Governing Top Managers: Board Control, Social Categorization, and Their Unintended Influence on Discretionary Behaviors

• Author: Thomas Dalziel,Joshua R. Knapp,Marianne W. Lewis
• DOI: http://doi.org/10.1111/j.1467-8683.2011.00845.x
• Published date: 01 July 2011
• Date: 01 July 2011

Governing Top Managers: Board Control, Social

Categorization, and Their Unintended Inf‌luence

on Discretionary Behaviors

Joshua R. Knapp, Thomas Dalziel,* and Marianne W. Lewis

ABSTRACT

Manuscript Type: Conceptual

Research Question/Issue: This paper seeks to complement agency and stewardship perspectives regarding the governance

of top managers by using insights from social categorization theory.

Research Findings/Insights: This paperlooks inside the black box of the control-performance relationship. We acknowledge

that boards can positively inf‌luence organizational functioning by monitoring the top managementteam. However, we also

argue that board control contains a hidden cost. The model we develop describes how control can highlight the distinction

between principals and agents thereby causing the top management team to adopt a biased and less cooperative “us vs.

them” orientation towards owners and their representatives. We contend this results in an increase in negative discretionary

behavior and a decrease in positive discretionary behavior, which dampen the positive inf‌luence of control on f‌irm

performance. We also describe techniques for mitigating this unintended outcome of control.

Theoretical/Academic Implications: Agency and stewardshiptheories offer alternative views of human nature and provide

divergent prescriptions for governance. This paper presents social categorization theory as a complementary lens empha-

sizing a situational and social view of human nature that helps explain top managers’ discretionary behaviors thatinf‌luence

f‌irm performance.

Practitioner/Policy Implications: Ongoing governance scandals are costly illustrations of unchecked managerial opportun-

ism. They demonstrate the need for vigilant control. A control approach to governance, however, does not consistently

improve f‌irm performance. This paper offers an explanation. It acknowledges that board control is necessary, while arguing

that it can haveunwanted side effects. We describe two tools (individualization and social recategorization) thatcan be used

to ameliorate these effects.

Keywords: Corporate Governance, Agency Theory, Stewardship Theory, Social Categorization Theory

GOVERNING TOP MANAGERS:

SOCIAL CATEGORIZATION AND

THE UNINTENDED CONSEQUENCES

OF CONTROL

Periodic governance scandals(e.g., Parmalat, Enron,Tyco,

World.com) have resulted in an outcry from investors

and a clear response from regulators. The Sarbanes-Oxley

Act (Sarbanes & Oxley, 2002), for example, stressed the

value of independent, control-oriented boards and thorough

auditing. Consistent with this emphasis, investors have

continued to call for greater control and accountability. Most

recently, their call has been amplif‌ied by a world-wide f‌inan-

cial crisis, in which self-interested managers promoted the

sale, bundling, and resale of risky mortgages in the pursuit

of short-term prof‌its (Ibarra, 2009). This ongoing stream of

scandals has created an environment in which the need to

control managers seems ever present.

This control focus is consistent with the tenets of agency

theory (Fama, 1980; Fama & Jensen, 1983; Jensen & Meck-

ling, 1976). Through this lens, top managers appear as self-

maximizing individuals thattend to engage in opportunistic

behaviors and shirk responsibility. In response, agency

theory prescribes controls that include boards of directors,

ownership, and compensation. Empirical results, however,

suggest that such mechanisms do not consistently address

*Address for correspondence: Thomas Dalziel, University of Cincinnati, PO Box

210165, Cincinnati, OH 45221-0165, USA. E-mail: tom.dalziel@uc.edu

295

Corporate Governance: An International Review, 2011, 19(4): 295–310

© 2011 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2011.00845.x

the problem or improve f‌irm performance (e.g., Dalton,

Daily, Certo, & Roengpitya, 2003; Rhoades, Rechner, &

Sundaramurthy, 2000; Tosi, Werner, Katz, & Gomez-Mejia,

2000).

Critics have proposed that this inconsistency may stem

from agency theory’s assumptions about human nature

(see Eisenhardt, 1989; Petersen, 1993). Offering an alterna-

tive, stewardship theory views human nature as altruistic

rather than opportunistic (Donaldson & Davis, 1991). It

suggests managers tend to act as stewards by fulf‌illing

assigned responsibilities and by engaging in other altruistic

organization-centered behaviors. Unfortunately, steward-

ship theory, not unlike agency theory, focuses on how indi-

vidual nature shapes managers’ behaviors,but overlooks the

inf‌luence of managers’ social context. Given the complex

social environments within corporations and repeated calls

to incorporate social theories into the governance literature

(Lubatkin, 2005), this is an important gap to address.

Theories with socio-psychological origins might be used

to address this gap. For example, reactance theory (Brehm

& Brehm, 1981) helps explain how an individual executive

(e.g., the CEO) is likely to respond to increased control

(Westphal, 1998), but it is less suited to situating individuals

within a rich social context or explaining how groups within

this social context emerge and interact. Davis, Schoorman,

and Donaldson (1997) contribute a signif‌icant discussion of

the link between agency and stewardship theories and

numerous motivational theories, including job characteris-

tics theory and equity theory. They conclude the notion of

intrinsic motivation is inherent in stewardship theory, while

extrinsic motivation is inherent in agency theory. Admit-

tedly, given its economic origins, agency theory provides a

parsimonious view of what motivates human behavior (i.e.,

economic utility). Yet it largely overlooks other extrinsic

motivations, such as aff‌iliation or belonging.

Social categorization theory offers a response to this

limitation (Hogg, 2001). First, it is specif‌ically designed to

explain the emergence of categories (groups) and to predict

the likely interactions between them (Turner, 1978). As

such it is focused on the category or group – rather than the

individual or the organization– as the unit of analysis. Thus,

as compared with agency or stewardship theories with their

respective focus on individuals as agents or stewards, it

can provide a richer view of the social landscape within the

organization and the associated dynamics between princi-

pals and managers. Furthermore, it complements agency

theory and stewardship theories by acknowledging aff‌ilia-

tion or belonging to a group as other extrinsic motivators.

Given its potential to complement agency and steward-

ship theories, we draw upon insights from social categori-

zation theory. Our work responds to recommendations that

scholars get inside the “black box of governance” by explor-

ing processes that mediate the relationship between controls

and f‌irm performance, and by more closely examining the

perceptions, thoughts, and behaviors of the f‌irm’s off‌icers

and directors (e.g., Lawrence, 1997; Pugliese, Bezemer,

Zattoni, Huse, Van den Bosch, & Volberda, 2009). In so

doing, we seek to complement agency and stewardship

views of human nature by depicting managers as adaptive

social beings who are category-centric and capable of behav-

iors that benef‌it and behaviors that harm the f‌irm.

The proposed model illustrateshow controls interact with

the cognitive process of social categorization in board-top

manager relations. We acknowledge that board control may

foster certain desired behaviors in top managers; yet we

also examine the side effects on managers’ categorization of

themselves and others. The model illustrates how board

control can encourage executives to adopt biased perspec-

tives, which may prove counterproductive to the f‌irm by

shaping both their positive and negative discretionary

behaviors. This depiction provides a novel explanation of

the inconsistent f‌indings in studies that attempt to predict

performance using coarse-grained measures of control (e.g.,

board independence, duality, among others) (see Dalton,

Daily, Ellstrand, & Johnson, 1998 for a review) and pre-

scribes the social mechanisms of individualization and

social recategorization as means to curb these unintended

consequences.

As foundation for our model, we review the contributions

of agency and stewardship theories and calls for research

to address their limitations. We summarize the tenets

of social categorization theory, demonstrating how its

insights complement the disparate views enabled through

agency and stewardship lenses. From this base, we build

a model that unpacks links between board control and

top managers’ behaviors. Leveraging social categorization

theory,we propose unintended consequences of control and

approaches to managing them. Finally, we discuss implica-

tions of a social categorization view for governance research

and practice.

Insights and Boundaries of Agency &

Stewardship Theories

As summarized in Table 1, agency theorists build upon

economics (e.g., Berle & Means, 1932), and portray the f‌irm

as a nexus of contracts between principals (i.e., owners who

delegate work and authority) and agents (i.e., persons who

manage on behalf of principals)(Fama & Jensen, 1983; Jensen

& Meckling, 1976). They assume agents (e.g., top managers)

are individualistic and extrinsically motivated by the self-

interested pursuit of economic gain. They have articulated

problems associated with employing managers (e.g.,

adverse selection, moral hazard) (Eisenhardt, 1989), studied

means to lessen these problems (e.g., board control,compen-

sation, stockholder monitoring) (Rediker & Seth, 1995), and

identif‌ied costs (e.g., bonding costs, monitoring costs) and

benef‌its of control mechanisms (Walsh & Seward, 1990).

For example, because directors often own stakes in the

f‌irm, control executive compensation, and appoint and

replace CEOs, corporate governance researchers have

shown a keen interest in the inf‌luence of boards on top

managers. Collectively, studies of board control (Dalton et

al., 1998), executive compensation and stockholder monitor-

ing (Dalton et al., 2003; Tosi et al., 2000) suggest that efforts

to control top managers’ behavior, and thereby curb agency

costs, are inherently complex. While much has been learned

from an agency perspective, all theories are necessarily

bounded. In this case, mixed f‌indings have raised concerns

over agency assumptions (see Eisenhardt, 1989; Petersen,

1993). In response, some researchers have proposed an

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