Ironically, the more experts they have on their boards the more likely firms are to succumb to novel challenges
August 22, 2016
For more information, contact: Ben Haimowitz, (718) 398-7642, email@example.com
In constituting a corporate board, how much expertise about its industry
should a company seek? As much as possible, common sense would seem to suggest.
In the words of a new study, "the idea that expert-dominated boards might
have serious negative consequences for organizations clearly defies
Yet, defy it the new research proceeds to do. The study in the
current issue of the Academy of Management Journal finds
that in situations that engender uncertainty, "the higher the proportion
of domain experts on a board, the higher the likelihood of organizational
In sum, expert-heavy boards navigate familiar routes well enough but
have an increased tendency to go awry once off the beaten track, the paper
concludes from data involving more than 1,300 U.S. community banks over a
period of 17 years. In the words of the study, "Despite the perception
that the value of domain experts comes from their ability to manage
uncertainty...ironically, it is precisely under conditions of uncertainty that
a higher proportion of domain experts is associated with organizational
What accounts for this? Based on interviews with banking
executives and findings of other researchers, the paper's authors, Juan
Almandoz of IESE Business School in Spain and András Tilcsik of the University of Toronto, cite three factors
that compromise experts’ effectiveness in addressing new or challenging
circumstances. One is what they call "cognitive entrenchment," a lack
of flexibility in responding to unfamiliar situations. A second is
overconfidence, a characteristic that prior research has uncovered in experts
as varied as physicists, psychologists, and CIA analysts. The third is
"reduced task conflict," excessive deference of non-experts toward a
cluster of industry-savvy board colleagues, the experts’ flaws in judgment notwithstanding.
The professors distinguish their study from the preoccupation with
diversity that has traditionally characterized research on corporate board
composition. "Consider two examples," they write. "First, a
manufacturer of solar panels has a board of directors that includes five
solar-energy experts, two lawyers, and two bankers. Second, the board of
another firm in the same industry includes two solar-energy experts, five
lawyers, and two bankers...In the literature on team diversity, these two
boards would be typically coded as equally diverse in terms of the variety of
professional backgrounds. Yet, these boards differ dramatically in the
proportion of domain expert directors."
And, while there has been no shortage of research on diversity,
they add, the role of domain expertise has been "largely overlooked."
The study therefore breaks notable ground in finding that "the
proportion of domain expert directors [is] related to a vital organizational
outcome – survival or failure – even after accounting for the influence of
professional, tenure, and gender diversity on boards."
Profs. Almandoz and Tilcsik arrive at their findings by
investigating the rate of bank failures in circumstances which banking
executives they interviewed identified as entailing heightened uncertainty.
One situation involves rapid asset growth, when "the bank is
likely to be operating in uncharted market territory, often facing decisions
about previously unknown borrowers, lending areas, and sources of loans."
Another is associated with non-standard real estate loans – that
is, loans for “other than ordinary family residential properties...includ[ing]
land, construction, and development loans, farm loans, large multifamily
residential loans, and other commercial real estate loans…Clients in such
markets tend to be highly heterogeneous...in contrast to...regular family
residential properties, which are characterized by a low degree of uncertainty
because of the availability of detailed information about past patterns and
The study's sample consists of 1,307 local banks founded from 1996
(before which biographical information on board members is spotty) through
2012. A local, or community, bank is defined as having its own legal charter,
aggregate assets below $1 billion, and a business model that focuses on lending
and deposit-gathering in the surrounding locality. Domain experts are directors
with backgrounds in banking or real estate before joining boards – those in banking
typically as executive vice presidents or higher and those in real estate as
top executives of firms in property development or investment.
Of the 1,307 banks that were monitored, 124 (9.5%) failed, 1,015
survived, and 168 disappeared as a separate entity due to a merger or
reorganization that did not involve a failure to meet depository obligations.
Analyzing the relationship between organizational failure and the proportion of
domain expert directors, the professors found that in the two circumstances
cited above – where a bank's assets were rapidly increasing or a bank had a hefty
portfolio of non-standard real estate loans – the rate of organizational
failure increased significantly with the proportion of directors who were domain
The professors note, however, that for the sample as a whole
"the proportion of directors who were banking or real estate experts had
no significant main effect on bank failures...Rather, as we theorized...the
relationship between the proportion of domain experts and the risk of bank
mortality was contingent on the level of decision uncertainty."
And this relationship is quite clear. For example, in banks with relatively
small portfolios of non-standard real estate loans (bottom 15th percentile), failure
rates are similarly low whether real estate experts constitute 10% or 40% of
board members. But in banks with relatively large portfolios of such loans (top
15th percentile), the failure rate is about three times higher when 40%
of directors are real estate experts than it is when 10% fit that description.
The authors took care to ascertain that their results were not
unduly influenced by the major financial recession of 2007-09, when many banks
failed. As they explain, "our models accounted for year-to-year variation
in economic conditions by controlling for the rate of GDP growth and the number
of bank failures each year."
Could it be, though, that their findings are special to banking
but not applicable to other industries? The professors concede that possibility
but note that their conclusions resonate with earlier research dealing with
solar-cell manufacturers, an industry quite different from banking. That
earlier study found that management teams in which most of the executives
were domain experts were less flexible than others in adapting to environmental
In conclusion, the authors caution that "most boards in our
empirical context include at least two directors with prior banking experience
to fulfill minimum regulatory requirements of financial expertise. Thus,
our findings should not be taken to imply that boards with no domain experts
whatsoever are optimal; rather, what our results point to is the importance of
appointing a non-trivial number of directors with primary expertise beyond the
focal domain, especially in boards that are likely to face a significant degree
of decision uncertainty."
The paper, “When Experts Become Liabilities:
Domain Experts on Boards and Organizational Failure," is in the
August/September issue of the Academy of Management Journal. This
peer-reviewed publication is published every other month by the Academy, which,
with almost 20,000 members in 127 countries, is the largest organization in the
world devoted to management research and teaching. Its other publications
are Academy of Management Review, Academy of Management Perspectives,
Academy of Management Learning and Education, Academy of Management Annals,
and Academy of Management Discoveries.