Outside Directors In SME Boards.pdf

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Corporate Board: role, duties & composition / Volume 1, Issue 1, 2005

Virtus Interpress a Corporate Governance Publisher28

OUTSIDE DIRECTORS IN SME BOARDS: A CALL

FOR THEORETICAL REFLECTIONS

Jonas Gabrielsson* & Morten Huse**Abstract

Good governance for SMEs is critical for economic development and growth in both developedand developing economies. In this paper we focus on boards and governance in small and me-dium sized enterprises (SMEs) by investigating the role and contribution of outside directorsin this setting. By contrasting board role theories against different types of SMEs, firms areexpected to recruit outside board members for various reasons. Illustrated by 52 empiricalstudies of outside directors in SMEs we show how agency theory, resource based view of thefirm, and resource dependence theory can be applied to understand the multiple roles thatoutside directors can play in family firms, venture capital-backed firms and other SMEs. Theillustration shows that the concept outside director is not the same in different theories andin different empirical settings. Based on this finding, we argue for the need to have a consciousand balanced use of theories for understanding the role and contribution of outside directors

in SMEs.

Key words: Boards of directors, outside directors, SMEs, family firms, venture capital

*Norwegian School of Management BI, Oslo, Norway, and SIRE/Halmstad University, Halmstad, Sweden. E-mail:[email protected].**Norwegian School of Management BI, Oslo, Norway, and Bocconi University, Milan, Italy. E-mail:[email protected].

Introduction

We are experiencing a new era in the governanceof firms of all sizes - small as well as large.Boards of directors that earlier were consideredto be passive, or just formal organizational bodiesbarely involved in strategy, and rubber-stampingdecisions already been taken (i.e. Mace, 1971),have now received more attention among schol-

ars and practitioners than never before (Monksand Minow, 2001). This wave of interest goesacross national boundaries, and global medicinesfor developing and empowering boards havebeen prescribed. In the majority of cases are theintroductions of outside directors the solutionfor developing boards.

The aim of this paper is to develop theoryon boards and governance by studying the roleand contribution of outside directors in smalland medium sized enterprises (SMEs). Researchand literature on SMEs have long recognized thatoutside directors can be beneficial for the

growth and development of SMEs (Castaldi andWortmann, 1984; Nash, 1988; Daily and Dalton,1992). The bulk of empirical research on the role

and contribution of outside directors has how-ever mostly been conducted on large publiclyheld companies (c.f. Daily et al, 1998). There areconsequently very few studies that have exploredthe role and contribution of outside directors inthe context of SMEs, and those who do have of-ten uncritically adapted concepts and theoriesdeveloped for large corporations without adjust-ing the situation to differences in for example

ownership involvement, and the general lack ofinternal resources that often characterize theseventures (Huse, 2000; Daily et al, 2002). Thereconsequently seems to be deficiencies in ourknowledge of the role and contribution of out-side directors in SMEs.

The rest of the paper is structured as fol-lows. The framework for analyzing our researchquestion is developed in the next section. In thissection we present various board role theoriesand their perspective on the contributions ofoutside directors. The section continues withthe argument that SMEs is not a homogeneous

concept, and that contingencies and contextsmust be included in understanding these firms. Inparticular we present how family firms and ven-


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Virtus Interpress a Corporate Governance Publisher 29

ture capital-backed firms diverge. In the thirdsection we illustrate our arguments by analyzing52 research projects about the role and contribu-tion of outside directors in SMEs. In the fourthsection we present an analysis of the projects.The final section summarizes the conclusions and

contributions of the paper.

Outside directors in SMEs a litera-ture review

Above we addressed the question of the role andcontribution of outside directors in SMEs. Ourresearch question will in this section be posi-tioned in relation to existing board role theoriesand the use of the outside director concept inthese theories.

Theories of board roles

Board roles can be categorized and listed in vari-ous ways. For the purpose of this paper we havefocused on agency, resource based and resourcedependence arguments in explaining the role andcontribution of outside directors in SMEs.These theories have frequently been used to mo-tivate for the development of boards (Johnson,Daily and Ellstrand, 1996). Other board roletheories deal with property rights, the boardsinstitutional role, strategy role, disciplinary role,figurehead role, ethical role, auditing role, classhegemony role, etc (c.f. Hung, 1998; Zahra and

Pearce, 1989).Monitoring and independent directors

agency theory. It is often argued that privatelyheld SMEs could benefit from the external over-sight a governing board can offer by shielding theinvested stakes of the key resource providers ofthe enterprise (equity holders, as well as debtholders and employees) from potential manage-rial self-interest, as well as from the risk that theCEO may mix personal and business goals (Cas-taldi and Wortmann, 1984; Nash, 1988; Hughes,1996; Daily et al, 2002). This monitoring role ofdirectors can be largely derived from agency the-

ory (Fama and Jensen, 1983; Jensen and Meck-ling, 1976). The theory argues that the board canreduce agency costs and maximize shareholdervalue by being actively involved in the monitor-ing of managerial and firm performance (Famaand Jensen, 1983). From an agency theory per-spective is the main contribution from outsideboard members their ability to introduce inde-pendent considerations prior to decision-making.The board of directors can in this perspectivefunction as an important information system forexternal stakeholders to monitor managerial be-havior and firm performance, and to reduce

asymmetric information between contractingparties. The main contribution of outside direc-

tors according to agency theory is consequentlytheir ability to be independent when over-seeoperating matters, protecting the assets of thefirm, and holding managers accountable to thefirms various key stakeholders to ensure the fu-ture survival and success of the enterprise.

Advice and directors with expertise re-source theories (RBV).The resource-based viewof the firm argues that a firm's internal environ-ment, in terms of its resources and capabilities, iscritical for creating sustainable competitive ad-vantage (Prahalad and Hamel, 1990; Teece, Pis-ano and Shuen, 1997). Being aware of, improv-ing, and protecting the unique resources of thefirm will then reinforce firm strengths and rear-range firm weaknesses, and thereby improve afirms competitive position. Small firms are how-ever generally characterized by a lack of internalresources, and in-house knowledge may in many

cases be scarce or non-existing (Storey, 1994). Ithas in this respect been considered important tohave a board with experienced outside direc-tors in order to overcome this internal lack ofresources and complement the management withexperience, knowledge and skills (e.g. Castaldiand Wortmann, 1984). The board of directors,and especially the outside directors, may hencebe considered as a bundle of strategic resourcesto be used by and within the small firm as theycan provide timely advice and counsel to theCEO and the management in areas where in-firmknowledge is limited or lacking. The resource-

based view consequently recognize that can be avaluable source of competitive advantage throughtheir professional and personal qualifications.

Legitimation, networking and co-opted di-rectors resource dependency theory. Resourcedependency theory argues that the long-term sur-vival and success of a firm is dependent on itsabilities to link the firm with its external envi-ronment (Pfeffer and Salancik, 1978). A basicargument in the theory is that firms constantlymust interact with its environment, either to pur-chase resources or to distribute its finished prod-ucts. Firms should therefore seek to gain control

over its environment to create more stable flowsof resources and lessen the effects of environ-mental uncertainty (Pfeffer and Salancik, 1978).The outside board members are in this respectseen as a linking mechanism between the firmand its environment that may support the manag-ers in the achievement of the various goals of theorganization (Zahra and Pearce, 1989). The firmcan also co-opt representatives from importantexternal organizations as board members in orderto achieve organizational goals (Pfeffer and Sal-ancik, 1978:167; Borch and Huse, 1993). Hence,resource dependency theory recognizes that out-

side directors may add value to SMEs by help-ing to initiate and maintain control over critical


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relationships, assets and contacts in the externalenvironment of the firm.

Taken together, the theories indicate, bothindividually and combined, that the developmentof boards can be followed through the introduc-tion of outside directors. However, the reason

for recruiting outside directors, and the contri-bution of outside directors seem to vary acrosstheories. Hence, various theories seem to havevarious rationales for explaining the role and con-tribution of outside directors in SMEs (John-son, Daily and Ellstrand, 1996; Zahra and Pearce,1989).

Understanding boards in the context ofSMEs. In this study we want to explore boardsand governance in SMEs. Mainstream researchon boards and governance has however been fo-cused on large Fortune 500 companies (Zahraand Pearce, 1989; Johnson, Daily and Ellstrand,

1996; Forbes and Milliken, 1999). Althoughthese companies might give valuable insights intoboard practices and board behaviour do they rep-resent only a minor form of economic organiza-tion. The major bulk of companies around theworld are instead small firms that are involved insmall-scale manufacturing and provision of ser-vices (Landstrm, Frank and Veciana, 1997).Focusing only on boards in large publicly heldcompanies might thus limit our knowledge of therole and contribution of boards in other settings,for example start-ups, family businesses, or fastgrowing entrepreneurial ventures (Huse, 1998;

Lynall, Golden and Hillman, 2003). This indi-cates that a relevant question is to which extentour current understanding and conceptualisationsof outside directors can be used in SMEs with-out adjusting the situation to differences in con-text (Huse, 2000).

The question above is based on the assump-tion that expectations about boards may vary de-pending on the dynamics of board-stakeholderinteractions (Huse, 1998; Huse and Rindova,2001) and the relative power of various groups ofinternal and external stakeholders (Rosenstein,1988; Gabrielsson and Huse, 2002; Huse, 2002).

Such dynamics and power balances may varydepending on the context in which the firm oper-ates. SMEs are in this respect often characterizedeither by ownership and control consolidated inone or a few individuals, or by close relationshipsbetween owners and managers (Storey, 1994).The context of SMEs may consequently varyfrom a context of large Fortune 500 companies,and various ownership configurations may alsoaddress questions about board compositionaldefinitions as that of insiders vs. outsiders.

Two categories of SMEs that recently havereceived increased attention are family businesses

(Corbetta and Tomaselli, 1996; Ward and Hardy,1988) and venture capital-backed firms (Fried et

al, 1998; Gabrielsson and Huse, 2002). In addi-tion we also recognize other ownership configu-rations and contexts for SMEs, such as subsidiar-ies, joint ventures and partnerships (Kriger, 1988;Huse and Rindova, 2001; Goodall and Warner,2002). These three groups firms will be described

below.Family businesses. ManySMEs are compa-nies that are entirely owned by the members of asingle family. These companies are generallyconsidered family businesses (Corbetta andTomaselli, 1996; Cowling and Westhead, 1996;Gersick et al, 1997). There are however manydefinitions of family businesses1. The broadestdefinition defines a family business as a firmwhere a family has the voting control of a com-pany (e.g. Neubauer and Lank, 1998). This defi-nition will include close to 95% of all registeredcompanies in Europe (Mustakallio, 2002). In this

paper we will use a common definition of a fam-ily business in order to highlight the special fea-tures of such firms: a firm where the CEO con-siders the firm to be a family business. This con-sideration means that everyday business life be-comes as important as maintaining family tradi-tions and building a future for generations tocome.

Studies of boards in family businesses havefound that they often have relatively few direc-tors, with one or two family members on theboard in addition to the owner-manager (Wardand Handy, 1988; Cromie, Stephenson and Mon-

teith, 1995; Corbetta and Tomaselli, 1996). In thecases when there is an outside director on theboard, it is often a person that has a close connec-tion to the business, such as the family attorney, abanker or a friend of the CEO (Ward and Handy,1988; Corbetta and Tomaselli, 1996). The boardis moreover expected to have relatively little po-tential influence as the owner-manager often ex-ercise power over the board through his or hercentral role in the selection and remuneration ofdirectors, and by shaping the information pro-vided to them (Ward and Handy, 1988; Johannis-son and Huse, 2000). The typical board in family

businesses can thus be pictured as a rubberstamp-board that only meets to formally ap-prove what the owner-manager has already de-cided to do (Mace, 1971).

Literature on family businesses howeverpoint out that in firms where the second, or evenlater, generations has taken over ownership con-trol over the company often differ significantly intheir governance structures compared with firstgeneration family businesses (Gersick et al,

1 The definitions most often include one or more as-sumptions about family ownership, about the number

of generations the firm has been in the possession of afamily, and that the owning family also should havemanagement positions.


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1997). The complex ownership-situation thatcharacterize many family businesses may hencecreate demands from distant (non-involved) fam-ily members on organized systems for controland influence among the various branches of afamily such as a board of directors (Neubauer

and Lank, 1998).Venture capital-backed SMEs. Venturecapital backed SMEs are firms in which profes-sional investors have invested alongside man-agement due to the firms potential for significanteconomic returns. Venture capital-backed SMEsare in this respect often found in emerging indus-tries where new start-ups have the potential todevelop into major economic contributors (Friedand Hisrich, 1995; Manigart and Sapienza, 2000).While family businesses by definition may berelatively old and mature firms, will venture capi-tal-backed firms consequently often be young

and fast-growing firms in which the need foralertness and proactiveness in turn calls for short-term planning and frequent follow-ups (Manigartand Sapienza, 2000).

Studies of boards in venture capital-backedSMEs have indicated that venture capitalists(VCs) often is a key stakeholder group that putpressure to change and develop boards in SMEs.Studies of venture capital backed companies forexample reports that the boards are dominated byoutside board members, with VC-appointeddirectors rather than management in control(Rosenstein, 1988; Rosenstein et al, 1993; Fried,

Bruton and Hisrich, 1998; Gabrielsson and Huse,2002). The VCs presence on the board of direc-tors may for example help the firms executivesto focus their efforts to closely monitor firm per-formance and in developing systems to rewardinnovation and creativity (Fried et al, 1998;Markman et al, 2001). Moreover may VC ap-pointed directors provide managerial competenceand valuable resources through their experienceand personal network built up during their ca-reers, which can be of great help for young entre-preneurial firms (Deakins et al, 2000; Politis andLandstrm, 2002). The adoption of outside

directors on the board is hence not only due tothe power of purse, where the VC partnershipwants to monitor CEO and firm performance, butis also a way for these small entrepreneurial ven-tures to get access to the expertise and network-ing resources that the VC possess (Rosenstein,1988; Gabrielsson and Huse, 2002).

Other ownership configurations and con-texts for SMEs.There are also various other fea-tured ownership structures in SMEs than thetypical family firm or venture capital-backedfirm. Subsidiaries are one common example(Kriger, 1988; Huse and Rindova, 2001). The

management in the parent company often consti-tutes the board in subsidiaries, and the parent

company management is sometimes supple-mented with employee directors, and even someoutside directors (Bjrkman, 1994). J oint ven-tures, partnerships and employee-owned firmsare other ownership configurations in SMEs.Firms with such ownership structures may have

particularly active boards, but the board membersare most often the partners and both of these ex-amples have distinctive governance mechanismsand practices (Gulati and Westphal, 1999; Goo-dall and Warner, 2002).

Framework for the analysis

Through the literature review we have developeda framework for analyzing the role and contribu-tion of outside directors, and the outside di-rector concept in SMEs. The literature reviewabove indicates the importance of using multiple

theories for understanding this issue. Moreover,the review indicates that various ownership con-figurations and contexts seem to be a main crite-rion for understanding alternative logics for hav-ing outside directors in SMEs. This gives us aframework with two dimensions: i) board roletheories and ii) ownership configuration and con-text. The framework suggests that various theo-ries (agency theory, resource based theories andresource dependence theory) can be applied todifferent kinds of SMEs (e.g. family businessesand venture capital-backed firms) through expec-tations about the role (monitoring, providing ad-

vice and council, and managing resource depend-encies) and characteristics (independence, exper-tise, boundary spanner) of outside directors.This framework will now be used to explore therole and contribution of outside directors in asample of studies of boards in SMEs.

Illustrative sample

In this section we will present the illustrativesample and main concepts used in the presentstudy. We decided to use a review of 100 studentreports on boards of directors to meet our re-

search question of the role and contribution ofoutside directors in SMEs. The student reportsare all empirical studies of boards in Norway andSweden. For the purpose of this paper we se-lected reports that included issues relating tooutside board members in SMEs. A total of 52reports met these criteria. A more general over-view of the accumulation of knowledge fromthese 100 reports is given in Huse and Gabriels-son (2002).

The sample: 52 research reports

The empirical data used in this paper consists of52 unpublished empirical research reports, in


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which Norwegian and Swedish master studentshave collected data on boards of directors be-tween 1989 and 2000. A variety of methods wereemployed in the research reports, from one-firmcase studies till large-scale postal questionnaire

surveys. In some cases even studies of boardminutes and participant observation were em-ployed. An overview of how the 52 studies fitinto the framework developed in the previoussection is presented in table 1 below.

Table 1.The reports: theories and types of firmsBoard role theory Agency theory RBV RDT

Board role Control/ moni-toring

Resource: Adviseand council

Managing dependencies:Source for co-optation

Outsider characteristics Independent Expert Boundary spanner1. Family businesses 5 projects 11 projects 2 projects2. Venture capital backed firms 5 projects 4 projects 3 projects3. Other SMEs(Subsidiaries, joint ventures,employee-owned firms, firmswith dispersed ownership)

7 projects 8 projects 7 projects

The table shows how the various reportsmatch the framework developed in the literaturereview. The theoretical perspectives used (agencytheory, resource based theory and resource de-pendence theory) and the types of firm in focus(family business, venture capital-backedfirms, or other kinds of firms) are displayed.In the group of other kinds of firms we findstudies of subsidiaries, joint ventures, employee-owned firms and small firms with dispersed own-ership.

Main concepts

The main concepts in this paper are outsidedirectors, small and medium sized enterprises(SMEs), family businesses, and venture capitalbacked firms. Definitions of family businessesand venture capital backed firms has been pre-sented and discussed in previous sections. Wewill here present how we will use the conceptsoutside directors and small and medium sizedenterprises (SMEs).

Outside directors. Outside directors inSMEs often include directors who are neitheremployed as managers, nor are family members

(or relatives) to the CEO. Earlier studies havehowever reported the many ways to define in-sider/outsider ratios (Johnson, Daily and Ell-strand, 1996). Our research question implies toshow how such definitions are theory- and con-text- based. More specifically, we ask questionabout who are outsiders of boards in SMEs.

Small and medium sized enterprises(SMEs). The main definitional difference be-tween large corporations and SMEs is companysize, but size can be measured according to sales,number of employees, equity, market prices,market shares, etc (Storey, 1994). In this paper

we will not make any clear definition of SMEsize other than that SMEs are different from large

publicly held corporations, such as less structur-ally complex and less formalized, have limitedcapital and manpower, and are managed directlyby their owners (or part-owners) in a personal-ized way (dAmboise and Muldowney, 1988;Storey, 1994).

Analysis and results

The literature review presented a framework foranalyzing the role and contribution of outsidedirectors. The framework used the theoreticallyderived board roles and firm category as sorting

variables. We used the definition of an outsidedirector as a mediating variable. The analysis wasthen conducted by investing how the generallyaccepted concept of an outside director wasinfluenced by theory and context in the variousempirical reports. A summary of the findings isshowed in table 2 below.

The role and contr ibution of outsidedirectors

Family businesses. The outside directors infamily businesses had various contributions, de-

pending on the theoretical approach taken. Thedescriptions of the outsider directors also var-ied. In the reports using the agency theory per-spective was the contribution of the outsidedirectors mainly described as reducing informa-tion asymmetry between various branches of thefamily, or between the family and important ex-ternal stakeholders. Reports using the resource-based perspective highlighted the role of out-side directors in bringing resources and compe-tencies into the firm, and bringing a detachedview on the family business, involving keystakeholder interests and public responsibilities.

Also, especially in more mature family busi-nesses, the possibility to avoid the risk of in


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breeding (Johannisson and Huse, 2000) wasmuch valued. The role of outside directorsfrom a resource dependence perspective waslinking the firm to its external environment bynetworking activities. This was particularly the

case in periods of expansion. Moreover, duringCEO successions the outside director helpedthe family business with signaling legitimacy andstability in relation to external stakeholders.

Table 2. Outside Directors and Their Contribution on Boards in SMEsAgency theory - control RBV advice and counsel RDT managing resource de-

pendencies

Reducing information asymmetryamong branches of the family, orfor external stakeholders.

Bringing resources and compe-tencies into the firm.Reducing the risk of in-breed andbringing a detached view on thefamily business.

Helping with contacts and net-works during expansion (e.g.during internationalization).Legitimation during CEO suc-cessions.

Family busi-nesses

Outsiderscontribution

Who is anoutsider?

Experienced non-family personon whom the family and externalpowerful stakeholder trusts (oftenthe family lawyer).

Experienced non-family personon whom the CEO/dominatingfamily members trust (familyfriend, family lawyer, accountantor consultant).

Experienced non-family personon whom the CEO/dominatingfamily members and other pow-erful stakeholders trust.

Monitoring managerial and firmperformance to maximize eco-nomic returns for equity holders(VCs and/or entrepreneurs).

Complementing entrepreneurslack of competence in key func-tional areas, such as finance,marketing, etc.

Using their network to recruitkey personnel and to attractadditional funding.

Venture capitalbacked firm


Who is anoutsider?

VC, VC appointed director, orother director on whom the VCtrusts.



Reducing information asymmetryand protecting shareholdersagainst managerial indiscretion.

Strengthening the resources andcapabilities of the firm.

Offering legitimacy in the busi-ness community, and influenc-ing important stakeholdergroups.

Other SMEs


Who is anoutsider? A non-executive shareholder, or

businessperson not employed bythe firm on whom shareholderstrust.

Experienced businessperson onwhom CEO trust, often an execu-tive in another firm.

High profiled person on whomexternal stakeholders trust.

The empirical reports moreover showed thatexecutives and CEOs in family businesses seemnot to outright avoid outside directors, but theydo not necessarily always welcome them either(e.g. J ohannisson and Huse, 2000). Suspicion andfamily politics are common ingredients in theselection process, and the choice is not always in

favor of the outsider. Noteworthy is that ma-ture family businesses (firms in the 2nd or 3rdgeneration) were more likely to employ outsidedirectors, either to monitor firm performance forthe firms main stakeholders (i.e. variousbranches of the family or the bank), or as asounding board for aging CEOs (e.g. Fiegener, etal, 2000).

Then who are the outside directors infamily businesses? The reports show that thisvaried somewhat depending on the theoreticalapproach applied. In studies using the agencytheory perspective was the outside director a

person on whom the family trusts could be inde-pendent from the influence of the management

team. This could for example be the family law-yer. From a resource based perspective was theoutside director an experienced person onwhom the CEO and the dominating family mem-bers trust. This could be a long time familyfriend, the family lawyer or other persons thefamily has known for a long time. From a re-

source dependence theory are outside directorssupposed to be boundary spanners, and in thefamily firms they are experienced persons thatthe CEOs, family members and other powerfulstakeholders trust. All theoretical perspectivesconsequently highlight experience and trust astwo main features for understanding the role andcontribution of outside directors in the familybusiness context.

Venture capital-backed firms. The contribu-tion and definition of outside directors in ven-ture capital backed firms differ somewhat fromthat of the family business. Reports using the

agency theory approach highlighted the outsidedirectors contribution in reducing managerial


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opportunism, and monitoring managerial andfirm performance to maximize economic returns.Reports using the resource-based perspective theoutside directors highlighted that outsidedirectors complemented the lack of in-housecompetence. The outside directors were for

example often complementing the managementslack of competence in various functional areassuch as finance, general management, marketingetc. From a resource dependence perspective theoutside directors contributed with establishingand maintaining important links to externalstakeholders. The outside directors were inthis respect mainly active in using their networksto find and recruit key personnel, and in receivingadditional funding during its various stages ofdevelopment (Rosenstein, 1988). From the CEOspoint of view, the board was hence a much-valued resource despite the strong monitoring

focus.The outside directors in the venture capi-

tal-backed firms were the VCs, or a person ap-pointed by the VCs in all three theoretical per-spectives. It happened that the entrepreneur hadappointed other outside directors to counterbal-ance the influence of the venture capitalist, butthen it was a person that also was trusted by theventure capitalists. A main difference from fam-ily businesses is hence that while family busi-nesses recruit directors on whom family memberstrust do venture capital-backed firms recruit di-rectors on whom the VCs trust.

Other SMEs. In addition to family busi-nesses and venture capital backed firms did theresearch reports include samples from subsidiar-ies, employee-owned firms, partnerships, jointventures etc. Reports using the agency theoryperspective in these kinds of firms indicated thatoutside directors were recruited primarily tocheck against managerial indiscretion and reducethe information gap between external owners andthe management team (which sometimes waspart-owners). This was the case both when therewas a single owner (such as a parent-company)or when the ownership was dispersed among sev-

eral owners outside the firm. Reports using theresource-based perspective highlighted the out-side directors role in strengthening the re-sources and capabilities of the firm by contribut-ing with their expertise and experience. Reportsusing resource dependency theory describedoutside directors as helpful in offering legiti-macy in the business community, influencingstakeholder groups, and seeking to achieve com-petitive advantage through networking activities.Both the resource-based and the resource de-pendency perspective indicated that outsidedirectors could be regarded as much valuable

resources that could be exploited for a rather lowcost, as they brought valuable expertise, and ac-

cess to valuable resources by making their busi-ness and personal networks available to the smallfirm (Borch and Huse, 1993).

The definition of an outside director inthis group of SMEs also varied depending on thetheoretical perspective applied. In reports using

agency theory, outside directors were mostoften external owners seeking influence overcompany decisions. In reports using resource-based perspective was outside directors experi-enced businesspersons on whom the CEO trusts -often acquaintances that were CEOs in otherfirms. The resource dependency perspective de-scribed outside directors as high profiled per-sons on whom external stakeholders trust, thatwere chosen for his or her reputation.

The above illustration shows how outsidedirectors can play multiple roles in SMEs. More-over, the concept outside director is not the

same in different theories and in different empiri-cal settings. This leads us to question previousuniversalistic approaches and general theorizingwhen trying to understand the role and contribu-tion of outside directors across various types ofSMEs. From an agency theory perspective is themost important qualification for outside direc-tors their ability to be independent (Fama andJensen, 1983). But should independence be de-fined in relation to the firm, the management, orthe owner-family? In family businesses outsidedirectors are often defined as non-family direc-tors. The reports however show that outside

directors in family businesses tend to have strongties to the CEO and/or the dominating familymembers. Their independence can therefore bequestioned. It can even be likely that non-executive members of the family may be moreindependent than an outside director that isrecruited through the professional and privatenetwork of the CEO. In venture capital backedfirms, outside directors were often defined asVC or VC appointed directors, i.e. directors in-dependent of the entrepreneur, despite that VCsalso can deliberately withhold information, notperform as agreed, and pursue short term self

interest seeking behavior to the expense of otherstakeholders. In the third category of firms (otherSMEs), outside director was often a non-management shareholder. These findings clearlyindicate that research on director independence inSMEs must include explicit discussions of whatdirectors are supposed to be independent of.

Moreover, both the resource-based viewstressed other outside director qualificationsthan independence. In the resource-based viewoutside directors were supposed to have a goodknowledge of the market and the industry inwhich the firm operates, so that their experience

could improve firm performance. Resource de-pendency theory on the other hand stressed that


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outside directors had a well-developed personaland business network that could mediate trust,reduce internal resource dependencies, and estab-lishing links between internal and external stake-holders. The various theoretically derived expec-tations on the role and contribution of outside

director make it hard to include all these qualifi-cations in the same person. Alternative opera-tionalizations of outside directors independ-ence and expertise should be sought dependingon theory and context.

Taken together, the analysis indicates thatoutside directors can be critical for effectiveboardroom governance in SMEs, but also that thetraditional definition of an outside director as anon-management director is an overly simplisticterm (Daily, Dalton and Johnson, 1999). Ourunderstanding of the role and contribution ofoutside directors in SMEs seem instead to vary

depending on the theoretical framework used,and the type of firm being studied. The conceptof an outside director is not generic and shouldnot be used interchangeably without reflectionsof what the consequences will be. Hence, an openand context based definition may be required tounderstand the various roles and contributions ofoutsider directors in various settings of SMEs.

Summary and conclusion

The aim of this paper has been to develop theoryon boards and governance by investigating the

role and contribution of outside directors inSMEs. Various board roles theories have beenpresented, and so also theoretically derived defi-nitions of outside directors. Based on an ana-lytical framework of board role theories and dif-ferent firm categories, we have analyzed the roleand contribution of outside directors through areview of research reports on boards in SMEs.Firms are shown to recruit outside directors inorder to develop their boards for various reasons.The illustrative sample shows that the widelyused concept outside director is not the same indifferent theories and in different settings. A

main contribution of this paper is raising the con-sciousness about how outsider definitions inpractice vary across theories and contexts. Theempirical observations about outside directorsis largely dependent on the theoretical lens usedto understand their role and contribution, and ahigh degree of consciousness should be displayedwhen moving the outside director concept fromone context to another.

In this paper we have contrasted variousboard role theories against different types ofownership structures in SMEs to understand therole and contribution of outside directors in this

setting. However, the context for SMEs goes be-yond ownership structure. A life cycle approach

is for example often considered as important tounderstand boards of directors in SMEs (Huse,1998; Lynall, Golden and Hillman, 2003), and soare other contingencies such as industry, firmcomplexity, and the presence and role of thefounder (Randy and Goel, 2002; Gabrielsson,

2003). These things are however largely unex-plored issues, and it is consequently highly rele-vant for future research on boards and govern-ance to continue to investigate how various con-tingencies in and around SMEs could influencethe development of boards and the role and con-tribution of outside directors. These insightswould then be significant contributions to ourknowledge of corporate organization and govern-ance in SMEs.

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