A Tale of Two Factions: Why and When Factional Demographic Faultlines Hurt Board Performance

• Author: Dennis B. Veltrop,Jakob Haan,Niels Hermes,Theo J. B. M. Postma
• DOI: http://doi.org/10.1111/corg.12098
• Published date: 01 March 2015
• Date: 01 March 2015

A Tale of Two Factions: Why and When

Factional Demographic Faultlines Hurt

Board Performance

Dennis B. Veltrop*, Niels Hermes, Theo J. B. M. Postma and

Jakob de Haan

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: The authors posit that to understand the effects of board demographic diversity on board

performance, it is critical to recognize that board members often do not come to a board as independent entities but

rather as delegates of specif‌ic interest groups so that the board has factions. The authors propose that demographic

differences between these factions are likely to negatively affect board performance through social categorization

processes.

Research Findings/Insight: A study of 318 Dutch pension fund boards shows that factional demographic fault-

lines negatively affect board performance, measured as perceived board effectiveness, and f‌inancial return on invest-

ment, through the perception of board members that the board is split into factional subgroups (i.e., faultline activation).

At the same time, the disruptive effects from factional demographic faultlines are found to be reduced by board

ref‌lexivity.

Theoretical/Academic Implications: Based on social categorization theory, this study shows that demographic faultlines

between factions affect board performance to the extent that the faultlines are activated. If unnoticed by board members,

demographic faultlines are unlikely to inf‌luence board behavior. The attenuating effect of board ref‌lexivity underlines the

importance of insight into the factors that drive social categorization within boards.

Practitioner/Policy Implications: Practitioners should be aware that although factional demographic faultlines can be

disruptive, there are ways to reduce these negative aspects. By overtly ref‌lecting on board processes, board members can

prevent factional demographic faultlines from resulting in social categorization within boards.

Keywords: Board Composition, Board Diversity, Board Processes, Faultlines, Ref‌lexivity

INTRODUCTION

Demographic diversity of organizational boards is

becoming increasingly important. Regulators are now

actively stimulating demographic diversity in the board-

room, as it is widely believed that diversity is benef‌icial for

board decision making. Yet, despite the intuitive appeal of

this view, several meta-analyses and review studies demon-

strate that there is no clear relationship between board

demographic composition and f‌irm performance (Certo,

Lester, Dalton, & Dalton, 2006; Daily, Dalton, & Cannella,

2003; Dalton & Dalton, 2011; Johnson, Schnatterly, & Hill,

2013). In this vein, governance scholars have long argued

that to understand the potential effects of board demo-

graphic diversity on f‌irm performance it is crucial to under-

stand the mechanisms through which demographic board

composition affects board functioning (e.g., Lawrence, 1997;

Miller & Triana, 2009; Minichilli, Zattoni, Nielsen, & Huse,

2012; Van Ees, Gabrielson, & Huse, 2009). Nevertheless,

despite some advances, few studies have gone beyond a

simple direct relationship between board demographic

diversity and f‌irm performance. As a consequence, knowl-

edge is limited as to why and when board demographic

*Address for correspondence: Dennis B. Veltrop, Department ofAccounting, Faculty of

Economics and Business, University of Groningen, Duisenberg Building, Room 824,

PO Box 800, 9700 AV Groningen, The Netherlands. Tel: +31503637238; E-mail:

d.veltrop@rug.nl

145

Corporate Governance: An International Review, 2015, 23(2): 145–160

© 2015 John Wiley & Sons Ltd

doi:10.1111/corg.12098

diversity affects board functioning. There is need for an

explanation of the process through which board demo-

graphic diversity affects f‌irm performance and the contin-

gencies that weaken or strengthen these potential mediating

effects.

We maintain that to understand the relationship between

board demographic composition and board performance, it

is f‌irst necessary to acknowledge that board members often

do not come to a board as independent entities, but rather as

delegates of specif‌ic interest groups or as representative fac-

tions (cf. Li & Hambrick, 2005). These factions provide

demarcations or schisms within boards that may affect how

board members respond to demographic diversity. That is,

differences between factions are interpreted differently

than differences within the same faction (cf. Li & Hambrick,

2005; see also Kaczmarek, Kimino, & Pye, 2012). Second, we

maintain that governance scholars need to be particularly

aware that demographic board diversity may very well

foster social categorization within boards that can be

expected to disrupt board effectiveness (cf. Tajfel, 1978; van

Knippenberg, Dawson, West, & Homan, 2010; Williams &

O’Reilly, 1998). The categorization perspective holds that

social categorization is likely when a group can be separated

into demographically homogeneous subgroups that differ

from one another (Van Knippenberg et al., 2010). Thus, when

a board consists of factions that differ from one another

demographically (e.g., one factionis comprised of older men

and the other faction consists of younger women), there is a

greater likelihood of in-group/out-group categorization,

because each faction will feel like it is facing a monolithic

adversary.

Drawing from Lau and Murnighan’s (1998) concept of

demographic faultlines, it is possible to capture this

in-group/out-group distinction within boards, taking into

account that boards are often comprised of factions. Specif‌i-

cally, demographic faultlines foster social categorization

because board members rely on easily observable heuristic

cues to categorize one another into similar in-groups and

dissimilar out-groups (cf. Tajfel, 1978). In accordance with

faultline and social categorization theory,review studies and

meta-analyses indicate that demographic faultlines are often

aff‌iliated with increased conf‌lict and process losses, which

lead to decreased performance (Bell, Villado, Lukasik, Belau,

& Briggs, 2011; Thatcher & Patel, 2011; van Knippenberg &

Schippers, 2007). Pertaining to boards specif‌ically, Tuggle,

Schnatterly, and Johnson (2010) found that fractures within

boards can inhibit communication, thereby constraining

critical discussion. Similarly, recent research on top manage-

ment teams suggests that demographic faultlines within

top management teams can decrease f‌irm performance

(Hutzschenreuter & Horstkotte, 2013) and that faultlines

between executive and non-executive directors may have

a negative effect on f‌irm performance (Kaczmarek et al.,

2012).

It is important to realize, however, that not all potential

faultlines within a board affect board functioning. Demo-

graphic faultlines may very well remain dormant. That is, if

unnoticed by board members, demographic faultlines are

unlikely to inf‌luence board behavior (cf. Lau & Murnighan,

1998). In this vein, scholars have long argued that research-

ers ought to assess perceptions of demographic diversity to

better understand how diversity inf‌luences behavior and

outcomes, rather than to assume that a relationship between

board diversity and board behavior exists (cf. Lawrence,

1997; Zellmer-Bruhn, Maloney, Bhappu, & Salvador, 2008).

Indeed, in their original work, Lau and Murnighan (1998)

explicitly stated that the demographic faultline needs to be

“activated” by features in the context in which a group oper-

ates for the faultline to affect group functioning. While not

all possible demographic faultlines within boards can be

expected to affect board functioning, we believe that demo-

graphic faultlines between factions (hereafter referred to as

factional demographic faultlines) are likely to be aff‌iliated

with faultline activation (i.e., the perception of board

members that the board is split into factional subgroups; cf.

Jehn & Bezrukova, 2010).1Since factions provide a meaning-

ful demarcation within boards (cf. Li & Hambrick, 2005),

factional demographic faultlines will lead to the perception

that the board is split into subgroups, which is likely to

negatively affect board performance.

Because factional demographic faultlines affect board

functioning to the extent that they lead to faultline activation,

we believe it is particularly worthwhile to identify contin-

gencies that may prevent the factional demographic faultline

from being activated. We propose that board ref‌lexivity (cf.

West, 1996) – i.e., the extent to which a board actively ref‌lects

on its functioning and adapts its functioning accordingly –

can be expected to provide such a contingency. As noted,

factional demographic faultlines foster social categorization

because board members rely on easily observable heuristic

cues to categorize one another into similar in-groups and

dissimilar out-groups (cf. Tajfel, 1978). Ref‌lexive boards

engage in deep-level information processing (cf. De Dreu,

2007) and are therefore less likely to rely on heuristics to

inform their behavior. As a result, we expect that factional

demographic faultlines are less likely to lead to faultline

activation for boards that are high in ref‌lexivity.

Using a unique dataset of 318 Dutch pension fund boards,

we respond to the call for research to incorporate mediat-

ing mechanisms linking board demographic diversity to

board and organizational performance (Barrick, Bradley,

Kristof-Brown, & Colbert, 2007; Hambrick, 2007; Hambrick,

Werder, & Zajac, 2008). We demonstrate thatfactional demo-

graphic faultlines affect board performance through faultline

activation and that this indirect effect is contingent on board

ref‌lexivity. The attenuating effect of board ref‌lexivity sug-

gests that board leadership and regulators should be par-

ticularly attuned to stimulate ref‌lexive behaviors for boards

with strong factional demographic faultlines.

THEORETICAL BACKGROUND

To address the question of how demographic diversity

affects performance, organizational and social psychological

research has been largely guided by two research traditions:

the information/decision-making perspective and the social

categorization perspective (van Knippenberg & Schippers,

2007; Williams & O’Reilly, 1998). Governance scholars and

corporate practitioners mainly interpret board demographic

diversity from an information/decision-making perspec-

tive, assuming that having greater demographic diversity is

146 CORPORATE GOVERNANCE

© 2015 John Wiley & Sons Ltd

Volume 23 Number 2 arch 2015

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