RESOURCE DEPENDENCE THEORY

The resource dependence theory was first introduced by Pfeffer (1972), and later developments were done by Aldrich and Pfeffer (1976) and Pfeffer and Salancik (1978). They provide a view of the organisation from an external perspective and show how firms interact with their external environment. Bearing in mind that external environment has a significant impact on the firm’s businesses and its current and future affairs; it is reasonable to expect that firm’s management will start to take actions that respond to and mitigate the impact of the environmental conditions to the least in an endeavour to assure firm’s success and enhance firm’s performance (Pfeffer, 1972).

Aldrich and Pfeffer (1976) mention that the resource dependence model is grounded in an indisputable notion that, for firm’s survival and competitiveness, there is a need for resources and professional services that, definitely, can’t be entirely generated internally, and hence, there is a need for creating connections and transacting with external environment to get the required resources and services. Such argument is consistent with Pfeffer (1972) claim that organisational interdependence reduces firm’s autonomy and increases uncertainty.

Pfeffer and Salancik (1978) argue that organization in broad term of activities, inputs and outputs is part of the environment at which it works in, thus the firm affects and get affected by this environment; the firm controls resources that might be needed by other firms; and also, other firms might control their needed resources. Later, the resource dependence theory becomes an influential theory that was utilised, in organisation research and strategic management, to explain how firms adapt and deal with environmental uncertainty and interdependence (Hillman, Withers and Collins, 2009). Uncertainty constrains the firm’s ability in controlling their resources, directs firm’s strategies and even the firm’s daily activities (Hillman, Cannella and Paetzold, 2000). Building connections with organizations and directors outside the firm provide more sources of information and environmental awareness and allow firms to reduce uncertainty regarding the availability of resources (Muth and Donaldson, 1998). One more advantage of linking the firm with its external environment is reducing firm’s transaction costs; recruiting outside directors who are aware of the best ways to deal with different parties of external environment could

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reduce the effort exerted by the management, and reduce the transaction costs (Hillman, Cannella and Paetzold, 2000).

Pfeffer and Salancik (1978) argue that the most appropriate way to manage the environmental interdependence is to control the sources of this dependence, thus, they suggest a number of mechanisms that the firm can utilise to minimise firm’s environmental dependency; board of directors and mergers are examples of these mechanisms. Pfeffer (1972); Johnson, Daily and Ellstrand (1996) and Hillman, Shropshire and Cannella (2007) assert this by mentioning that board of directors is a crucial bonding mechanism between the firm and its external environment. In spite of the fact that agency theory is the cornerstone that has been employed in the board of directors literature, the resource dependence theory has a great influence in this area; moreover, reviewing the board of directors literature reveals that resource dependence theory is supported more than other perspectives including the agency theory itself; furthermore, resource dependence theory is more helpful and successful in understanding board’s dynamics (Hillman, Withers and Collins, 2009). In a reflection of the argument that the environment has a great influence over the firm, Hillman, Cannella and Paetzold (2000) and Hillman, Shropshire and Cannella (2007), among others, mention that board composition and membership could change in response to environmental changes; such changes might propose new resources to be acquires, thus new linkages should be established; and hence, new directors are required. Similar argument was early proposed by Pfeffer (1972); he argues that board is shaped in response to the external links in which the firm needs to construct; firms with more capital needs are more likely to recruit more bank representatives to their boards.

Under this theory, one of the major responsibilities of the board members is to act as boundary spanners. They have their personal connections, relations and communications with external parties that should be utilised to secure the required resources of the firm. These resources are essential for the firm’s daily activities, help it to survive, enhance firm’s performance and in some cases like rare resources, it might be a competitive advantage for the firm. Hillman, Shropshire and Cannella (2007) mention that the resource dependence theory focuses on the matching between the directors’ skills, experiences, capabilities and connections with external environment and the firm’s necessities. In other words, the value that the director

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will add to the firm and to what extend this value matches with the firm’s needs. In support of this argument, Dalton et al. (1999) mention that evidence from the prior literature (e.g., Pfeffer and Salancik (1978), among others,) reveals that, consistent with the resource dependence theory, large boards reflect firm’s ability to build more connections with the external environment; helping in better management of the environmental interdependence and uncertainty, which enhances firm performance. Daily, Dalton and Cannella (2003) give some instances of boundary spanning roles, which could be legal advices from the outside director who is solicitor or partner in a law firm, financial advices about the available sources of fund or getting the support of a board member who works at a financial institution to get the required finances.

Board interlock is a clear application of the resource dependence theory (Johnson, Daily and Ellstrand, 1996). The resource dependence theory, also, argue that interlocking directorates is one of the practices that can be employed to manage environmental interdependency (Zajac, 1988). Interlocking enables firms, through the shared board members, to create bonds between firms and create a common interest network (Davis, 1996). Pfeffer and Salancik (1978) mention that interlocking is a flexible and easy way to employ and enhance firm’s ability to manage the environmental uncertainty and interdependence; by appointing external members to the board, the firm establishes connections with the external environment; and hence, firms gain many advantages like access to resources, information exchange and gaining legitimacy.

In addition to these benefits, the advice and counsel service the external board members provide, as it is a kind of information that firms can gain from those members; empirical research provides evidence that supports these proposed benefits (Hillman, Withers and Collins, 2009). Another advantageous information the firm can gain from external directors is their nominations of new directors the firm can recruit (Davis, 1996). Davis and Cobb (2010) state that appointing executives of suppliers, customers, former parliament members, politicians, and cabinets, and venture capitalist to sit on the board could help in gaining their supports, contacts, open new channels in front of the firm and more financing sources. Davis (1996) states that the decisions which are taken by one board, within the same network, become the raw information for the decisions taken by other boards. The interlocked

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directors could be the CEOs of other firms rather than other directors. Johnson, Daily and Ellstrand (1996); Dalton et al. (1999) and Adams, Hermalin and Weisbach (2010), among others, argue that CEOs of other firms are expected to have a relevant and practical experience of how to deal with the complex business environment; thus appointing CEOs as outside directors should provide the board with valuable advice and counsel.

To sum up, the resource dependence theory views the firm as an open system that interacts with the surrounding environment. By considering the scarcity of both tangible and intangible resources coupled with the strong competition between firms to secure their needed resources, the firm has, continuously, to open connections and bridges with the external environment; which is one of the board of director vital roles. Grounded in this perspective, many arguments in the governance literature mention that firms could move to large boards with more interlocked directorships to build the required connections that can help in securing the needed resources.