This research examines the extent to which board members’ influence over firms’ strategic issues mediates the effects of board composition on the performance of a select group of high-growth, private firms. In addition, moderating effects of organizational characteristics on the board influence-firm performance relationship are examined. As predicted, board strategic influence mediates the effects of board composition on performance. In addition, the relationship between director influence and firm performance is contingent on the age of the firm such that the influence of insiders is more important to the performance of older, more established firms while outsiders were found to be more important to the performance of younger firms.

Public firms make up less than 1 percent of the total population of firms in the United States. Despite this, most research examining firm-level determinants of performance have focused on public firms, and large public firms in particular. This is especially true of corporate governance research where few studies have specifically explored the role of boards of directors in private firms (Ford, 1988; Robinson, 1982). In these studies, Ford (1988) found that the presence of outsiders on boards actually decreased the influence of the board while Robinson (1982) concluded that firms with outside board members had significantly higher profitability growth than did a matched sample of small firms without outside board representation.

The objective of this paper is to examine the mediating role of board influence on the relationship between board structure and firm performance among a sample of entrepreneurial, private firms. Thus, this study responds to both the need to examine the board of directors of successful private firms and to study board influence rather than board structure. In addition, this study builds upon prior research on the association between boards of directors and firm performance.

The influence of boards of directors on firm performance has been widely studied, and boards have been found to influence a variety of firm outcomes including bankruptcy rates (Chaganti, Mahajan, & Sharma, 1985), corporate restructuring (Johnson, Hoskisson, & Hitt, 1993), research and development spending (Baysinger, Kosnik, & Turk, 1991), and various financial performance indicators (Baysinger & Butler, 1985; Pfeffer, 1972; Vance, 1964). Most research examining the effects of boards of directors on firm performance has been concerned with board composition. In those studies, board size, the existence of outsiders, and the proportion of outsiders on the board were frequently hypothesized to have a direct affect on firm performance. However, the extent to which the board’s influence over strategic issues impacts firm performance has been largely ignored. The current investigation fills this gap in the literature by examining the potential mediating effects of board influence on the relationship between board composition and firm performance. In addition, this study examines the extent to which contextual factors affect the relationship between board influence and firm performance.

Many studies have been conducted over the past four decades to investigate the influence of boards of directors on firm outcomes, and most of these have been concerned with board composition. The size of a firm’s board of directors has been extensively studied, and the results of this research have been inconsistent. For example, Zahra and Stanton (1988) concluded that board size has no influence on firms’ financial performance. On the contrary, Chaganti and colleagues (1985) found a higher bankruptcy rate for firms with smaller boards while Daily and Dalton (1993) found that larger boards were associated with superior performance. Finally, Dalton, Daily, Ellstrand and Johnson (1998) found no consistent link between board composition and firm performance in a meta-analytic review of the field.

In addition to board size, several studies have been conducted to examine the influence of the number of outsiders on firm performance. Early work by Vance (1964) concluded that firms with insider-dominated boards outperformed firms with outsider-dominated boards. On the contrary, Baysinger and Butler (1985) and Daily and Dalton (1992, 1993) found that firms with more outsiders on their boards achieved superior returns.

Similar studies have been concerned not with the number of outsiders and insiders on boards, but rather with the ratio of insiders to outsiders. Several studies have concluded that the insider-outsider ratio has no influence on firm performance (Chaganti et al., 1985; Zahra & Stanton, 1988). However, Pfeffer (1972) found firms deviating from an “ideal” insider-outsider ratio had lower levels of performance relative to other firms in their industries. Similarly, Cochran and colleagues (1985) and Daily and Dalton (1992, 1993) found that firms with a larger proportion of outsiders on their boards had higher levels of performance. Firms having boards with higher outsider ratios have also been found to engage in more restructuring activities (Johnson et al., 1993) and spend more on research and development (Baysinger et al., 1991).

Despite abundant research on the board composition-firm performance relationship, relatively little research has been conducted to determine the affect that the cognitive construct board influence has on firm outcomes. Nevertheless, some empirical evidence exists regarding the relationship between board influence and organizational outcomes. Pearce and Zahra (1991) found that powerful boards were associated with higher levels of firm performance. In addition, Boyd (1994) found that lower levels of board control were associated with significantly higher executive compensation packages. Studies attempting to explain firm performance with executive compensation have largely led to mixed results. Thus, it appears that, in the absence of board influence, top executives may seek to increase their compensation beyond that which maximizes firm performance and the owners’ wealth. In tandem, the results of these studies highlight the potential importance of board member influence to organizational outcomes.

Mediating Effects of Board Influence

The current study attempts to shed additional light on the performance implications of boards of directors by examining both board composition and board influence in a single model. While board composition, and, to a lesser extent, board influence, have been shown to affect firm outcomes, the nature of the relationship between board influence and board composition has not been explored. Thus far, the intermediate relationships between board composition and firm outcomes have been treated as a “black box.”

We propose that the effects of board composition on firm performance are mediated by board influence. In other words, composition of a firm’s board of directors will affect the influence that the board has on the firm’s strategic issues; the board’s influence then affects firm performance. Stated differently, we hypothesize that board composition has an effect on firm performance through its effect on board influence. This is a dramatic departure from prior boards research, which focused almost exclusively on a direct link between board composition and firm performance.

In this study, we examine two types of board composition that have been widely explored in prior research, namely, board size and the proportion of board members who are outsiders. Consistent with several previous studies (see Ford, 1988, 1992) inside members are defined as present or former officers or managers of the firm and their family members. Outside members are all other members of the board, including representatives of financial institutions or investor groups, other professionals and academics, and executives of other businesses.

Larger boards and those with a higher percentage of outsiders are more likely to exert influence over a firm’s top management team. Larger boards may have a higher degree of influence over top management because they consist of members with a wider range of functional experience. In addition, they are less susceptible to domination by the firm’s management and are more likely to force management to consider a wider range of options (Zahra & Pearce, 1989). Furthermore, larger boards are more likely to have representatives of outside investors and will, therefore, seek to maximize the firm’s long-run economic performance. As a result, they will exert more influence over a broader range of organizational issues than will smaller boards.

Regarding boards with a higher proportion of outsiders, outside members generally have fewer ties to the organization than insiders and will be less likely to bow to managerial pressure (Ford, 1988). Further, outsiders’ loyalties may lie more firmly with outside owners, venture capitalists, suppliers, customer groups, and so on, leading them to be more objective and vocal in their assessment of the organization’s current situation. Furthermore, because their professional experience lies outside the firms they serve, they may be better able to suggest unique solutions to organizational problems, thereby potentially exerting more influence over organizational decisions. By contrast, insiders, some of whom may be subordinates of the board chairman (when he/she also serves as the top executive of the firm), may be much less likely to criticize current management policies. In addition, insiders who are current managers of the firm may be less likely to criticize current strategic initiatives because those insiders are oftentimes the ones who formulated the strategies initially. Thus, many inside directors may suggest strategies consistent with past organizational actions, even when it is clear that change is necessary. In other words, their strategic judgement may be clouded because of their other relationships with the organization. Thus, boards with a higher proportion of outsiders are more likely to exert influence over managerial behavior.

Not only do we propose that board size and the ratio of outsiders to insiders will affect board influence, but we also contend that higher levels of board influence will lead to superior firm performance. There are two primary reasons for this. First, boards of directors generally bring a broad variety of skills, experiences, and alliances to the task of strategic management. This is especially important for high growth ventures, because they typically have a need for external decision-making skills. Boards are oftentimes assembled with diversity of background in mind (Castaldi & Wortman, 1984), and their influence may result in unique solutions to complex organizational problems. In other words, boards concerned with strategic issues will pressure top management to consider a wider range of alternatives than the top management team alone may have considered (Zahra & Pearce, 1989). In doing so, strategically influential boards cause management to explore options more fully, thereby leading to more positive organizational performance. On the other hand, the failure of boards to provide the proper strategic guidance to organizations results in less creative strategies and, consequently, lower levels of organizational performance.

Second, boards are believed to protect the interests of the firm’s owners from misrepresentation or opportunistic behavior on management’s part (Jensen & Meckling, 1976) and will, therefore, suggest strategic solutions that are focused on enhancing the firm’s long run performance. By contrast, agency theory contends that top executives will formulate and implement strategies that increase their own wealth at the expense of the owners’ (see Fama & Jensen, 1983). Many top executives avoid long term, high risk-high return strategies due to short run costs and potentially higher levels of executive employment risk (Baysinger et al., 1991). Similarly, in firms where boards are less influential over firm strategy, top executives may engage in “empire building” to increase their perquisites and reduce their employment risk (Vance, 1983). However, in firms where the board is influential, strategies may be more narrowly focused on the firm’s core competencies. In other words, influential boards may force top executives to pursue strategies that maximize long run firm performance by building on the firm’s primary capabilities and minimizing unwarranted growth. On the other hand, where board member influence is lacking, the strategies chosen by top executives may be designed to increase executive benefits through ill-conceived acquisitions and similar behavior. Thus, we propose that firm performance will be enhanced by directors’ strategic influence. Boards that more successfully assert their influence will likely cause managers to develop more creative solutions to the problems that their organizations face. In addition, board influence should result in strategies that are designed to maximize returns to owners, as opposed to maximizing the benefits to the executives themselves. In sum, we propose a mediating relationship between board composition, board influence, and firm performance. More specifically, we assert that the effects of board composition on firm performance are mediated by the board’s influence over managerial behavior and firm strategy. We contend that board composition effects board influence, and board influence effects firm performance.

Hypothesis 1: Board member influence mediates the effects of board composition on firm performance.

Moderators of the Board Influence-Firm Performance Relationship

It is likely that the performance implications of board member influence are not the same for all firms. Rather, the relationship between board influence and firm performance may be contingent upon certain characteristics of the organization itself. We propose that two characteristics of the organization, firm age and firm size, are important moderators of the relationship between board influence and firm performance.

Firm Age as a Moderator

For several reasons, the value of board influence to firm performance may be contingent upon the age of the organization. Younger firms are more likely to be concerned with resolving important strategic issues for the first time, such as determining which opportunities to pursue, selecting a competitive strategy, choosing methods of strategy implementation, and establishing strategic control mechanisms (Stinchcombe, 1965). At the same time, managers in newer organizations are less likely to engage in formal strategic planning or thorough environmental scanning (Mohan-Neill, 1995). As a result, they may have less knowledge of external environmental factors, when compared with executives of older organizations. This is largely due to a lack of managerial/analytical resources available to younger firms (Boeker & Goodstein, 1993). Therefore, by providing strategic management consultation to the top management team of young organizations, boards of directors may have important effects on their performance.

Conversely, older organizations are more likely to have well-established environmental scanning systems (Mohan-Neill, 1995) and more sophisticated strategic planning capabilities. Consequently, they may be less likely to need board member strategic influence to achieve higher levels of performance. In addition, the increased levels of bureaucracy often associated with older, more established organizations may actually interfere with the ability of boards of directors to affect change. As a result, we propose that the influence of boards of directors have more important performance implications for younger firms, because these organizations may have resource constraints that limit their ability to engage in effective strategic management. In addition, older organizations likely have more complex strategic planning systems and bureaucracies in place that reduce the extent to which board members are able to influence firm performance.

Hypothesis 2: The effect of board influence on firm performance is moderated by firm age such that, for younger firms, the effect of board influence on performance is stronger.

Firm Size as a Moderator

The size of organizations has been widely discussed in the strategy and organization theory literatures and has often been tested as a moderator variable. For example, firm size has been shown to affect the influence that a CEO can have on the firm (Miller & Droge, 1986), the level of organizational formalization (Hall, 1987), and the relationships between internal/external successors and firm performance (Reinganum, 1985). It is also possible that the size of the firm influences the relationship between board influence and firm performance (Flamholtz, 1986).

We propose that the influence of boards of directors is more important to smaller organizations. For various reasons, smaller firms are less likely to engage in systematic strategic planning (Robinson, 1982). As a result, smaller firms should rely more on experts, such as accountants, consultants, boards of directors, and others, to offset their managers’ limited knowledge/experience and lack of internal strategic planning resources (Robinson, 1982). Thus, the strategic guidance of boards of directors may be much more important to the success of smaller organizations. Conversely, larger firms, with their more sophisticated planning tools and, in some cases, entire strategic planning departments, may rely less on the strategic influence of their boards of directors without suffering performance declines.

Hypothesis 3: The effect of board influence on firm performance is moderated by firm size such that, for smaller firms, the effect of board influence on performance is stronger.

Our sample consists of privately held firms listed in Inc. magazine’s rankings of the 500 fastest growing companies in America. Surveys were sent to 579 Inc. 500 CEOs (a slight research budget surplus allowed for surveys to be sent to a random sample of firms from a previous list), and completed surveys were received from 319 (55%) of them. Of the 319 firms responding to the survey, 198 (62%) of these had boards of directors (self-reported) and were included in the current study. These firms came from a broad variety of industries.

Firm Performance

Although there is little consensus regarding appropriate measures of performance, Dess and Robinson (1984) suggest the use of accurate, available performance measures. While growth in sales represents one of the most fundamental goals of businesses, it is also an accurate and available measure of performance based on the sample used in this study. Firm performance was measured using each firm’s sales growth rate for the previous five years, as published in Inc. magazine. The firms in our sample had an average growth rate of 1,527% for the most recent five-year period. In examining the link between board issues and firm performance, it would have been preferable to lag board composition and influence relative to the firm performance measure. However, when studying high growth firms, this temporal ordering may not be necessary. Daily and Dalton (1995) found an inverse relationship between board turnover and performance. Given that the sample in this study includes only high growth firms, it was expected that there would be a low level of board turnover. Indeed, the average tenure of a random sample of board members from firms in this study indicates that the average board member had served nearly 4.5 years on the board, corresponding closely to the five year performance period examined. Thus, it appeared that the boards in our sample were stable over the time period examined, reducing the need to lag our data. Although this research design is not optimal, we believe that our data collection technique adequately captures the phenomena under study.

Board Member Influence

To measure the influence of each firm’s board of directors, respondents to our survey were asked to rate the extent to which both inside members and outside members were influential in the following areas: strategic planning, new venture development, reviewing management policies, crisis management, and budgeting. Thus, the measure of board influence consisted of five items and was coded on a four-point scale (1 = not influential to 4 = highly influential). While these are not inclusive of all areas in which boards may have influence, they do represent a reasonably broad cross-section of a board’s areas of responsibility. As discussed above, inside members were defined for the respondents as present or former officers or managers of the firm and their family members. Outside members were defined as all other members of the board (see Ford, 1988). The internal reliability coefficient was .99 for insider influence and .98 for outsider influence. Due to a high correlation between insider influence and outsider influence (r  = .91, p < .001), we further analyzed these constructs to determine if there is a meaningful difference between them. A confirmatory factor analysis was used for this purpose, as it provides a rigorous test of construct validity. Given the high correlation between the two constructs, two structural equation models were compared. The first model included a single latent variable representing board influence. The second model included two latent variables representing insider and outsider influence. Multiple criteria were used to assess the fit of each model. Table 1 presents a comparison of the two models. Although both models may be argued to be acceptable representations of the sample, it is clear that model two, containing latent variables for both insider and outsider influence, fits the sample better than the model with one latent variable representing overall board member influence. Therefore, in our analyses, we examined the hypotheses described above separately for inside and outside board members. In this way, we are able to take a more fine-grained approach to the study of the potential mediating and moderating relationships that may exist.

Board size was measured as the number of individuals serving on the firm’s board, while the percentage of outsiders on the board was calculated by dividing the number of outsiders on the board by total board size. All of these data were collected on our survey. Firm age was measured as the number of years since the firm was founded, as reported in Inc. magazine. The average firm in our sample had been in business for slightly less than 8.5 years. Firm size was measured as the company’s total number of employees, which was reported in Inc. magazine. The average firm in our sample had approximately 89 employees. Finally, to control for variance in company performance based on their industry, we followed the procedure used by Pearce and Zahra (1991).

Means, standard deviations, zero-order correlations, and internal reliability coefficients for the variables in our analyses can be found in Table 2.

Mediating Effects of Board Influence

Baron and Kenny (1986) note that three things must be proved to demonstrate a mediating relationship. First, the independent variables (in this case board size and the percentage of outsiders on the board) must be related to the proposed mediating variable (board influence). As shown in Table 2, board size and the percentage of outsiders on the board were significantly and positively correlated with both insider and outsider influence. In addition, as shown in Columns 1 and 2 of Table 3, board size explained a significant amount of variance in both insider (b = .76, p < .001) and outsider (b = .51, p < .001) influence, even after controlling for firm age, firm size, and industry. Furthermore, the percentage of outsiders on the board explained a significant amount of variance in insider (b = .10, p < .10) and outsider (b = .40, p < .001) influence. Together, the independent variables explained 68% and 76% of the variance (adjusted for the number of independent variables) in insider and outsider influence, respectively. Thus, this first requirement is fulfilled. Second, Baron and Kenny (1986) note that the independent variables (board size and percentage of outsiders on the board) must be related to the dependent variable (sales growth). As indicated in Table 2, board size is significantly and positively correlated with sales growth. The correlation between percent of outsiders on the board and sales growth was not significant. The regression equation in which sales growth is regressed on board composition is shown in Column 3 of Table 3. Board size (b = .18, p < .01) was a significant predictor of sales growth. Percent of outsiders was non-significant. A linear combination of the predictors explained 4% of the variance in sales growth. Thus, Baron and Kenny’s (1986) second requirement is met for board size, but not for outsider ratio. Finally, it must be shown that the mediating variables (insider and outsider influence) are related to the dependent variable when the dependent variable is regressed on both the proposed mediators and the independent variables. As shown in Column 4 of Table 3, outside member influence (b = .40, p < .05) was a significant predictor of sales growth. Insider influence was non-significant. In addition, because the relationship between board size and sales growth disappears with the introduction of board influence into the fourth regression, our results indicate that board influence fully mediates the effects of board size on firm performance (Baron & Kenny, 1986). In other words, our results suggest that board size affects firm performance only through its effects on board influence. Board size affects the influence the board has on strategic issues, and this influence effects firm performance. This model explained 7% of the variance in sales growth. Thus, hypothesis 1 is partially supported.

Moderating Effects of Firm Age and Firm Size

Moderated multiple regression analyses were used to test the extent to which firm age and firm size moderate the relationships between the two types of board influence and firm performance. Linear-by-linear interaction terms were created by multiplying the proposed moderators by the independent variables (Stone & Hollenbeck, 1988). After entering the proposed main effects into the equation, the multiplicative terms were added. The regression weights for the multiplicative terms were then examined for significance. Columns 5 and 6 of Table 3 show the results of our analyses for the moderating effects of firm age and firm size. As shown, firm age moderates the relationships between both insider (b = .94, p < .01) and outsider (b = -1.54, p < .001) influence and firm performance. A linear combination of the predictors explained 15% of the variance in sales growth. The sign for insiders was the opposite of what was predicted; therefore, hypothesis 2 is only partially supported. Our findings suggest that the influence of inside board members is more important to older, more established firms. At the same time, our findings for outside board members suggest that the strategic influence of outsiders is more important to younger organizations. Taken together, our results indicate that the value of insider and outsider influence changes as the firm evolves. In a firm’s early stages of development, outside board members make a more valuable contribution to performance, perhaps because of their collective experience in a broad variety of industries and the informal networks they may establish with other firms. However, it appears that, as firms mature, influence by insiders become more important, possibly because of their increasing knowledge of the complexities of the organizations they serve. Column 6 of Table 3 also shows the results of our tests for the moderating effects of firm size. Firm size was not a significant moderator of the board influence-firm performance relationship, although the p-values were only slightly greater than .10. Thus, hypothesis 3 is not supported.

The purpose of this study was to examine the mediating role of board influence on the relationship between board structure and firm performance among a sample of high-growth, private firms. Our results indicate that board member influence has an important mediating effect between board composition and firm performance. Furthermore, the effects of board influence on firm performance were found to be contingent upon firm age. Although several prior studies have examined the direct effects of board composition on firm performance, there has been little attention given to the way in which the influence of boards may affect the relationship between board composition and firm performance. Furthermore, few studies have examined the potential moderating effects of firm characteristics on the board influence-firm performance relationship. The current study filled these gaps in the literature by testing a model including board influence as a mediator of the relationship between board composition and firm performance, as well as by testing potential moderators of the relationship between board influence and firm performance.

Our analyses suggest that board composition may have less of a direct effect on firm performance than commonly believed. Although prior governance studies have examined and found direct relationships between board composition and firm outcomes (Chaganti et al., 1985; Daily & Dalton, 1993), those studies generally failed to include board influence in their models. Our mediation results point out that the effects of boards on firm performance are highly complex and multi-staged. We found that the effects of board size on firm performance were completely mediated by the board’s influence on strategic issues. In other words, board size has no significant, direct effect on firm performance. Instead, larger boards exert more influence over managerial behavior, and that influence translates into superior firm performance. Thus, the effects of board size are fully explained by board influence. This highlights the need for management researchers to continue testing more complex theories of board issues.

Our results also highlight the need for future research to explore further both the antecedents and consequences of board influence. Boards that make a greater contribution to firm strategy are providing vital guidance to the organizations they serve. By furnishing managers with strategic input, directors play an important role in firm success. However, the influence of inside board members appears to have different performance effects than the contributions made by outsiders. Specifically, we found that strategic input from outside board members has a more positive influence on firm performance. Our finding of a more important role of outsiders provides further empirical support for Baysinger and Butler’s (1985) conclusion that outsiders on boards will enhance firm performance. Our results also provide empirical support for Johnson and colleagues’ (1991) assertion that outsiders may have the best interests of the owners in mind.

The effects of board member influence on firm performance are not the same for all firms. Rather, we found the relationship between director influence and firm performance to be contingent on the age of the firm. Specifically, we found that the influence of insiders is more important to the performance of older, more established firms. The opposite relationship was found for outsiders’ influence; they are more important to the performance of younger firms. These findings indicate that firms’ director-related needs change as the organization evolves. Younger firms appear to need strategically influential outside directors, perhaps because of younger firms’ less experienced management teams and lower levels of environmental scanning and strategic planning (Mohan-Neill, 1995).

This study has several limitations. First, our finding that inside board members’ influence has no direct effect on firm performance may have occurred because of this study’s narrow focus on sales growth as the indicator of firm performance. Since we only used a financial performance measure for our dependent variable, we may not have adequately captured the non-financial performance effects of insider influence. Thus, future research should investigate the influence of board influence on non-financial performance measures. A final limitation of this study is that it is cross-sectional in nature. Future research should attempt to gather longitudinal data on board characteristics, board influence, and firm performance in order to make stronger causal inferences regarding the interrelationships among these variables.

CONTACT: Joseph Coombs, College of Business, MSC 0205, James Madison University, Harrisonburg, VA 22807; (T) 540-568-3238; (F) 540-568-2754; coombsje@jmu.edu

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