Evaluating Board Work for Innovation.: Towards an Analytical Framework.

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IN THE FIELD OF TECHNOLOGY DEGREE PROJECT

VEHICLE ENGINEERING

AND THE MAIN FIELD OF STUDY MECHANICAL ENGINEERING, SECOND CYCLE, 30 CREDITS

,

STOCKHOLM SWEDEN 2019

Evaluating Board Work for

Innovation

Towards an Analytical Framework

OMAR ALI

KTH ROYAL INSTITUTE OF TECHNOLOGY

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Evaluating Board Work for Innovation

Towards an Analytical Framework

Omar Ali

Master of Science Thesis TRITA-ITM-EX 2019:502 KTH Industrial Engineering and Management

Machine Design SE-100 44 STOCKHOLM

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Examensarbete TRITA-ITM-EX 2019:502 Utvärdering av Styrelsearbete för Innovation

Mot ett analytiskt ramverk

Omar Ali Godkänt 2019-06-21 Examinator Sofia Ritzén Handledare Mats Magnusson Uppdragsgivare IMIT Kontaktperson N/A

Sammanfattning

Ett flertal omvärldsfaktorer ökar innovationsbehovet i många företag idag vilket således ökar brådskan för förnyelse och mer agila förhållningssätt. Digitalisering av processer, produkter och tjänster ställer helt nya krav på kompetenser men ändrar också värdeskapandet och

konkurrenskraften hos dagens företag. Under de senaste åren har managementfokus skiftat från renodlad optimering av produktionsprocesser, logistik och försörjningskedjor, till att inrymma innovation och förnyelse genom ett flertal förändringsarbeten så som formella ledarskapsroller med innovation som fokus, förnyade processer och innovativa affärsmodeller

Syftet med studien är att undersöka hur styrelseutvärderingar används som ett verktyg för att förbättra styrelsearbetet och att studera hur väl styrelser vägleder innovationsambitionerna i ett företag. Fortsättningsvis är målet med denna studie att utveckla ett ramverk som kan ge ett helhetsperspektiv av balansen mellan både kontroll och strategiska innovationsaspekter.

Resultatet från en omfattande litteraturgranskning och analys av styrelsens utvärderingsdata visar att det saknas innovationsintegration i styrelseutvärderingar och ett bristande statistiskt underlag vid konstruktionen av frågebaserna för utvärderingen.

Det föreslagna ramverket ger vägledning åt alla som behöver utvärdera styrelser med ambitionen att utforma ett utvärderingsverktyg som är mer innovationsorienterad och som möjliggör

rekommendationer med konkreta insikter till styrelser, grundade i statistiska modeller så som linjär regression och intern konsistens analys som kan möjliggöra utvecklandet av en skalbar digital utvärdering.

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Master of Science Thesis TRITA-ITM-EX 2019:502 Evaluating Board Work for Innovation

Towards and Analytical Framework

Omar Ali Approved 2019-06-21 Examiner Sofia Ritzén Supervisor Mats Magnusson Commissioner IMIT Contact person N/A

Abstract

There is an increased need for innovation activities in companies today due to mounting pressure from external factors increasing the urgency for renewal and agility. Digitalisation of processes, products and services sets completely new requirements for competence but also changes the value creation and competitiveness. In recent years, management focus has shifted from optimization of production processes, logistics and supply chains, to being more oriented towards an innovation focus, promoting business renewal and innovative business models.

The purpose of this study is to examine how board evaluations are used to improve board work and to study how well boards guide the innovation ambitions of their companies. Furthermore, the aim of this study is to develop a framework that can provide a holistic perspective of both control and strategic innovation aspects. Results from a comprehensive literature review and analysis of board evaluation data indicate that there is a lack of innovation inclusion in board evaluations and a clear lack of statistical approach when constructing surveys.

The result of the study is a proposed framework that provides guidance for designing an innovation inclusive board evaluation tools and recommendations for providing actionable insights to clients, backed up by statistical models such as regression analysis and consistency analysis that has the possibility to scale into a digital assessment tool.

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FOREWORD

I would like to extend my sincere gratitude towards Professor Mats Magnusson for his invaluable guidance and support in this thesis work. It was a rewarding experience to be entrusted a study of this magnitude and complexity. I thank Mats for his sense of direction and support that enabled this thesis. I would also like to thank Liselotte Engstam for her never-ending enthusiasm, insights and valuable discussions that helped form this thesis. Additionally, a sincere thank you to representatives from Company X for their openness and curiosity in every workshop that left me energized and motivated to pursue the research aim and I hope to have provided value for their future endeavours.

Furthermore, thank you Sebastian Wattle Björk, for your ability to provide clarity and support in trying times and for motivating me to excel in my work.

In closing, my heartfelt gratefulness extends to Leona Clarin for her belief in me and her encouragements throughout our time together.

Omar Ali Stockholm June 2019

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NOMENCLATURE

Notations and Abbreviations used in this Master thesis are presented in the table below.

Notations

Symbol

Description

Δ Delta

Abbreviations

CSR Corporate Social Responsibility CEO Chief Executive Officer

KS Kolmogorov-Smirnov test

SPSS Statistic Package for the Social Sciences

SW Shapiro-Wilks test

ROA Return on Assets

ROI Return on Investment

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1 INTRODUCTION

This chapter describes the theoretical and practical motivations for this study and presents the research purpose, aim and questions as well as the delimitations.

1.1 Theoretical Motivation

Global competition has made it difficult for companies to maintain a competitive advantage (Brown & Eisenhardt, 1998). A company’s long-term survival is highly dependent on their ability to identify and exploit new business opportunities. Several external factors contribute to the increased pressure and load on companies to continue innovating. The long-term value creation goes hand in hand with a company’s ability to renew their offering, but also their operational capabilities. Throughout the years, the focus of management theory has changed from being largely focused on optimization of production processes, logistics and supply chains, to become more oriented towards accommodating innovation and business renewal studies. With this shift, management in companies have started to include innovation within their daily work where formal roles, such as manager of innovation, have been shaped. Surprisingly, only a few organizations have a clear and long-term innovation strategy. One reason for this is that the executive management does not work actively with questions regarding innovation. There is also a clear risk that innovation is not prioritized when more acute problems, which often are short-term oriented, have to be managed. An example of this is that innovation is rarely prioritized during recessions. The problem is clear that this prioritization is often not an optimal strategy for a company that seeks to maximize economic value. Also, traditional organizational structures and control systems often prevent new investments, and the connection between innovation and strategy is often very diffuse. However, ultimately responsible for companies are the board of directors and typically boards are not stewarding the innovation ambition of companies due to several factors such as focusing on risk and control aspects and lack of monitoring of innovation capacity. Moreover, the board members are affected by corporate governance regulations that, in recent years to focus on a check list approach to issues instead of focusing on how governance structures can add value to the company (Vemeulen, 2018). Evaluating board of directors is therefore an important aspect of ensuring that the efforts of the board result in sustainable value creation and ensuring renewal momentum in the company.

1.2 Practical Motivation

Digital, global and sustainability issues put high pressure on companies for better foresight, innovation and speedy change. There is therefore a need for boards to better ensure that continuous corporate renewal is included in their business strategies. Majority of board

evaluation today follow the focus of current corporate governance practices. That focus is more oriented towards risk mitigation and control activities, there is therefore a call for finding ways to better evaluate boards guidance of continuous innovation and provide actionable insights that enable the board to provide fruitful conditions for innovation.

1.3 Purpose and Aim

The purpose of this research is to investigate how board evaluations are used to improve board work and how well boards are guiding the innovation ambition and innovation status of

companies, assessed by evaluation tools.

The aim is to develop a framework for board evaluations that addresses both control and strategic innovation aspects. Moreover, the framework proposed will be used to provide recommendations for building a digital tool that captures a wider scope of board evaluation

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highlighting inputs, throughputs and outputs of board work in an effort to capture the factors influencing innovation work in companies and how that be translated into actionable insights for boards.

1.4 Research Questions

In order to reach the aim and purpose of this research the following research questions will be addressed:

• RQ1: How are company boards evaluated in terms of the processes, methods and tools used?

• RQ2: How is innovation assessed in board evaluations?

• RQ3: What changes needs to be implemented to board evaluations when these are digitalized?

1.5 Delimitations

• Only data from Swedish private equity firms is used in the analytical section of this study due to inconsistent datasets provided by Company X.

• The thesis excludes descriptive data such as company size and respondent data due to limited return for the aim of this study.

• The framework is constructed with peer reviewed articles, largely omitting insights from consultancy reports due to time limitation.

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2 EXPOSITION OF THEORY

Chapter 2 presents the theoretical reference behind the tentative framework to highlight the state of research by analysing the content of scientific journals related to board work, corporate governance implications and innovation practices. The tentative framework is based on findings in the literature presented below in an effort to gain a holistic understanding of important drivers for value creation in an organization. The exposition of theory is initiated by describing the value creation in an organization to form a baseline level of knowledge of what drives value in different perspectives. Secondly, a study of innovation inclusion in strategy is presented in the succeeding chapter with the aim to connect different studies regarding innovation management and strategy work, in an effort to obtain best practices and behaviours. These two subchapters lead up to the foundation of the framework, the prerequisites of innovation describing different characteristics and fundamentals of board work and practices. The main focal point of this thesis is studying board evaluations, subsequently the following chapter describes practices and research about board evaluation as a tool to gain an understanding of how to develop board evaluation further into different use cases such as a digital analytical tool. The analytical framework is presented as a conclusion to chapter 2 with an illustrative description of the outlining factors describing the broad field of evaluating boards.

2.1 Value Creation

Section 2.1 is initiated with describing value in different settings and perspectives. The second part of this section is an exposition of how value can be created from looking through different lenses, either through a corporate governance or a renewal and innovation lens. Defining value in an organization is not as straightforward as one might think due to the broad definition of value. Value is dependent on a magnitude of factors, most notability value to whom? It is an important distinction since what might be value adding for one can be value destroying for another. Therefore, establishing an understanding of the value spectrum as it pertains to different stakeholders and interests within an organization and in a grander sense, the society and community as a whole is important.

2.1.1 Company Value

Understanding how the board of directors create value for the company is key to understanding the drivers of sustainable value creation in the company that covers both short and long-term interests. The board of directors play an increasingly important role in guiding the company towards a sustainable competitive advantage, especially in the fast-paced markets of today’s digital economies that emphasize the relevance for innovation and renewal efforts (Teece, 2018). Moreover, innovation proficiency may strengthen the image of the company and the offered products that may enable the company to increase their financial results (Hung & Chiang, 2010). Boards that are on the forefront of understanding the challenges their company faces in terms fast paced innovation disruptions are more likely to outperform their competitors in terms of Return on Assets (ROA), revenue growth and market cap growth (Weil, Apel, & Woerner, 2019).

2.1.2 Shareholder Value

A traditional view on the purpose of a corporation is the shareholder theory, which implies that the main responsibility of a business is to increase profits. This theory is said to originate from an article published by Milton Freidman in 1970 which underlines the only social responsibility of a business is to use the resources to increase profits (Freidman, 1970). This view is however challenged by more progressive views that criticise the shareholder theory for placing the

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interests of shareholders above all others, which arguably contributed to large corporate scandals which in turn led to more extensive corporate governance laws such as the Sarbanes-Oxley Acts implemented in 2002 after multiple scandals such as the bankruptcy of Enron, the largest energy company at the time (U.S. Securities and Exchange Commission., 2019). A shift from

maximizing shareholder value at all cost is needed to an expanded responsibility for

stakeholder’s interests in today’s increasingly global, disruptive and connected world (Shahzad & Wales, 2016).

2.1.3 Stakeholder Value

A stakeholder is an entity that has an interest in the organization and is affected by the behaviour of the firm. Examples include, stockholders, employees, customers and in a larger setting, the community or society (Schilling, 2012). In other words, a stakeholder is any group or individual that can affect or is affected by the achievement of the organization’s activities and objectives (Freeman & McVea, 2001)

The board of directors have an interest in understanding a holistic stakeholder perspective when governing the company in terms of strategies and long-term success that exceeds only

shareholder interests (Hillman & Keim, 2001).

2.1.4 Corporate Governance for Value Creation

Corporate governance has not traditionally been associated with innovation, one could say that corporate governance has focused on the opposite to innovation, minimizing risks and protecting the value of the firm at all costs. Innovation on the other hand, especially radical and disruptive innovations described in detail below, is inherently risky and unknown. Thus, a dilemma arises for the board. Stop innovating and stagnate, possibly going obsolete, or approve daring and risky endeavours with the possibility of bankruptcy. Corporate governance is the system that enables the board to direct and control the organization with the purpose of ensuring long term-success (Olisa & Clark , 2017). Benchmarks, and different codes are used to observe whether governance procedures are adhered to. However, staring at the benchmarks will only get you so far, multiple historic example exists of enterprises that looked great on paper but failed catastrophically such as the Lehman’s Brothers collapse that triggered a global recession or the Enron scandal that lead to the Sarbanes-Oxley Act.

A Swedish point of view on corporate governance showcase some interesting differences compared to more dominant views such the Anglo-Saxon governance system. Most notably, many aspects of corporate governance practices in other jurisdictions are integrated in the Swedish Companies Act. Examples include board compensation regulation, separation between the CEO and Chairman of the Board, remuneration models and transparency towards

shareholders and the general public (Lekvall, 2009).

What is expected from businesses has changed over the years to transcend simply enabling financial gain to shareholders. Businesses today are expected to consider the well-being of all stakeholders such as employees, business parts and society at large (ACCA, 2018). In other words, the organisational boundary between the firm and society has been blurred and the effects of corporate governance reaches beyond the organization and provides value for the long-term prosperity of the society and environment at large. In closing, the board has a significant impact over the decisions influencing said value creation and hold an increasingly important role.

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2.1.5 Innovating for Value Creation

Involving the board of directors in a systematic innovation practice is key to ensure significant knowledge about changing customer needs, competitor dynamics and market disruptions that changes at a rapid rate. At that end, the board of directors should be considered a partner with management to ensure cohesion and common vision (Useem & Carey, 2014). One way to enable said partnership is through the use of Innovation committees by integrating the board of directors into the innovation stream and enable knowledge exchanges and insights from competent and knowledgeable board members (Chaudhary, 2015). However, it is important to stress that the board of directors is not the entity that operationally drives innovation in the company; that responsibility usually falls under a Research and Development unit or a similar source (Schilling, Strategic Management of Technological Innovation, 2012) . Boards, however, hold the ultimate responsibility to ensure timely corporate renewal, and therefore need to establish and influence the environment that enables innovation and, in that regard, they hold an immensely important part in ensuring the continuing renewal of the company.

2.2 Strategy & Innovation

Innovation is an important activity in an organization in order to sustain a competitive advantage (Lichtenthaler, 2018). Moreover, the relevance for innovation is increasing in the context of digital disruptions that provides new challenges and opportunities for both management teams and board of directors (Teece, 2018; Helfat & Raubitschek, 2018). The board’s role in these challenges lies in the strategy development of the organization, setting the course and enabling the conditions for fruitful innovation practices. However, there is a lack of academic literature about the role of boards in innovation competitiveness and how corporate governance influences innovation (Denoo, 2016).

In an effort to shed light on this fact, the following section is initiated by describing different horizons and the balancing act of focusing on the short-term and long-term interests. Moreover, the different types of innovation are presented and is succeeded by goal development, innovation measurement and resource allocation to form the basis of innovation in strategy for the

framework.

2.2.1 Horizons & Ambitions

There is a clear distinction between focusing on short term and long-term results as the names imply. The decisions leading up to a short-term or long-term focus must be balanced for sustainable and fruitful value creation in the organization. One such balancing act can be obtained with the Innovation Ambition Matrix presented by Nagji & Tuff (2012). An optimal ambition balance varies depending on the company’s specific characteristics but a general recommendation by the authors is 70 % core, 20 % adjacent and 10 % transformational, which implies that a portion of the strategy should in fact go towards more long-term initiatives such as the transformational objectives that are inherently risky and unknown.

Balancing the different horizons and ambitions in a company has proved to be difficult since different agents in a company operate with different mind sets and goals. Executive management and directors are usually remunerated by performance and have historically had a bias towards delivering short term results each quarter (Antia & Pantzalis, 2009). A survey from 2015 of more than 600 executives and directors reported that two-thirds of those surveyed stated that the pressure for short term results has increased in the last five years (FCLT, 2015). Moreover, much of said pressure arise from boardroom reaction and urgency to short term-oriented public

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Furthermore, as the concentration of insider directors increase on the board, focus on long term success decreases (Galbreath, 2016), which implies that outsider directors, with their different perspectives and knowledge bases, can mitigate short-terminism (Lee, Wu, & Dong, 2019). A recent McKinsey survey also highlight the increased short-terminism in the corporate environment and the increased pressure felt on executives and directors. Moreover, the survey shows that the increased focus on short term result does not result in long term success. A notable example is that companies that spend on average 50% more on Research and

Development, an investment that usually has a high payback time and can be considered a long-term effort, reported on average 36% higher earnings and higher year to year growth than short-term oriented companies (Barton & Manyika, 2017).

To conclude, there is a need for advocates of long-terminism in an organization to ensure sustained value creation and long-term success. These advocates can either be within the board as outside directors with an intrinsic motivation to pursue long term efforts and executive management directors eased pressure to provide quarterly results and more focus on the long-term well-being of the multitude of stakeholders.

2.2.2 Types of Innovation

The word innovation is ambiguous as it is often used as a one size fits all description of new ideas, ventures or improvements. On a broad level, Innovation can generally be defined as the commercialization of an invention, thus covering the fact that an idea or product needs to have a market for it before being defined as an innovation (Denoo, 2016). Moreover, different kinds of innovation require different knowledge and ways of working with different organizational impact as stated above. To familiarize with the concept of innovation, the following section summarizes the different categorizations and dimensions used in practice as: Product versus process innovation, radical versus incremental innovation, competence enhancing versus competence destroying, and architectural versus component innovation (Schilling M. , 2012). What is innovated

Historically the main types of innovation concerned either products or processes. Product innovation is the output of an organization; it can be goods or services. For example, a new car model or a new computer is a product innovation. Process innovation on the other hand is the way a firm conducts its business, such as the way production is set up or how employees are organized. Usually, process innovation is targeted towards improving effectiveness or efficiency. These different modes of innovation are not opposites; they often occur in tandem. A process innovation may open up for a wide range of product innovation and vice versa.

In recent years however, business model innovations have the most profound ways to drive innovation change and are paramount for ensuring company resilience, growth and ultimately – survival (Mangematin, Ravarini, & Scott, 2017). To illustrate, many of the most prolific

companies such as Amazon, Facebook and Google are platform-based companies; a business model that enabled their growth and dominance in their respective fields.

Level of change of innovation

Understanding changing customer dynamics, market forces and internal matters is important for the board of directors to aid in innovation matters. Furthermore, understanding the multiple layers of innovation is key when aiming for a more holistic approach to innovation management on a board level. The following section is therefore an attempt to solidify the existing literature base on the level of change of innovation.

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A common dimension used to describe different types of innovation is the continuum between radical and incremental innovation. Simply put, radical innovations are typically new and different from prior solutions while incremental innovation makes improvements on existing offerings or practices. To illustrate, the very first iPhone is a radical innovation due to the fact that nothing like it had been conceived before and the implications that followed changed the usage of mobile devices. The annual updates of the iPhone models are subsequently incremental innovation since they build on an existing platform and serves essentially the same customers. It is important to note that the degree of radicalness of an innovation is relative in respect to different industries or firms. What is radical in one field might be incremental in another. There is a measure of risk associated with radical innovation since it involves venturing into the unknown, both from a technical and a commercial perspective (Denoo, 2016). Firms that can strike a balance between radical and incremental innovation are defined as being ambidextrous, equally good at implementing both dimensions in their organizations (Tushman & O'Reilly, 1996). Ambidexterity matters because there will always be a trade-off for an organization to handle between focusing on today versus planning and preparing for the future. The most successful organizations are the ones that can reconcile these trade-offs and reach long-term success (Gibson & Birkinshaw, 2004)

Another important dimension to consider is that between Competence enhancing and destroying innovations. An innovation that is competence enhancing adds to existing knowledge and build on the firms’ experience. Competence destroying innovation on the other hand either does not build on existing knowledge or renders it obsolete. An illustrative example is the introduction of handheld calculators in the fifties that rendered slide-rulers obsolete within a couple of years.

2.2.3 Clear and Challenging Goals for Innovation

Clear goals and a shared vision for innovation is important in order to align the efforts in the innovation processes in an organization. Moreover, clear goals for innovation enables evaluation processes that can shed light on company direction in terms of renewal and innovation. Research on goal setting for innovation is inconclusive, some researches argue that goals should be

ambiguous in order to inspire novelty while other argue that clear goals are important to ensure efficiency (Lund & Magnusson, 2015).

2.2.4 Innovation Measurement

Measuring innovation is a complex affair assigned to management teams or board of directors in an organization that is critical for innovation success (Adams, Bessant, & Phelps, 2006).

However, there is still ongoing debate if innovation measurements hinder or supports innovation with one side of the discussion stating that innovation measurement help managers audit their processes and outcomes to ensure that innovation practices in the organization is supported and performed efficiently (Criscuolo & et.al., 2017), while the other side argue that innovation measurement push focus and attention to a narrow field of view that hinders innovative efforts. Dependent on how metrics are bundled and used, measurement of innovation can increase project efficiency and firm exploration (Brattström et al., 2017).

Research on innovation is diverse and based on a broad range of disciplines. Finding a one size fits all solution to manage and organize innovation is unlikely, as specific technological and market environments differ between industries (Tidd, 2001). There is a need for a holistic approach to innovation measurement that is tailored for the specific firm.

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Measuring innovation effectively involves understanding the problem measurement should solve and design the measurement framework appropriate for the identified needs. A framework proposed by Richtnér et al, illustrated in the figure below, can be used to assess the innovation measurement of the case companies and provide a base for discussion. The framework is based on both innovation measurement literature and research based on surveys from practitioners and case studies of global companies. Moreover, the framework proposed is aimed at providing tangible best practices and enables firms to develop a holistic measurement system that measures inputs, throughputs and outputs of innovation processes.

Innovation Measurement Framework

The proposed innovation measurement is composed of three phases with distinct steps designed to give a holistic tool that includes both quantitative and qualitative metrics and is summarized below.

.

Figure 1: Innovation measurement process (Richtnér et al. 2017) Phase A •1) Identify existing innovation measurement practices •2) Assess the current innovation focus Phase B •3) Develop or improve measures for evaluating the innovation portfolio •4) Develop or imporove measures for evaluating the innovation process •5) Develop or improve measures for evaluating the innovation

projects

Phase C

•6) Set routines for innovation measurement •7) Implement the new innovation measures and routines

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Step 1: Identify existing practices. An organization that strive to implement an effective

innovation measurement practice needs to do is assess their current measurement system and identify patterns and characteristics. This step is important to showcase the balance of

quantitative and qualitative measures and identify the frequency of follow up and other indirect innovation activities.

Step 2: Asses current innovation focus and priorities. Assessing the current innovation focus and

set priorities to understand the balance between different innovation outcomes. Radical

innovation calls for different measures than incremental innovation and understanding that fact is key to use innovation measurement effectively.

Phase B: Improve core innovation measurement practices.

Once assessment is done, the attention is shifted towards understanding areas of improvement. Three overall categories should be considered: overall portfolio measurements, measures of

innovation process and measures of individual innovation projects.

Step 3: Develop measures for evaluating innovation portfolios. This step involves balancing

radical and incremental innovation with large and small projects while also balancing high and low risk projects. A balanced innovation portfolio is important for understanding how to gauge the expectations for the projects.

Step 4: Develop measures for evaluating the innovation process. Another important aspect

besides balancing a portfolio is to develop a measurement system for the innovation process that covers inputs, throughputs and outputs.

Step 5: Develop measures for evaluating innovation projects. Innovation activities are usually

conducted through projects and developing measures for assessing individual innovation project is important to manage the uncertainty associated with running innovation projects. Having fewer projects run simultaneously is proven to be more effective since more time can be spent on each one.

Phase C: Deploy innovation measurement practices.

The final phase is about making sure that the new or improved measurement systems are implemented and used while also establishing routines.

Step 6: Set routines for innovation measurement. An important activity is setting up routines for

the measurement systems by assigning measurement owners and deciding on measurement frequency.

Step 7: Implement innovation measures and routines. The final step in this framework is making

sure that employee training and follow up is in place to ensure successful roll out. Moreover, a process for re-evaluation is necessary to ensure that the measurement system is functioning as intended.

In conclusion, an innovation measurement practice is key to ensure that the process of renewal can be well understood by the board and communicated across the organization. This will in turn enable the board to be included in innovation matters. Strategizing for innovation is a multi-faceted area with many aspects influencing decisions and discussion in the boardroom. Understanding the drivers behind these decisions and discussions is therefore logical step

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To understand how innovation can be incorporated in firm strategies, an understanding of the enabling factors such as board composition, market intelligence and management interactions are key to the form a base of inputs when constructing a framework. The drivers of renewal ambition presented in the next chapters collects these factors and others to form a foundation for the analytical framework and subsequently forms the inputs to value creation.

2.3 Drivers of Renewal Ambitions

The drivers of renewal efforts and ambitions are the prerequisites to value creation in an organization. Innovation is a commonly used word to describe renewal, however the usage of innovation as a label for all things new can be ambiguous and vague in the boardroom and can put directors in a defensive mind state. Being more direct and clearer, by calling innovation renewal, as in activities that ensures momentum, is a step in the right direction for including innovation in the board agenda as a less stigmatised topic.

Different building blocks in an organization such as board compositions, ownerships structures and management interactions enable different outcomes in terms of value created. Assessing these building blocks is important to gain an understanding of the driving forces behind the dynamic issues such as sustainable long-term value in an increasingly complex business environment Section 2.3 is therefore initiated by discussing how different ownership structures influence the renewal ambition in an organization which is proceeded by examining board compositions and the influencing factors to renewal work. The drivers for renewal are concluded by examining the interactions between the board and the managements team to form a solid foundation for the tentative framework.

2.3.1 Ownership Structures

For innovation to prosper within a company it is important to have a shareholder that supports a strategy and business model promoting innovative activities. Both internal and external

shareholders have different but important roles when innovation is promoted within a company. Internal shareholders have a perspective which is usually long-term oriented and hold intrinsic knowledge, while external shareholders contribute with capital but usually have a short-term oriented interest. According to Stein, there is an acute information asymmetry between the two different types of shareholders in a company (Stein, 1988), and there is therefore a need for alignment for shareholders that are involved and engaged in a company’s work related to innovation to ensure effective and successful projects.

According to research, companies that seek to be innovative could benefit from being privately held because fund managers on the public markets promote short-term financial gains and the market itself lacks the long-term orientation and tolerance that innovation requires (Lerner, Sorensen , & Strömberg, 2011). When short-term gains are absent or share prices drop,

shareholders may require that the strategy is changed which could hinder innovation to prosper since prospering usually requires a long-term strategy and perspective (Stein, 1988; Asker et al., 2014; Davies et al., 2014)

A specific type of shareholder could also have an important role in creating the right condition for innovation to prosper, based on how capital should be used and over which time-horizons the investments are going to yield financial gains. Both management ownership and ownership by industrial companies positively affect innovation within companies (Dushnitsky & Lenox, 2005). Management ownership has a tolerance that is coherent with the time-horizon that innovation requires because the shareholder has a better understanding of the associated risks and are also

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better in managing the information asymmetry between the various shareholders. In the case of ownership by industrial companies, the shareholders are more viable in choosing a strategy that promotes innovation and which is long-term oriented, rather than focusing on short-term financial gains (Dushnitsky & Lenox, 2005). Pension funds, private equity firms and venture capital firms are also positively associated with creating the right conditions for innovation (Johnson, 2015; Lerner, Sorensen , & Strömberg, 2011). In the case of pension funds, they are often long-term oriented and can, therefore, provide time horizons which innovation investments require (Johnson, 2015). Venture capital firms are mainly beneficial for innovation in companies which are in an early stage because they can supply relevant expertise and advice but also because they can act as the link between the customers and suppliers. Regarding the equity funding, venture capital firms also act with a tolerance which is beneficial for innovation. In the case of private equity funds, the structure of the ownership allows a high level of knowledge to be obtained by the shareholders, which enables the company to act in a long-term oriented manner that allows innovation to prosper (Lerner, Sorensen , & Strömberg, 2011)-

Shareholders of institutional types, such as hedge funds, often do not have either the time or the expertise to fully comprehend the opportunities and the technological, scientific and commercial risks which are related to innovation. This creates doubts regarding if shareholders that lack specialized knowledge are appropriate in firms that aim to innovate (Lazonick & et al., 2004). Institutional shareholders also have a short-term orientation that is not compatible with the horizons that innovation requires, and therefore could affect innovation in a negative manner within a company (Brossard & Lavigne, 2013). In the case of institutional shareholders, bank ownership has also been negatively associated with innovation due to their risk averse behaviour (Tribo & Berrone, 2007).

2.3.2 Board Composition

Several studies have found that a board’s ability to bring strategic resources related to innovation is influenced by how the board is composed (Huse, 2007; Mizruchi, 1996). Furthermore, it is important to focus on the individual members' roles within the boards together with their background and characteristics (Ruigrok et al., 2007).

Dependent and independent directors

Several researchers have found that the advising quality of a board can be strengthened by both the unique experience and knowledge members that the board has, especially in firms where the operations are complex. The researchers argue that both the experience and knowledge can be brought to the board by independent directors and that it could affect the decisions regarding the company’s strategy (Faleye et al., 2011; Kor & Sundaramurthy, 2009; Adams & Ferreira, 2007)

Several researchers argue that the knowledge, experience and information are hard to obtain without allowing independent directors into the boardroom because the attributes are acquired from their personal experiences within the industry or at specific companies (Kor & Sundaramurthy, 2009; Adams & Ferreira, 2007). Furthermore, research shows that members of the independent type that have an advising or monitoring role in other companies that are active in closely related markets are related to strategic decisions that lead to positive outcomes. The growth of sales was the indicator of prosperous decisions taken by the board, and the researchers argue that the independent directors’ experience within the industry enhances their ability to both monitor and advise the executive management team (Carpenter & Westphal, 2001; Kor &

Sundaramurthy, 2009). Rutherford and Buchholtz (2007) argue that the quality of information within a board is increased with a higher proportion of independent directors, and other studies showed that the availability of information, for instance form social networks, allows companies to acquire firms of successful sorts (Schonlau & Singh, 2008; Cohen, Frazzini, & Malloy, 2008)

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The research community is divided depending on if dependent directors actually increase a firm’s R&D expenditure. Several studies do not find any relation to the rate of inside-outside directors within a board (Hoskisson et al., 2002; Kor, 2006). Moreover, research suggests that dependent directors also have a better understanding of the CEO’s behaviour, such as the actions taken by the person, than independent directors. Together with their specific knowledge

regarding the environment the company is active within and their firm-specific knowledge makes them important in the monitoring process of the executive management team (Ocasio, 1994; Morck, 2004)

Board members’ background

A group’s educational background affects their acceptance of changes and innovation. A broader educational background increases their willingness to accept changes, as well as their ability to be creative. The educational level also increases their level of skills and knowledge, as well as their ability to process information. These individuals are more aware of important activities related to R&D but are also more tolerant when managing uncertainties (Wally & Baum, 1994; Datta & Rajagopalan, 1998) Members of the board that obtain a higher education degree are associated with an improved understanding of how to manage innovation, and that boards consisting of such members in some cases have a long-term oriented and reasonable attitude for their strategic decisions, where they also include R&D within the investments (Danziel, Gentry, & Bowerman, 2011; Zhou, Jin, & Ren, 2012).

The important role of the Chairperson

A chairperson typically leads the board of directors as the preceding officer. The chairperson holds an important role in a boardroom due to the added responsibilities such as organising and leading the board work, ensuring effective meetings and discussions while also keeping the board up to date in company manners (Kollegiet , 2016). Moreover, the chairperson is ultimately responsible for guiding the board focus and is therefore the person balancing between control and development activities. Peer reviewed literature on this topic is limited which means that alternative sources have been used to form an understanding of the chairperson’s role in the board and in the company. A recent INSEAD survey (Shekshnia, 2018) shows that a good chairperson facilitates discussions and ensures collective exploration instead of offering best solutions and insights into specific problems. Chairperson characteristics that can enable fruitful discussions are restraint, patience and availability which implies that the most successful chairs studied are the ones that have learned not to jump in with answers and take over decisions and discussions.

Moreover, the study highlights the importance of measuring inputs of board work and not outputs since the latter is difficult to measure in real time. Inputs such as board composition, agendas, materials, processes and meeting minutes can and should be measured to ensure board work quality and the person usually facilitating these practices are the chairpersons of the boards, either through internal functions or by hiring external actors. Furthermore, global professional services firm Alvarez & Marsal generated a report (2014) that emphasises the notion that good boards are enabled by good chairpersons that provide active leadership of the board, by both being immersed in company matters such as risks, threats and opportunities and the ability to leverage individual director contributions to form a high performing team.

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2.3.4 Board & Executive Management interaction Mode of interaction

Studies have examined the characteristics of the relationship between the board and the executive management, and the general perception is that this relationship is often of either control or collaborative sort (Sundaramurthy & Lewis, 2003). According to Eisenhardt (1989), relationships that focus on control are aimed to induce the behaviour of the executive

management to become self-driven. In contrast, collaborative behaviour aims to reduce the separation between the board and the executive management trough for instance empowerment and collaboration within the decision-making process (Davis, Schoorman, & Donaldson, 1997). Furthermore, there is a clear difference between Control and Collaboration when discussing aspects such as their roots, the individual motivation they provide and the role of the board (Sundaramurthy & Lewis, 2003)

Due to the fact that the collaborative relationship seeks to align their goals and the decisions are aimed to be carried out together, the main pitfall is that the group can fall into groupthink, that could make the relationship suffer from strategic persistence and faulty attributions (Kisfalvi, 2000; Lindsley, Brass, & Thomas, 1995). The author argues that due to these pitfalls, there is a need for complementary monitoring activities that provide critique to the executive management team. In contrast, because the control type of relationship focuses highly on strict monitoring, the main pitfall is that rational system used to control performance is distrust between the board and executive management (Ghoshal & Moran, 1995). The author argues that in such cases it could be beneficial to include aspects of a collaborative relationship instead. Importantly, the pitfalls and their outcomes could become reinforced and follow a counterproductive spiral pattern because of defence mechanisms (of behavioural and cognitive sort) that might cause teams to avoid confrontation of practices they use or their underrating of specific issues (Lewis, 2000; Frey, 1997; Hambrick & D'Aveni, 1988). Different types of cycles are also important to consider within the context because they affect the outcomes of the pitfalls. High-performance cycles refer to situations of team success, while the low-performance cycle refers to the situation when the team has suffered from declines in both performance and efficiency (Lindsey et al., 1995). Several types of research suggest that the role of the board should not be strictly about

monitoring the performance of the executive managing team. Several researchers argue that the board should have a role in engaging the executive management team but also in the process of crafting the strategy, in cooperation with the executive management team (Blair & Stout, 1999; Dess, Lumpkin, & Covin, 1997). Hillman and Danziel (2003) argue that the board has the ability to provide the executive management team with resources which are critical for the decision-making process for the team. This ability makes the board an important asset that could be important for the firm when trying to gain a competitive advantage (Barney, 1991). Boot and Macey (2004) suggests that objective relationships lead to distance between the board and executive management. The distance could have a negative impact on the quality of the

information exchange that could lead to less accurate timing of interventions from the board on decisions that have been taken by the executive management. In opposition, a closer and more subjective relationship between the board and executive management includes a higher quality of the information exchanged between the sides and provides a better timing regarding necessary interventions from the board. This type of relationship also facilitates quick, preventive and correctional actions (Boot & Macey, 2004). Failures conducted by the executive management team have an impact on both members’ individual reputation which could lead to them losing their position. These aspects could influence their willingness to invest in a highly risky project such as innovation (Zahra & Covin, 1995).

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Firstly, boards and executive management could achieve a higher level of trust within their relationship and obtain better collaborative capabilities, used when solving problems, if a shared understanding is achieved. Secondly, diversity can both utilize a board’s rational control, but also enhance their ability to take beneficial decisions. Diversity contributes with new and different ideas and refers to aspects such as members background (academic, occupational, technical), but also if the individuals are of dependent or independent type (Sundaramurthy & Lewis, 2003)

Dependent directors usually obtain a deeper understanding of the company’s internal processes and operations, but also have access to resources that could be of a critical sort for the company. These directors are usually more committed to the firm that they are active in. In contrast,

independent directors usually provide with information regarding changes on the market from an external point of view. These changes could be of a technological and legislative sort and could help to increase the understanding of the industry’s direction. Independent directors’ external perspective could be used to induce debate in the board room, but also between the board and executive management (Daily, 1999; Demb & Neubauer, 1992). According to Pearce and Zahra (1991), the combination of dependent and independent directors that provides different

perspectives, and having a chair that obtain an external viewpoint, could induce conflicts of a productive sort when the members have a strong voice. Non-dual boards could also help to promote the role of the independent director, allowing them to speak up and share their point of view (Pearce & Zahra, 1991).

Clear Responsibilities

Fama and Jensen (1983) argue that there are benefits in applying clear responsibilities regarding who should implement strategies, and who should monitor the progress and the outcomes. The initiation and implementations process of certain strategies should lie in the hands of the executive management team, while monitoring of the outcomes should be the board

responsibility (Fama & Jensen, 1983). Sundaramurthy and Lewis (2003) argue that there are two main problems arising when boards are directly involved in the tasks of the executive

managements teams which are:

• The responsibility of the executive management team becomes diffuse to them

• The separation between the board and the executive management team weakens, and the board and executive management team becomes more integrated.

These issues that these problems cause are that the responsibilities become diffuse, which causes issues on the deliverance of the tasks (Sundaramurthy & Lewis, 2003). This separation has also been discussed by Wu (2008) in which the author suggests that there must be a clear separation between the board and the executive management. The board should provide executive

management with strategic direction but should act with carefulness so that the role of the executive management team is not encroached (Wu, 2008). According to Westphal (1999), aspects such as trust between the board and the executive management and perceived obligations for each of the sides, could enable both of the sides to be involved in the process of constructing the strategy of a company, by enabling the executive management to ask for advice, in a

comforting manner, from the board in combination with adequate counselling. However, Daily and Dalton (1994) argue that independence within boards is an important aspect which could have a negative impact on a board’s administrative efficiency if the sides become too dependent on each other.

A correlation between the board of directors and the executive management’s social relationship and the performance of a company’s product innovation was found by (Wu, 2008). The stronger performance is built upon a comforting relationship which encourages executive management to

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seek guidance from the board, and results in a higher involvement by the board, but also a higher quality of the information exchanged between the sides. Wu (2008) implies that when the

relationship between the board and the executive management is weak, the board should act more advising. The combination of frequent advising and formal monitoring interactions could improve performance. However, if a board acts only in an advising manner and the relationship becomes too personal, there is a risk of immoderate cohesion which could encounter the

external, and more objective, point of view the independent directors have. Research implies that the advisory role should serve as a complement to formal monitoring control because it serves the purpose of an accurate feedback system which allows information to be exchanged more precisely, but also encourages executive management to seek guidance (Wu, 2008).

Understanding how board evaluations can be used to assess the different aspects of an

organization that drives renewal and innovation is important to form a holistic framework. The following section therefore studies existing theories about board evaluations in an effort to understand the balancing act between control and development activities in a firm. Key to

understanding the balancing act is studying theoretical frameworks and international practices by boards and jurisdictional policies influencing board assessments.

2.4 Board evaluation approaches

The final section of the framework describes how board evaluations can be used as a tool for evaluating the three different stages; Value Creation, Innovation in Strategy and Drivers of

Renewal Ambition. The following section explores the mechanisms and practices of board

evaluations in an effort to understand practises and methods used.

Board evaluations are a systematic tool to evaluate the performance of the board and executive management. With the board being increasingly strategically involved in a company’s direction, rather than only controlling performance, there is an increasing need for board evaluations (Huse M. , 2005; Kiel & Nicholson, 2005). Sonnenfeld (2002) argues that board evaluations can be beneficial for the leadership’s learning, but also in their ability to create stronger value for the firm by using systematic evaluation practices. With the increased strategic involvement by the board, strategic accountability, leadership and control is demanded by external stakeholders, institutional investors and regulators. Previous organizational failures from both strategic misjudgement and poor interpersonal relationships have also demonstrated the importance of board evaluations (Kiel & Nicholson, 2005).

2.4.1 Areas evaluated

There are no agreed upon areas to focus on when evaluating a board. This is due to the fact that areas could be differently evaluated depending on the purpose of the evaluation and is typically tailor made to the specific needs of the board. However, areas such as group dynamics, board processes and the boards’ role are aspects which are included in several researchers’ work. These authors also include the evaluation of the board as a unit as well as individual members’ role within the board. The areas often examine the interplay between skills, experience and

motivation on an individual level, but also the interactions and relationships between the board and executive management (Kiel & Nicholson, 2003; Minchilli et al., 2007). Investigating supporting governance processes, procedures and policies and effectiveness are often also included in the majority choice of understanding concerns related to a company (Kiel & Nicholson, 2003). Figure 2 showcases other specific topics which a board evaluation could be focused on and provides an overview of the framework proposed by Kiel & Nicholson.

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Figure 2: Elements which are commonly evaluated within board evaluations (Kiel & Nicholson, 2003) 2.4.2 Evaluation process

The evaluation process consists of several steps that answer different questions. The questions are presented in figure 3 below.

Figure 3: A framework used for bard evaluations (Kiel & Nicholson, 2005).

Firstly, the aim and objective of the evaluation have to be specified. The objectives are often related to the problems within the competitive environment the company is active in, or to problems internally within the boardroom the company seeks to resolve (Kiel & Nicholson, 2005). A clear purpose with clear objectives enable both an efficient process to be used and outcomes to be measures throughout the process (Conger, Finegold, & Lawler, Appraising Boardroom Performance, 1998; Conger, Evaluating the Directors: The Next Step in Boardroom Effectiveness, 2002). Conger et al (1998) argue that answering on what is going to be evaluated

Defining Governance Roles

•Role of the board •Board structure

•Role of individual directors

Imporving Board processes

•Board meetings •Board meeting agenda •Board paper

Key Board Functions

•Strategy formulation •Monitoring •Compliance •Risk management Continuing Imporvement •Board evaluation •Director Remuneration •Director development

What are our objectives? Who will be evaluated? What will be evaluated?

Who will be asked? What techniques will be used?

Who will do the evaluation? What will you do with the results?

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also is a prerequisite for board ability to create collective annual objectives and responsibilities with respect to both the capabilities and resources needed to achieve success.

Secondly, it is important to specify whose performance will be evaluated. The choice of members to evaluate should reflect the aim of the board evaluation, but also the benefits of including and excluding specific individuals or groups (Kiel & Nicholson, 2005). Depending on the purpose of the evaluation, the evaluation could also aim to evaluate the board as a unit or individuals such as directors or key individuals within the company. Evaluating individuals serves the purpose to enable self-reflection on individual duties but also on individual strength and weaknesses, while evaluation of the board as a unit evaluates the efficiency and activity of the board as a whole (Kiel & Nicholson, 2005; Minchilli et al., 2007). The different actors that the evaluation could be aimed towards are presented in detail in figure 4 below.

Figure 4: The different actors an evaluation could seek to evaluate (Kiel & Nicholson, 2005).

Areas that are chosen to be evaluated should reflect the purpose of the evaluation and should have a value-creation perspective in mind (Minchilli et al., 2007). Shultz (2009) highlight the importance of evaluating certain areas based on the purpose because it enables a comparison of the results. Specifying exactly what will be evaluated have a clear implication in understanding the potential problems and their root causes. Moreover, the difference to the second dimension presented in figure 5, highlights the importance of including other sources of important

information which could be used within the evaluation. Kiel and Nicholson (2005) divides these sources into both an internal and external segment, where the internal segment refers to the same aspects presented in figure 4 (such as board members, CEO and other internal management), and where the external segment refers to shareholders, governmental instances, and the company’s customers and suppliers, but also other stakeholders which are involved (Kiel & Nicholson, 2005). The different segments and their components are presented in figure 5.

Establish objectives and scope of evaluation Board Board as a whole Board committees Directors

Chairperson Lead independent _director

Individual directors

Governance Personnel

CEO

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Figure 5: The specific segments and their corresponding components (Kiel & Nicholson, 2005). Board evaluations can be conducted internally, or by an external firm that has knowledge of corporate governance practices (Kiel and Nicholson, 2005; Leblanc, 2005; Minichilli et al., 2007). If the evaluation is conducted internally, the chairperson of the board is usually in charge of the execution, but in some instances, it could be beneficial to allow a non-executive or the board committee to be responsible for the evaluation (Kiel & Nicholson, 2005). Benefits from conducting the evaluation internally are that it is often a cost-effective alternative which allows a board to set the standards and culture they want the rest of the organization to prioritize (Kiel & Nicholson, 2005). This alternative could also be beneficial when assessing internal processes that has an element of heightened confidentiality (Minchilli et al, 2007).

External firms used for evaluations are beneficial when transparency and objectivity are highly requested or when a company lack internal capabilities to conduct the evaluation. External evaluators also provide a different lens and are often independent of the company they are

evaluating (Kiel & Nicholson, 2005). This can be used to find a focus of the evaluations which is tailored to the company in question, where they also can have a facilitating role when assessing issues related to dynamics of the group, but also other complex problems. Furthermore, their expertise and experience from evaluating boards from other companies can play an important role in providing advice (Kiel & Nicholson, 2005).

Furthermore, several jurisdictions have included in their corporate governance code that board evaluations and external board evaluations should be conducted. A recent OECD (2018) report describes the evolution of international board evaluations practices and compares practices of 20 countries to form a broad understanding of board evaluation processes and practices illustrated in table 1 below. A finding in that report is that the G20/OECD Principles recommend the

inclusions of regular boards evaluations in a country’s corporate governance framework. In the same research, out of the 20 researched countries, China is the only one that has not yet

introduced or implemented any specific rules, regulations or best-practices on board evaluation, which does not imply that boards are not evaluated, but they are not widespread (Vemeulen, 2018).

Establish objectives and scope of

evaluation

Internal evaluations

Board members CEO & senior _management

Other management &employees

External evaluations

Shareholders Goverment

Customers &

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Table 1: Comparative overview of international board evaluation practices

The board evaluation principles in the United Kingdom are a good example of more detailed assessment requirements, where they state, “The board should undertake a formal and rigorous

annual evaluation of its own performance and that of its committees and individual directors.”

And the UK supporting principles outlines; “Evaluation of the board should consider the

balance of skills, experience, independence and knowledge of the company on the board, its diversity, including gender, how the board works together as a unit, and other factors relevant to its effectiveness”. Moreover, as can be seen in the figure above, the UK code states that external

evaluators should be involved at least every three years and France also has a recommendation to involve external board evaluators (Vemeulen, 2018).

Additionally, the chairperson should act on the results of the performance evaluation by recognizing the strengths and addressing the weaknesses of the board and, where appropriate, propose new members to be appointed to the board or on the other side, seek the resignation of directors. Individual evaluation should aim to show whether each director continues to contribute effectively and to demonstrate commitment to the role (including commitment of time for board and committee meetings and any other duties). In closing, with the main purpose of the

evaluation in mind, the output from the evaluation has to serve a purpose. The results can be used to construct a series for actions which could be used to resolve the identified issues.

2.4.3 Evaluation techniques

Board evaluation data can be obtained either qualitatively or quantitatively. The qualitative alternative gathers information through interviews, observations and from various documents, while the quantitative approach involves gathering numerical data form different types of surveys (Kiel & Nicholson, 2005).

The qualitative approach aims to answer questions such as: "what", "how", "why", "when" and "where", while the quantitative approach aims to answer questions such as: "how much" and "how many". Interviews can be conducted both in a group, but also individually where the second alternative often provides more insights if confidentiality is guaranteed (Kiel &

Evaluating Board Work for Innovation.: Towards an Analytical Framework.

Evaluating Board Work for

Innovation

Towards an Analytical Framework

OMAR ALI

Evaluating Board Work for Innovation

Towards an Analytical Framework

Omar Ali

Sammanfattning

Abstract

FOREWORD

Notations

Symbol

Description

Abbreviations

TABLE OF CONTENTS

1 INTRODUCTION

1.1 Theoretical Motivation

1.2 Practical Motivation

1.3 Purpose and Aim

1.4 Research Questions

1.5 Delimitations

2 EXPOSITION OF THEORY

2.1 Value Creation

2.2 Strategy & Innovation

2.3 Drivers of Renewal Ambitions

2.4 Board evaluation approaches