hospital markets in California
to reflect competition among hospitals for both
patients and physician services. Second, we
included a measure of excess capacity iri hospital
markets based on the total number of hospital
beds per capita. The greater the number of beds
per capita, the greater the pressuie on hospitals
to utilize facilities and services efficiently.
Regulatory environiment. The implementation
of the Medicare Prospective Payment System
(PPS) in 1983 represented a significant environ-
mental jolt in the health care sector (Meyer et
al., 1990) that placed greater financial pressure
on hospitals and motivated hospitals to constrain
costs and seek new sources of revenue (Shortell
et al., 1990). A dummy variable was included in
each of the years of implementation (1983-85)
during this study.
Performance. The effect of hospital perform-
ance on strategic change was controlled for by
including the operating margin as a percentage
of net revenue (Shortell et al., 1990).
Finally, the following variables were included
to account for differences among hospitals in the
following areas:
Total number of hospital services. This measure
takes into account differences in the total range
of services provided by the hospital.
Hospital size. We accounted for variations in
hospital size by including the total number of
beds.
Hospital ownership. We controlled for hospital
ownership by distinguishing between for-profit,
not-for-profit, religious, and government hospi-
tals. Prior studies (Shortell et al., 1990) indicate
that service changes vary depending on the
ownership of the hospital.
Data Analysis
The data were analyzed using a pooled time
series and cross-section data structure. A total
of 335 hospitals were examined over five waves
in the study: t... .t- 1. We computed service
changes from 1980-81, 1981-82, 1982-83,
1983-84, 1984-85 and related these clhanges to
246 Research Notes and Communications
the independent variables measured at time t.
Each model was estimated using a weighted
generalized least squares (WGLS) procedure
developed by Kmenta (1986). This procedure
explicitly corrects for autocorrelation and het-
eroscedasticity.
RESULTS
The descriptive statistics for the dependent,
independent and control variables are included
in Table 1. The three measures of strategic
change are positively correlated with each other,
indicating that institutions tend to initiate changes
in all three areas together. Also, all three
measures of strategic change are negatively
correlated with the three measures of board
structure viz. size, diversity and percentage
outsiders, though the correlations for board size
are less than those for diversity and outsider
representation.
The results in Table 2 indicate modest support
for the hypothesized relationship between board
size and strategic changes made by the organiza-
tion (H1). Larger hospital boards tended to
initiate fewer service reorganizations, but board
size had no significant effects on service additions
and divestitures. Consistent support was found for
the hypothesized negative relationship between
board diversity and strategic change. In hospitals
with more occupationally diverse boards, these
boards tended to initiate fewer service additions,
divestitures and reorganizations.
The analyses also revealed that when both
board diversity and outsider representation are
taken into account, it is board diversity that
appears to have significant effects on strategic
changes. The proportion of outsiders on the
board, an important variable used by researchers
in studying the governance role of the board,
had no significant effects on the extent of
strategic changes. We discuss in greater detail
the implications of these varying effects for board
diversity and outsider representation.
In addition to board structure, a number of
organizational characteristics had a significant
effect on strategic change in hospitals. For-profit
hospitals were most likely to initiate service
additions, divestitures, and reorganizations.
These results are consistent with other national
studies that indicate that for-profit hospitals are
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more proactive in initiating strategic change in
response to competitive and regulatory changes
(Shortell et al., 1990). The extent of strategic
change was also influenced by hospital size. As
hospital size increases, the number of service
changes declines, suggesting that smaller hospitals
may have greater flexibility in adapting the
structure of the hospital to the environment.
Finally, it is interesting to note that the effects
of total hospital services varies depending on the
type of strategic change. In hospitals with
more hospital services, there were more service
additions and reorganizations, but fewer divesti-
tures. Our results suggest a pattern of strategic
change in which comparatively larger hospitals
with more services are more likely to continue
to add services while smaller hospitals with fewer
services may be more likely to further reduce
hospital services.
DISCUSSION
The objective of this study was to explore the
effects of board structure on strategic changes
initiated by organizations. We pursued this
objective out of a broader fundamental concern
that board structures that traditionally facilitate
the service and governance functions of the
board, i.e., large and diverse boards, may limit
its strategic function. In particular, we argued
that large and diverse boards would have limited
effectiveness in directing strategic change during
periods of environmental turbulence.
The effects of board diversity on strategic
change strongly supported our earlier arguments.
We noted that board diversity may lead to
potentially conflicting conceptions of strategic
change and limit the board's ability to take timely
strategic action. We found that organizations with
diverse boards are less likely to initiate strategic
changes than those with homogeneous boards.
These findings are consistent across three separate
measures of strategic change viz. additions,
divestitures and reorganizations, and were
recorded during a period of great environmental
turbulence in the health care industry when
strategic changes were expected in most health
care institutions (Meyer et al., 1990; Shortell et
al., 1990). Further, these findings were arrived at
after controlling for other plausible organizational
and environmental determinants of strategic
 Research Notes and Communications 247

*p<0.5;N=167

Table1.Dscriptv

1.Numberofsvicad6572

2.Numberofsvicdt78961*

3.Numberofsvicganzd102875*6

4.Boardsize10265-*3

5.Boardivesty03-14*82

6.Percntagofusidb0483-*1527

7.Totalbeds1643-0"*28

8.Totalservic907234-15*

9.Profitmagn04162-*

10.Hospitalerc(')2-8*539

1.Bedsprcait(0')364*52-8

12.PSimplentao06493-8*

13.Religouscntr052-6*7

14.Not-frpicnl0392*857

15.For-pfitcnl03849*276

MeanS.D(1)234567890

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248 Research Notes and Communications

Table 2. The effects of board size and board diversity on change in hospital
services

Dependent variables

Number of Number of
Independent Number of services services
variables services added divested reorganized

Board size -0.003 -0.017 -0.015**

Board diversity -0.107 ** -0.102*** --0.055***
Percentage of outsiders on
board -0.038 --0.042 0.022
Total beds -0.320*** -0.109*** -0.255***
Total services 0.332*** -0.127*** 0.045***
Profit margin -0.016 0.006 -0.011**
Hospitals per capita -0.024 -0.060*** -0.076***
Beds per capita 0.035*** 0.031** 0.080***
PPS Implementation 0.009 -0.017 -0.008***
Religious control 0.020 0.053** -0.054***
Not-for-profit control 0.008*** 0.015 0.009
For-profit control 0.161*** 0.108*** 0.126* * *
R 2 0.257 0.218 0.324

aReported coefficients are standardized. N = 1670

*p < 0.05; **p < 0.01; ***p < 0.001

change, such as performance, degree of compe-
tition, and regulatory change.
There was only modest support for the
hypothesized effects of board size on strategic
change. Though the correlation coefficients for
board size were negatively correlated with all
three indices of strategic change, the results of
the regression indicated that board size was
a significant constraint only in the case of
reorganizations. Perhaps this is due to the nature
of the problems associated with size. Board size
may act as a barrier to change due to the
difficulties in coordinating a large decision-
making body. However, such barriers may be
partly mitigated through the use of subcommittees
that may improve coordination even in larger
boards.
These findings raise an important issue for the
expanding literature on the strategic function of
the board. While prior research has focused
primarily on the relationship between the struc-
ture of the board and the board's institutional
and governance functions, few studies have
considered how the structure of the board might
influence the board's ability to initiate strategic
change. The negative relationship we found
between board diversity and strategic change
raises a potentially important strategic dilemma
for organizations: large and diverse board struc-
tures that have traditionally facilitated the insti-
tutional and governance functions of the board
may hinder the board's ability to initiate strategic
change, particularly during periods of environ-
mental turbulence. Researchers advocating more
diverse representation of board membership may
need to consider the strategic implications of
such measures.
An additional contribution of this study is to
highlight the importance of integrating into board
research measures of board structure that reflect
the potential diversity of interests on the board.
Rather than considering the board exclusively in
terms of an outsider/insider duality and assuming
that board outsiders are a monolithic group with
similar interests (Kosnik, 1990), governance
researchers should incorporate measures of board
diversity that reflect relevant differences in
occupational or functional backgrounds (Kosnik,
1990).
Our research also emphasizes the need to
study the internal processes of boards. Studies
of board process have been extremnely limited.
While data limitations may be one reason for
lack of board process research (Kosnik, 1990),

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more such studies are needed. One alternative
is for researchers to adopt archival methods as
used in this study, or to adopt survey methods
used in other recent studies (Johnson, Hoskisson
and Hitt, 1993; Judge and Zeithaml, 1992; Pearce
and Zahra, 1991).
While there were important benefits in
pursuing this research in the health care
industry, certain factors must be considered in
generalizing the results of this research. The
comparatively small size of hospitals and high
level of involvement of board members in
strategic affairs, suggests that these results
might apply primarily to small and medium-
sized corporations whose boards are similar to
hospital boards in terms of the scale of issues
considered and degree of board involvement
(Judge and Zeithaml, 1992). The relevance of
these results to larger organizations needs to
be explicitly considered. Although the boards
of large corporations are socially more homo-
geneous than hospital boards, there are still
important variations in occupational back-
grounds (e.g., functional backgrounds) within
corporate boards (Kosnik, 1990) that may have
similar implications for strategic change.
Future research should also consider if these
results extend to other types of strategic change.
In the health care industry, for example, hospitals
have also engaged in mergers, affiliations with
HMOs and joint ventures to cope with their
changing environments (Shortell et al., 1990). As
some of these changes may involve substantial
governance changes, the effect of board size and
diversity on these decisions may be particularly
relevant for study.
Finally, this study emphasizes the strategic role
of the board in comparison to its other functions.
Recent studies have pointed to the increased
involvement of boards in strategic planning and
implementation (Baysinger and Hoskisson, 1990;
Judge and Zeithaml, 1992). With institutional
pressures for greater corporate accountability,
the strategic function of the board is expanding
from a caretaker function to one of dominant
participation (Pearce and Zahra, 1991). This
study clearly encourages board reseachers, who
have largely focused on the institutional and
governance function of board structure, to direct
greater attention to the strategic function of the
board and the effects of board structure on
strategic decisions.
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Research Notes and Commuunications 249
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