Top Management Team Dynamics as a Microfoundation of Adaptive

Capability?

This paper examines the effects of subsidiary TMT composition as a microfoundation

of firm strategic adaptive capability and performance in a transition economy. Using a unique

survey dataset of 107 MNC subsidiary firms in China, the paper investigates a path between

TMT functional diversity and firm performance through increased adaptive capability.

Unexpectedly, the results show that a functionally-diversity has no positive effect, however

when functionally-diverse TMTs engage in debate, there is a significant positive impact on

adaptive capability, and through this, performance. Our findings suggest that, as long as

TMTs engage in debate, the benefits of functional diversity outweigh the potential costs of

conflict and information-withholding leading to a positive and significant impact on adaptive

capability. Conversely, without debate, the negative impact of functional diversity

overshadows the benefits, and diversity does not contribute to adaptive capability or

performance.

Track: Strategy

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Top Management Team Dynamics as a Microfoundation of Adaptive Capability?

The capacity to transform internal organizational resources in response to

environmental changes is consistently linked to sustained competitive advantage and

therefore fundamental to management research (Hoopes & Madsen, 2008; Teece, Pisano, &

Shuen, 1997). To face this challenge firms must develop dynamic capabilities to reconfigure

and adapt their existing resources (Teece & Pisano, 1998; Teece et al., 1997). Adaptive

capability, a core dynamic managerial capability, reflects an organization’s capacity to

reconfigure resources and adapt processes in an efficient and effective response to a changing

environment (Gibson & Birkinshaw, 2004). It comprises the capacity to search for new

opportunities, process relevant external and internal information and swiftly adapt

organizational structure and processes (Oktemgil & Greenley, 1997; Staber & Sydow, 2002).

Despite the recognised potential for adaptive capability to facilitate organizational success,

most research in this area has not responded to recent calls to empirically investigate the

mechanisms and circumstances conducive to its development (Zhou & Li, 2010). This

parallels a significant research gap relating to the foundations of capabilities more generally

(Felin, Foss, Heimeriks, & Madsen, 2012), which the current paper attempts to address by

investigating microfoundations of adaptive capability (Felin & Foss, 2009).

Across the strategy, organisational behaviour and human resource management

literature, there is increased interest in the microfoundations of firm-level constructs in

general (Felin & Foss, 2005; Felin & Hesterly, 2007). This is often articulated as the drive to

better understand the individual and unit level constructs (Felin & Hesterly, 2007) and

organizational processes and interactions (Teece, 2007), that comprise and cause higher-level

strategic elements, such as capabilities (Abell, Felin, & Foss, 2008; Foss, 2011).

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A promising, yet underexplored, perspective on the micro-foundations of capability

development is derived from upper echelons theory, which suggests that top management

team (TMT) characteristics influence, not only the overall strategic direction of organisations,

but also decisions about the allocation of resources towards strategy implementation (Augier

& Teece, 2009; Hambrick, 2007; Hambrick & Mason, 1984). TMTs make decisions based

on member expertise and knowledge, and consistent with their experience-based perspectives

(Hambrick & Mason, 1984). As these factors are strongly influenced by member’s job-related

or demographic background (Smith, Smith, Olian, & Sims, 1994), it has been argued that

TMT composition is likely to directly affect decision-making and the development of

organizational capabilities (Buyl, Boone, & Matthyssens, 2011). Based on upper echelons

theory, we suggest that TMT diversity potentially plays a significant role in the development

of adaptive capability (Barney, 1991; Carpenter, Sanders, & Gregersen, 2001; Hitt, Bierman,

Shimizu, & Kochhar, 2000). Building on past work demonstrating the leveraging role of team

dynamics in realizing the benefit of diversity (Auh & Menguc, 2006; van Knippenberg, De

Dreu, & Homan, 2004), we further introduce debate processes as a moderator of functional

diversity’s influence. Therefore, an important second aim of this study is to investigate the

moderating effects of debate, defined as the questioning or challenging of others assumptions

and direct and open presentation of rival hypotheses or recommendations (Simons, Pelled, &

Smith, 1999), as a boundary condition that determines when diversity facilitates the

development of adaptive capability. We predict and investigate a mediated path between

TMT functional diversity, adaptive capability and firm performance, and specify debate as an

important boundary condition of this pathway.

This article is structured as follows: First, we describe the theoretical foundations

underpinning the influence of TMT diversity and debate as a micro-level basis for dynamic

capabilities, and adaptive capability in particular. We then develop our research model and

3

justify component hypotheses. Following this, we present our methodology and results and a

discussion of our findings incorporating theoretical and practical implications.

Theoretical Background

The resource-based view links heterogeneous firm resources and capabilities to

sustainable differences in firm performance (Sirmon & Hitt, 2003). Valuable, non-imitable,

rare and appropriable resources that are accumulated, combined and exploited create value

and confer competitive advantage. Capabilities are organisational processes that allow

resources to be deployed (Helfat & Winter, 2011) and dynamic capabilities, a special type of

capability, allow firms ‘to integrate, build, and reconfigure internal and external

competencies to address rapidly changing environments’ (Teece & Pisano, 1997, p. 516).

Dynamic capabilities, then, are higher-level processes of significant scale and scope

embedded in firms (Eisenhardt & Martin, 2000). Processes allowing acquisitions, alliances

and new product development are examples of dynamic capabilities, which allow firms to

alter the ways in which they earn their living (Helfat & Winter, 2011). Such major strategic

moves involve the reconfiguration and manipulation of the firm’s resources into new value-

creating activities. These strategic decision-making processes have been labeled managerial

adaptive capability, since they focus on managers’ resource reallocation decisions (Adner &

Helfat, 2003; Kor & Mesko, 2013; Ma, Yao, & Xi, 2009). Building adaptive capability

requires internal efforts and draws on internal firm-specific resources rather than market

acquisitions. This makes it unique and largely inimitable and therefore a potential source of

sustainable competitive advantage (Griffith & Harvey, 2001).

Dynamic capabilities are the focus of much previous theoretical and conceptual

discussion, but few empirical analyses have investigated the factors inside organizations that

lead to the development of dynamic capabilities (Macher & Mowery, 2009). In particular,

little research has detailed how individual and team characteristics affect the ability to

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develop or leverage dynamic capabilities (Adner and Helfat, 2006; MacCormack and Iansiti,

2009), despite growing interest in how this may occur and the potential contribution of

managerial skills and experience (Ambrosini and Bowman, 2009; Augier and Teece, 2009;

Rothaermel and Hess, 2007). A promising approach to integrating research on the impact of

managerial attributes and the development of dynamic managerial capabilities lies in the

study of capability microfoundation (Felin & Foss, 2006).

A microfoundations approach conceives capabilities as collective constructs, the

explanation of whose development requires consideration of lower-level factors.

Microfoundations of organizational capabilities therefore encompass their constituent

components, such as individuals and processes, and the interactions. In particular, the role of

individuals is crucial to understanding capabilities and their development (Felin and Hesterly,

2007). Substantial previous research has highlighted the importance of individuals to

organizational performance (Felin & Hesterly, 2007) and provides consistently support for

the important role of managerial cognition in individual, TMT and firm behavior (Gavetti,

2005; Naranjo-Gil, Hartmann, & Maas, 2008; Tripsas & Gavetti, 2000). Dynamic capabilities

generally, and adaptive capability specifically, are impacted by the firm’s environmental

turbulence, instability and uncertainty (Baum & Wally, 2003; Teece & Pisano, 1997), which

produce deficits in the information needed by managers to identify and understand cause-and

effect relationships (Carpenter & Fredrickson, 2001). In this context, individuals differing

perspectives, beliefs and interests affect their decision-related choices as does their human

capital (knowledge, skills and cognitive capacity) (Felin et al., 2012). The demographic and

occupational profiles of TMTs, particularly the extent to which these profiles reflect a

diversity of backgrounds and experiences, are therefore potentially related to capability

development and subsequent performance outcomes (Certo, Lester, Dalton, & Dalton, 2006;

Hambrick, Cho, & Chen, 1996).

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Upper echelons research and reviews of team diversity have differentiated between

two analytical perspectives, both of which have been applied to top management teams (van

Knippenberg et al., 2004; Williams & O'Reilly, 1998). The information/decision-making

perspective on diversity, argues that teams with representatives from different categorical

backgrounds potentially have access to a broader range of relevant knowledge than more

homogeneous groups (Williams & O'Reilly, 1998). Diverse teams are therefore better

positioned to analyse the implications of environmental changes as well as develop more

innovative responses, consequent to the integration of disparate knowledge (Ancona &

Caldwell, 1992b; Bantel & Jackson, 1989; DeDreu & West, 2001).

The alternative, social identity, perspective on diversity holds that differences and

similarities between team members provides a basis for the process of categorising

individuals into subgroups, represented on the basis of prototypical attributes that typify one

subgroup and differentiate it from others (Ashforth & Mael, 1989; Tajfel & Turner, 1986)

(Lau & Bruton, 2011). Building on the similarity-attraction paradigm and theory of

intergroup bias, the social identity perspective argues that members within a subgroup are

likely to share positive relationships characterised by trust and knowledge sharing, while

interaction across subgroups is typified by conflict and hostility (Tajfel, 1982; Williams &

O'Reilly, 1998). While TMT diversity might enhance capacity to sense opportunities because

of increased access to knowledge (Certo et al., 2006), it has been argued that the direct effect

of TMT diversity may be mixed because of the potential for costs associated with conflict

and associated tendency to withhold information (Williams & O'Reilly, 1998). This situation,

in which diversity may potentially generate positive, negative and no effect has been termed a

‘dilemmatic structure’ (Gebert, Boerner, & Kearney, 2006). This ‘dilemmatic structure’

suggests the benefit of examining moderating variables that enhance the likelihood of

information sharing and utilisation and minimise the negative impact of diversity. The

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categorisation elaboration model of diversity (van Knippenberg et al., 2004), which integrates

both information/decision-making and social identity perspectives, suggests that the positive

effects of diversity are contingent on team processes that engender knowledge elaboration

and integration.

The following section builds on the categorisation elaboration model of diversity to

argue a positive effect of TMT functional diversity, defined as variety in functional

composition (Harrison & Klein, 2007), on adaptive capability, and, through this,

performance. We argue a moderating role for debate, defined as open discussion of

differences related to the team’s work (Simons et al., 1999), in the path between diversity and

adaptive capability, and build our rationale for a moderated mediated model.

Model Development and Hypotheses

The information/decision-making perspective suggests that TMT functional diversity

provides access to increased breadth of knowledge and skills, and a wider external network

on which team members can draw (Williams & O'Reilly, 1998) as well as cross-fertilisation

and the generation of novel connections (Fay, Borrill, Amir, Haward, & West, 2006; Jehn,

Northcraft, & Neale, 1999). These knowledge-related advantages facilitate the development

of a thorough understanding and assessment of environmental pressure and market

opportunity for change, as well as the development of more informed and innovative

responses to market opportunities or challenges (Caligiuri, Lazarova, & Zehetbauer, 2004;

Punnett & Clemens, 1999).

Upper echelons research has consistently posited a connection between TMT

compositional diversity, including functional diversity, and the adoption of a more ‘broader-

minded’ approach to opportunities and complex problems (Dahlin, Weingart, & Hinds, 2005;

Gong, 2006), based on the collective resources of TMT members (Carpenter, Geletkanycz, &

Sanders, 2004), and consequent development of a more comprehensive portfolio of responses

7

to environmental pressures (Punnett & Clemens, 1999). By enabling a deep understanding of

customers, competitors and technology, a functionally-diverse TMTs wide-ranging

information sources allow it to assess its position, determine appropriate strategies and

initiate quick responses (Qian, Cao, & Takeuchi, 2013).

As well as their own knowledge assets, functionally-diverse TMTs have access to

more extensive external network ties (Ancona & Caldwell, 1992a; Lee & Park, 2006). These

ties represent a rich source of information, which further increases the depth and breadth of

knowledge available to inform decisions and facilitate the development and evaluation of

alternative solutions (Finkelstein & Hambrick, 1996; Naranjo-Gil et al., 2008). This capacity

to identify and acquire external knowledge and to analyse and interpret externally-sourced

information from a diversity of perspectives (Dahlin et al., 2005), provides greater

opportunity to identify pressures towards change in the external environment, as well as

opportunities (Murray, 1989). When environmental conditions change rapidly, their external

information network allows diverse TMTs to recognise these changes quickly and make

speedy, well-informed decisions regarding appropriate responses. While TMT functional

diversity has not been empirically linked to adaptive capability, a number of studies directly

or indirectly link TMT composition to organisational change (Bantel & Jackson, 1989;

Boeker, 1997).

In summary, findings of extant studies support a connection between TMT functional

heterogeneity and adaptive capability and lead to the following propositions:

Hypothesis 1: Top management team functional diversity is positively related to

adaptive capability.

Despite these advantages, the benefits that accompany functional diversity are

predicted to occur with significant costs. Social categorization and social identification

theory, along with the similarity-attraction paradigm, point to an increase in friction,

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information-withholding conflict when in-group diversity increases. This effect can suppress

the knowledge-related effects that we have argued are likely to enhance adaptive capability

(Pietro, Shyavitz, Smith, & Auerbach, 2000). The inclusion of moderator variables in the

categorisation-elaboration model (CEM) of diversity effects suggests that elaborative

processes may enhance the knowledge-related benefits of diversity and lessen some of the

negative impact of social categorisation in diverse teams (van Knippenberg et al., 2004).

Functional diversity leads to the availability of different perspectives, however, it is

only when team processes facilitate the expression and critical consideration of these

perspectives, that the group is able to generate innovative solutions (van Knippenberg et al.,

2004). Debate processes have been found to result in the consideration of more alternatives

and the more careful consideration of alternatives, to foster a deeper understanding of task

issues and to facilitate exchange of information that enhances problem solving, decision

making and the generation of ideas (Eisenhardt, Kahwajy, & Bourgeois, 1997; Okhuysen &

Eisenhardt, 2002; Pelled, Eisenhardt, & Xin, 1999). In addition, there is evidence that debate

of member perspectives and the consequent development of alternative problem solutions

prevents premature consensus by limiting the development of confirmatory information-

seeking biases (Schweiger, Sandberg, & Rechner, 1989). Debate about assumptions, data

and recommendations and prevents uncritical acceptance of what initially appears obvious to

members (Schweiger et al., 1989) and also leads to the development of enhanced

understanding and clarity regarding causal connections and successful actions (Jehn, 1995,

1997). Such processes increase understanding of others’ positions and have been found to

reduce the likelihood that group members’ existing preferences, such as those deriving from

stereotypes, will bias the information they choose to retrieve, present, utilise and absorb

(Huber & Lewis, 2010).

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Based on these arguments, we posit that the effect of TMT functional diversity on

adaptive capability will be positive as debate increases. The rationale for this positive

interaction between TMT diversity and debate rests on our argument that greater debate can

diminish the costs while heightening the benefits associated with diversity. It does this by

facilitating the expression and critical consideration of disparate perspectives and also

limiting the likelihood of information-withholding and bias in decision-making. This also

implies that TMT diversity on its own is less likely to exert a positive effect on adaptive

capability. In the absence of debate, due to the opposing benefits and costs associated with

diversity, we expect the relationship between TMT diversity and adaptive capability to be

inconclusive. Only when debate suppresses the costs and strengthens the benefits associated

with diversity will a positive relationship emerge. Accordingly, we propose the following

contingency hypothesis:

Hypothesis 2: TMT debate will moderate the relationship between functional diversity

and adaptive capability. This relationship will be such that greater debate will be

associated with a stronger positive relationship between diversity and adaptive

capability.

The ability to effectively adapt to external changes is argued to allow organisations

obtain competitive advantage through a series of short-term gains (D'Aveni, 1994). While

there is potential for some organisations to achieve competitive advantage by developing

certain firm-specific competencies, the dynamism that typifies contemporary markets means

that such advantage is often short lived and continuing on the same path of development may

not provide further gains (Leonard-Barton, 1992). Environments characterised by changes in

demand and technological shifts require the capacity to continuously reshape, and respond

faster and more creatively to external challenges (Lavie, 2006). An organisation that is able to

understand and predict environmental changes, make well-informed and timely decision, and

10

rapidly implement changes to its processes and structure has the potential to gain and regain

competitive advantage (Li, Chen, Liu, & Peng, 2012).

The capacity to adapt their original strategies and patterns of activity allows

organisations to grasp opportunities more quickly than competitor firms and overcome

obstacles and avoid threats (Newey & Zahra, 2009).While other researchers, such as McKee,

Varadarajan, and Pride (1989) have suggested that adaptability requires resource utilization

and potentially leading to some loss of internal efficiency, the capacity to pursue market

opportunity and respond more quickly than competitors has been linked to enhanced firm

performance (Oktemgil & Greenley, 1997; Tuominen, Rajala, & Möller, 2004; Wang &

Ahmed, 2007)

Hypothesis 3: Adaptive capability is positively related to performance.

We have argued a path from TMT functional diversity to adaptive capability,

moderated by debate, and from adaptive capability to performance. In combination, this

suggests a moderated mediated path from TMT diversity to performance:

Hypothesis 4: Debate will moderate the relationship between TMT functional

diversity and performance. This relationship will be such that the positive relationship

between TMT functional diversity and performance through adaptive capability will

be stronger at higher levels of debate.

METHODOLOGY

Sample and data collection

Data was collected from organisations that were multinational subsidiaries in

Shandong, China in 2010. This sample allowed us to access subsidiary TMTs, which have

been relatively neglected in studies of top management and which are faced with multiple

demands of parent and host country in a relatively dynamic environment (Gong, 2006). We

first sent letters to the CEOs of these subsidiaries, explaining the study’s purpose and inviting

11

participation. Of the 250 subsidiaries invited to participate we received completed

questionnaires from 107, representing a 43% response rate. The data was collected through

two questionnaires, one to collect dependent variable data and one to collect independent

variable data, administered on-site due to advantages documented over mail surveys in China

(Hoskisson, Eden, Lau, & Wright, 2000). Site visits ensured that we gained access to the right

respondents, in this case the subsidiary Chief Executive Officer (CEO) and Chief Financial

Officer (CFO).

Language is a significant concern when using constructs developed in one country to

collect data in another country (Tsui, Nifadkar, & Ou, 2007). All items were translated from

English into the language of participants in China, using the application mode of translation

(Van de Vijver & Leung, 1997). With this method, it is assumed that the construct

operationalization is appropriate for the national group under investigation and that a

straightforward translation will suffice to derive a valid measure. The questionnaires were

initially developed in English and then translated into Chinese by two management

academics competent in both English and Chinese. The questionnaire was then back-

translated to English and reviewed by two different academics who focused on detecting

discrepancies between the translations and attempting to identify potential areas of

misunderstanding. Several of our variables, including team diversity, dynamism, munificence

and comparative performance had been utilised in previous organizational research in China

indicating that the measures used had cross-cultural validity (Atuahene-Gima & Li, 2004;

Auh & Menguc, 2006).

Two questionnaires were used to collect data. One questionnaire collected data on the

independent variables and the other questionnaire collected data on the dependent variable,

organizational performance. This approach lessened the risk of bias associated with collecting

data on independent and dependent variables from the same source (Podsakoff, MacKenzie,

12

Lee, & Podsakoff, 2003). In common with previous research, we sourced predictor variable

data from the CEO (Barringer & Bluedorn, 1999; Simsek, 2007). Prior research has found

that CEOs provide data that is as reliable and valid as those from objective data sources

(Heavey, Simsek, Roche, & Kelly, 2009). Our performance data was sourced from a separate

survey sent to the CFO in each firm.

Our sample of firms reported a mean annual turnover of 255 RMB/million ranging

from 1 RMB/million to 6480 RMB/million, and employed as average of 8,300 employees.

All subsidiaries were located in Shandong. Parent companies were globally dispersed with

55% located in the Asia Pacific region. The remaining parent organisations were located in

U.S., Europe, Canada and India. Subsidiaries were established in China between 1996 and

2006, with approximately 70% commencing operations since 2000. Eighty-six percent of

subsidiaries were involved in manufacturing with the other subsidiaries involved in assembly,

logistics, sales and R&D. The majority (95%) of our STMTs had less than six members with

a mean size of 4 members. The mean age of members was 44 years and the average time

working as part of the subsidiary TMT was just over 7 years.

Measurement:

Predictor Variables. Functional Diversity: TMT functional diversity was measured

using Blau’s (1977) index of heterogeneity: (1-ΣPi2), where Pi is the proportion of top

managers in ith category. Blau’s (1977) index has widespread usage as a measure of group

diversity, including functional and national diversity (Harrison & Klein, 2007). A higher

score on Blau’s index indicates greater functional diversity. Teams reported nine distinct

functional backgrounds with marketing the most frequent. Debate: Debate was measured

using a scale from Simons et al (1999). A sample item from this scale is ‘To what extent did

the group constructively challenge the suggestions and proposals of members?” The alpha

coefficient for this measure was .92. Adaptive Capability: This study uses the four item scale

13

developed by Zhou and Li (2010) based on the conceptual work of Chakravarthy (1982),

Lavie (2006), and Mckee et al. (1989). The first item focuses on organisational capacity to

undertake appropriate actions in response to environmental shifts, a key characteristic of

adaptive capability (Chakravarthy,1982; Mckee et al.,1989). The second item gauges the

organisation’s capacity to maintain their competitive advantages in the face of significant

industry changes by reconfiguring their existing capabilities (Lavie, 2006). The final two

items assess adaptive capability in terms of the organisation’s capacity to effectively deal

with challenges arising within the Chinese market, such as its entry into the World Trade

Organization. This measure has been verified by Zhou and Li (2010). A sample scale item is

“Our existing competencies can withstand changes in the industry”. The alpha coefficient for

this measure was .92.

Dependent Variable. Performance: Performance was measured using a scale

developed to capture a firm’s relative performance (Tan & Litschert, 1994). The items asked

the Chief Financial Officer to gauge their performance relative to close competitors. A 5-

point Likert scale was employed to assess performance, with each scale division representing

a 20% increment in comparative advantage. Following Tan and Litschert (1994), we chose

this comparative approach because comparative performance data is provided to firms in

China on an annual basis by the Chinese government. This approach to has been used to

effectively capture performance in western (Pertusa-Ortega, Molina-Azorín, & Claver-

Cortés, 2009; Smith, Guthrie, & Chen, 1989) and eastern contexts. We used an additive

approach to create a 15-point performance measure, combining all three items. Control

variables: Firm size was controlled for by including the square root of the number of

employees (Powell & Stark, 2005). Past performance has been found to impact future

organisational performance (Guthrie & Datta, 2008), and was controlled for by including a

measure of comparative subsidiary performance in 2007 (Tan & Litschert, 1994). TMT

14

national diversity was measured using Blau’s (1977) index of heterogeneity: (1-ΣPi2), where

Pi is the proportion of top managers in ith category. We also controlled for competitor

environmental volatility, as this has been shown to effect subsidiary performance, using a 3-

item measure developed from existing scales (Calantone, Garcia, & Dröge, 2003; McCarthy,

Lawrence, Wixted, & Gordon, 2010). A sample item from this scale is “In our industry,

competition changes in major and unpredictable ways as opposed to slowly evolving”. The

alpha coefficient for this measure was .86. Finally, we controlled for environmental

munificence by asking CEO to assess the extent to which firms in their industry experienced

profitability.

Analysis and Results

This study employed ordinary least squares (OLS) multiple regression analysis and

partial least squares (PLS) structural equation modelling (SEM) to analyse data. PLS SEM is

a second generation modelling technique is increasingly utilised in organisational studies

research (Chen, Lam, & Zhong, 2007), and was used to evaluate our full model. We used

SmartPLS version 2.0 software to undertake this analysis (Ringle, Wende, & Will, 2005).

Many published studies in management research utilise PLS including, for example, research

in group dynamics (Peng & Luo, 2000; Shanxing, Kai, & Jianjun, 2008); strategic

management (Julie Juan, 2005), and innovation (Peng, 2001). Of particular relevance for this

study, PLS SEM can be used effectively in the initial stages of theory development and

provides an overall indication of the predictive utility of models under investigation (Chen et

al., 2007).

Table 1 shows the means, standards deviations for each variable, and correlations

among variables. Prior to investigating our hypotheses, we generated factor loadings to

investigate the validity of our measures. Table 2 provides the factor coefficients for each of

the study constructs.

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Insert Table 1 and 2 about Here

Inspection of the data in Table 2 reveals that all coefficients are greater than .7. All

scale items display the highest coefficients with their parent scale. This support claims of

discriminant validity as it indicates conceptual homogeneity within scales and heterogeneity

between scales (Thompson, 1997).

Ordinary Least Squares regression analysis was employed to investigate our

hypotheses as summarised in Table 3. The regression analysis revealed a significant positive

path coefficient for the impact of functional diversity on adaptive capability (β=.09, t=1.19,

p=.24) providing no support for hypothesis 1.

Insert Table 3 about Here

To test hypotheses 2, a standardised cross-product interaction construct was computed

and included in the model (Allison, 1977). The analysis revealed a significant path coefficient

for the interaction variable regressed on adaptive capability (β=.16, t=2.03, p=.04). The

results show that debate moderated the impact of TMT functional diversity on adaptive

capability as predicted.

In order to explore the nature of the moderating effect further, we used simple slopes

computations and graphed the interactions using high (1SD above the mean) and low (1SD

below the mean) levels of the moderator. These analyses revealed that functional diversity

was significantly and positively associated with adaptive capability when debate was high

(simple slope=.99, t=2.43, p=.02) and was negatively, but not significantly, related to

performance when debate was at a low level (simple slope=-.27, t=-.59, p=.55), as depicted in

Figure 1. These results provide support for hypothesis 2 by indicating that functional

diversity is linked to adaptive capability when debate is high and not related to adaptive 16

capability when debate is at a low level. Analysis showed a path coefficient for adaptive

capability regressed on performance that was also significant (β=.34, t=2.98, p=.00)

indicating support for hypothesis 3. No evidence was found for a direct relationship between

functional diversity and performance (β=.06, t=0.64, p=.52).

Hypothesis 4 posited that the indirect effect of TMT functional diversity on

performance via adaptive capability depends on TMT debate. To test moderated mediation,

the data was investigated to assess whether the strength of the mediation via adaptive

capability differs across levels of the moderator, debate (Preacher, Rucker, & Hayes, 2007).

We generated a bootstrap-based bias corrected confidence interval for the specific indirect

effect at high (1 SD above the mean) and low (1 SD below the mean) levels of debate. For

low levels of debate, the conditional indirect effect of functional diversity on performance

through adaptive capability was not significant (effect = -.16 [95% CI -.87 - .36]). For high

levels of debate, the conditional indirect effect of functional diversity was significant (effect

= .59 [95% CI .18 -.1.64]), supporting our moderated mediation hypothesis.

Insert Figure 1 about Here

We used PLS SEM to assess the utility of our full model. While PLS SEM does not

generate indicators of model fit, the model r-squared statistic indicates the extent to which

hypothesised pathways combine to predict the dependent variable, performance. The r-

squared result for the full model, as depicted in Figure 1, was .63, which can be interpreted as

indicating good fit (Chin, 1998).

In order to further investigate the quality of the structural model, we chose to assess

the models capacity to predict adaptive capability and performance. In order to assess

predictive relevance, we used PLS SEM to generate the Stone-Geisser criterion (Q2) with an

omission distance of 7. Analysis resulted in a Stone–Geisser criterion Q2 value of 0.37 for 17

adaptive capability and 0.42 for performance, which is substantially above the threshold

value of zero, and which indicates the model’s predictive relevance (Henseler, Ringle, &

Sinkovics, 2009). This supports our claim that functional diversity has a significant impact on

adaptive capability and performance, and also supports the utility of the pathways that we

have investigated.

Discussion

The premise of the paper is that explanation for the development of capabilities

requires a focus on microfoundations that capture more fully what we know about individual

cognition and integrative processes within organizations. Motivated by this premise, we

developed a model of the impact of TMT functional diversity on adaptive capability, and

through this, organisational performance. In this study we answered the call to discover the

role that expertise plays in capabilities (Holcomb et al.2009) by synthesizing insights from

dynamic capabilities theory and upper echelons framework to reason that the knowledge-

related advantages bestowed through functional diversity would enhance adaptive capability

contingent on debate. Specifically we posited that, while functional diversity potentially

increases TMT access to knowledge, elaborative team processes are required to effectively

utilise these knowledge assets. We considered that the facilitative role of TMT diversity in

enabling greater adaptive capability would be bolstered by debate, which facilitates the

expression and critical consideration of their diverse knowledge.

Due to the cross-sectional nature of this study, support for causality cannot be claimed

except through theoretical arguments (Frazier, Tix, & Barron, 2004). However, given the

theoretical rationale, we interpret the results as providing support for our proposition that

functional diversity’s impact on adaptive capability, and through this performance, is not

significant unless TMTs engage in debate. Our data support debate as a critical boundary

18

condition of the path from TMT diversity to adaptive capability, and through this

performance.

This study makes several significant theoretical contributions. First, by identifying

functional diversity as an important driver of adaptive capability, this study addresses a

significant research gap pertaining to how TMT characteristics potentially contribute to the

development of a core dynamic capability (Lavie, 2006). The integration of upper echelons

and dynamic capability perspectives illustrates how a TMTs attributes affect its internal

resource assortment and reconfiguration. Our findings suggest that, as long as the benefits of

functional diversity (greater capacity to identify pressures towards environmental change,

‘broader-minded’ approach to opportunities and complex problems, greater ability to exploit

existing competencies) outweigh the potential costs of conflict and information-withholding,

functional diversity has a positive and significant impact on adaptive capability. Conversely,

when the negative impact of functional diversity overshadows the benefits, diversity does not

contribute to adaptive capability. These findings are important because they shed light on the

‘murky waters’ surrounding managerial and cognitive contributors to dynamic capability

development (Corbett & Neck, 2010). While considerable progress has been made in

understanding the unique role that dynamic capabilities play in competitive advantage, the

managerial and cognitive microfoundations of these capabilities have remained relatively

underexplored (Helfat 2007).

The second contribution of this study entails the investigation of the contingency

effect of debate on functional diversity. Our results were supportive of the role debate was

predicted to play in explaining the circumstances under which functional diversity generates a

positive impact. We found that, as debate increases, the effects of functional diversity on

adaptive capability were positive and significant. This suggests that TMT functional diversity

drove the development of adaptive capability only under situations where team members

19

engaged in debate. Our simple slope analysis supported this finding; the effect of TMT

functional diversity on adaptive capability increased as debate increased. We interpret this

finding as indicating that when TMTs are functionally-diverse, while they may have

sufficient knowledge assets to engender a more ‘broader-minded’ approach to opportunities

and complex problems, without team dynamics that facilitate elaboration and critical

assessment, these knowledge-related benefits are unlikely to be sufficient to outweigh the

costs associated with dissimilarity. When teams engage in debate, the benefits of diversity are

strengthened and the conflict and tension associated with dissimilarity are minimised. Under

these circumstances, diversity is linked to the development of adaptive capability. Therefore,

to succeed in dynamic environments, organisations should ensure that their TMT membership

is sufficiently diverse and also engages in debate. This leads to the speedy initiation of

actions in response to environmental change.

Our findings have important implications for practitioners. We demonstrate the utility

of adaptive capability for subsidiary firms operating in China, a dynamic market context. As

a subsidiary’s TMT composition and the processes it uses to make decisions are both

associated with adaptive capability, managers should pay attention to ensuring that members

from a range of functional backgrounds are not only represented on the TMT but are

encouraged to challenge other’s perspective and raise arguments against preferred positions.

Interventions such as Devil’s Advocacy and the introduction of openminded norms have been

demonstrated to increase the likelihood of such debate (Eisenhardt, Kahwajy, & Bourgeois,

1998).

As with all research, this study has a number of limitations. The sample size was

relatively small and moderated relationships were investigated, both of which may have

increased the risk that significant relationships were not identified (Ren, Kraut, & Kiesler,

2007). However, our hypotheses were supported, and given that the ability to detect

20

moderating variables is particularly constrained by small sample size (Dahl & Pedersen,

2004), we have additional confidence in the robustness of our findings. Another potential

limitation of our research stemmed from our use of survey questionnaires. Two different

questionnaires were administered separately and to different actors to collect information on

dependent and predictor variables. The data on dependent variables was collected from CFOs

and the data on predictor variables, including moderator variables, was collected from CEOs,

following previous research in strategic management fields which has relied mostly on senior

executives as the most knowledgeable respondents (e.g., Heavey et al., 2009). This approach

to data collection is in alignment with recommendations by Podsakoff et al (2003) and

provides some basis to argue that the risk of common method bias in our data is not

significant. However, we recognise that multiple TMT respondents would have enhanced our

research design and recommend that future studies in this area utilise such an approach.

While our research argued and supported the moderating role of debate, previous

studies have suggested that debate could operate as a mediating variable in teams in which

intergroup bias is low (Noordegraaf, 2011). We did not find evidence of a direct effect

between diversity and debate, however future research on other job-related or bio-

demographic diversity domains may support a model of sequential mediation between

diversity and performance.

In conclusion, previous research in the area of dynamic capabilities has been largely

conceptual and this study represents one of few to incorporate empirical investigation. In

addition, very few past studies have focused on the microfoundations that lead to the

development of dynamic capability and even fewer have done so using a quantitative

approach. In this study we use unique data from a sample of subsidiaries to investigate the

effect of TMT composition that facilitate the capacity assess environmental events, determine

appropriate strategies and initiate quick responses and subsequently build adaptive capability,

21

a key dynamic capability. This relationship was contingent on team debate, and together team

diversity and debate are the foundation for adaptive capability and through this performance.

Our results also support early arguments that, in dynamic environments, performance

differences may reflect differences in their capabilities in responding quickly to change

(Eisenhardt & Martin, 2000; Helfat et al., 2007; Teece & Pisano, 1997; Zollo & Winter,

2002).

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28

TABLE 1

Variable Means, Standard Deviations and Correlation Coefficients

29

Mean SD 1 2 3 4 5 6 7 8 9

1 Munificence 3.21 1.2

2 Dynamism 3.31 .98 .49**

3 Size 48.26 79.09 .13 -.08

4 Past Performance 3.6 .71 .35** .20* .07

5 National Diversity .20 .22 .02 -.02 -.11 .05

6 Functional Diversity .21 .22 -.05 -.04 .02 -.1 .12

7 Debate 3.85 .76 .18 .14 -.05 .37** -.06 -.13

8 Adaptive Capability 3.71 .90 .62** .39** .16 .28** .02 .06 .25*

9 Performance 7.03 1.72 .43** .23** .16 .32** -.10 .04 .19 .48**

*p<.05 **p<.01

30

TABLE 2

Latent Variable Factor Loadings

Dynamism Debate Adaptive

Capability

Comparative

Performance

Dynamism 1 .88 .09 .13 .13

Dynamism 2 .88 -.09 .12 .16

Dynamism 3 .87 .19 .29 .04

Debate 1 .09 .91 .06 .00

Debate 2 .07 .94 .13 .08

Debate 3 .02 .90 .15 .13

Adaptive Capability 1 .13 .15 .82 .08

Adaptive Capability 2 .12 .11 .88 .09

Adaptive Capability 3 .16 .08 .88 .19

Adaptive Capability 4 .22 .08 .86 .28

Performance 1 .14 .12 .08 .91

Performance 2 .11 .17 .21 .86

Performance 3 .07 -.06 .19 .79

31

TABLE 3

Model of Moderating Role of Debate on the Relationship between TMT Functional

Diversity, Adaptive Capability and Organizational Performance (N = 107)

Dependent Variable

Model 1

Adaptive

Capability

Model 2

Adaptive

Capability

Model 3

Performanc

e

Munificence .53** .53** .15

Dynamism .12 .14 -.02

Size .11 .11 .06

Past Performance .01 -.01 .18

National Diversity .02 .01 -.11

Functional Diversity .11 .09 .06

Debate .16 .12 .05

Functional Diversity X Debate .16* -.12

Adaptive Capability .34**

Adjusted R2 .40 .42 .25

R2 ∆ .02* .06**

a Beta weights are shown. *p<.05; **p<.01

32

FIGURE 2

Moderating Effect of Debate on Functional Diversity’s Impact on Adaptive Capability

33

Low Diversity High Diversity0

0.5

1

1.5

2

2.5

High Debate

Low Debate

Ada

ptiv

e Ca

pabi

lity

34