Noticing that leaders typically develop unique relationships with each follower in a group, Dansereau, Graen, and Haga (1975)  offered a leader-member exchange theory, which proposes that leaders use different styles with different members within the same group. LMX emphasizes the social exchange between leaders and followers. Leaders divide subordinates into an “in-group” and an “out-group.”

In LMX (Dansereau, Graen, & Haga, 1975), the in-group consists of the subordinates that the leader trusts and confides in. The members of this group are those who perform to the leader's expectations, who are interested in developing within the organization, and who are socially compatible with the leader. Superiors develop a “leadership exchange” with in-group members, meaning that they influence these subordinates without authority.

Compared to the out-group members, in-group members have greater access to information. They are allowed higher autonomy in their jobs. Out-group members have a more formal relationship with the leader. People in the out-group may not perform as well, may not want more responsibility, or are not socially compatible with the leader. The leader develops a “supervision relationship” with members of the out-group, primarily using their authority to influence out-group members (48).

Dansereau, Graen, and Haga (1975) found that two variables influence the quality of leader-member exchange: similarity of the leader-follower attitudes and follower extroversion. In a meta-analysis of 79 LMX studies, Charlotte Gerstner and David Day (1977) found that LMX positively influences performance, satisfaction, and commitment, reducing turnover and stress.

Theoretically, LMX theory paints a more realistic picture of leadership by recognizing that followers are not passive recipients of leadership influence but are active participants in the leadership process.

LMX implies two practical applications. First, since members of the in-group tend to perform better than members of the out-group, leaders might consider expanding the boundaries of the in-group. Of course, this assumes that membership in the in-group can increase performance when the opposite may be correct. This chicken-and-egg dilemma considers whether a person becomes a performer once allowed into the in-group or becomes a member of the in-group because of performance and social compatibility.

What the dilemma does not consider is that some out-group members may work harder to get into the in-group. In contrast, some that are in the in-group might take advantage of their status by loafing. Regardless of the elements in a dilemma, LMX theory suggests that developing positive exchange relationships can enhance leadership effectiveness.

The second application applies to subordinates: since members of the in-group tend to have higher satisfaction, reduced ambiguity, and lower stress, employees can engage in behaviors that may help them join the in-group. Among those behaviors are increasing extroversion, performing above expectations, emphasizing their similarities with leadership, and communicating their commitment to the organization.

An obvious problem with applying and fostering LMX is the competitive clique mentality that can develop between in-group and out-group members. An employee's relationships with a boss and co-workers fundamentally affect the work experience (Jex, 2002). An employee’s efforts to conform to the in-group could adversely affect an employee’s creativity while fostering a groupthink mentality that diminishes individual and group decision-making capacity.

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