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The board of directors is often presumed by strategy researchers to be key to firm governance and strategy creation (Pearce & Zahra, 1991). On the other hand, many have depicted boards of larger, public firms as ineffectual puppets of internal management (Huse, 1994). While research has implied that outside investors in new, closely-held ventures contribute to the success of new ventures primarily through their roles on the board of directors (e.g., Gorman & Sahlman, 1989; MacMillan, Kulow & Khoylian, 1989; Rosenstein, 1988), little is really known about how such boards function. In fact, little empirical work has been done on the processes and interactions in boards of directors in general (Huse, 1994). Most studies have tended to predict board decisions or managerial contracts from board composition without considering the intervening actions or behaviors of the boards. The central question driving our study is the simple question, What do boards of closely-held, newer firms do? Until we more fully understand where boards actually focus their attention, how they handle and resolve conflicts within and across constituencies, and how they actually make decisions we will but poorly understand the dynamics of board effectiveness and ineffectiveness.

In order to understand how and why closely-held boards function as they do we must first understand why they are structured as they are and how this structure itself is likely to influence interactions. Agency theory has been the dominant theoretical perspective used to explain board structures and to predict the behavioral outcomes of variations in board structure (Eisenhardt, 1989; Walsh & Seward, 1990). According to this theory, a central purpose of the board is to protect the interests of outsiders from misrepresentation or opportunistic behavior (agency risks) on the part of venture management (Jensen & Meckling, 1976). Agency risks exist because managers' (agents) interests do not perfectly match those of outside owners (principals) and because outside owners will not have sufficient information on all of management's abilities and actions. In short, the theory suggests that the board may utilize outcome-based devices such as equity position or stock options to align entrepreneurial management's interests with those of outside ownership, and behavior-based devices such as the board structure itself to provide information on managerial actions to limit agency costs. Clearly, some support has been garnered in the context of new or small ventures for these propositions (e.g., Barney, Busenitz, Fiet, & Moesel, 1989; Sapienza & Gupta, 1994). However, the evidence is scant and somewhat contradictory at this point (Huse, 1994; Sapienza & Korsgaard, 1996).

We posit that agency risks do predict board member behavior (i.e., including the behaviors of both entrepreneurial managers and outside board members), but imperfectly. For example, the theory provides little insight into how principals or agents determine risks and what defines acceptable risk. Specifically, it does not address how board processes such as information exchange influences the willingness of exchange partners to accept varying levels of agency risk. Moreover, agency theory focuses on a limited set of actions: those intended to minimize risk, such as monitoring and board structuring. Consequently, it has limited ability to explain how great a role a given board of directors will have in strategic decision making, how quickly it will make decisions, what the quality of decisions are likely to be, or even how it would enforce existing governance provisions.

We propose that insights from procedural justice theory may be used in conjunction with agency theory to predict how agency conditions and board member conduct affect ongoing board interactions. Procedural justice offers insights into the dynamics of process and decision control. While sharing with agency theory the assumption of self-interest, procedural justice accounts for additional motivations in joint decision making and speaks directly to the issue of how trust (the obverse of the fear of opportunism) may be built or undermined. Similar to agency theory, procedural justice is vitally concerned with the impact of self-interest on preferences for and responses to outcomes, but it also looks at how both the establishment of rules governing decisions and the interactions in the decision-making process itself affect the level of trust and reciprocity in the relationship. In summary, agency theory provides insight on ex ante contracting, and justice theory illuminates the dynamics of ongoing decision making. Together, the two hold significant promise for predicting and explaining what new venture boards do.

This investigation builds a model of board processes in new, closely-held ventures through the integration of agency theory and procedural justice theory. Because these processes are but poorly understood at this point, we went into the field and interviewed 14 current board members (entrepreneurial CEOs, private and venture capital investors, and other outside board members) on their experiences both inside and outside formal board meetings. We describe in the next section specifics regarding the collection and use of these interview data. In the central section of this paper, we use current theory and research to build propositions regarding what boards do. We focus in these sections on propositions regarding 1) the focus of board decision making, 2) the strength of conflicts over personnel, compensation, and valuation, and 3) the decision-making mode used. Where appropriate, we illustrate perspectives with quotes from the interviews. In the final section of this paper we discuss the implications of our model for practice and for future study.

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