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Leader-Member Exchange (LMX) Theory (Graen & Uhl-Bien, 1995), also known as the vertical dyad linkage theory, proposes that the quality of the relationship between the leader and the subordinate influences performance-related outcomes (for both the leader and the subordinate). The leadership theories discussed previously have a group-level focus; that is, the leader treats all subordinates in the same way. For example, transformational leadership is usually considered to be a group-level construct. However, LMX theory focuses on the relationship between the leader and each individual subordinate. This model is most appropriate for understanding how a leader manages a team of individuals. As a leader interacts with his or her team, the leader will classify individuals as members of either the in-group or out-group. These classifications, once established, tend to remain fairly stable over time. Although it is not entirely clear what governs the leader's allocation of subordinates to the in-group or the out-group, goal congruence seems to have an influence, in that individuals with similar goals to the leader are selected to the in-group (Uhl-Bien, Graen & Scandura, 2000).

Research in the area of LMX has established the positive benefits for both the leader and the subordinate of being in a high LMX relationship. High quality LMX leads to enhanced employee satisfaction, performance and OCBs (Ilies, Nahrgang & Morgeson, 2007; Phillips & Bedeian, 1994; Settoon, Bennett & Liden, 1996). Furthermore, high quality LMX has a positive impact on leader behaviours. For example, Mayer, Davis and Schoorman (1995) found that leaders in high quality LMX were more trusted by their subordinates, who were in turn, more trusted by their leader. This resulted in leaders delegating tasks to these subordinates and being more willing to empower them. Although there has been considerable research looking at the impact of high quality LMX, there has been less attention given to low quality LMX. In these relationships, the subordinate performs in-role behaviour (i.e., activities required by the job), but does not put extra effort into their work or engage in OCBs (Bauer & Green, 1996). Furthermore, Townsend, Phillips and Elkins (2000) demonstrated that low LMX is associated with negative consequences, such as retaliation behaviour (see Unit 3 in relation to psychological contracts). Recent research has focused on identifying situations in which leaders and subordinates are motivated to invest more work effort within low LMX relationships (Kacmar, Zivnuska & White, 2007).

The strength of LMX theory is its emphasis on the role of both the leader and the subordinate and its recognition of leadership as a dynamic interactive process. However, although there is broad support for LMX theory, there is currently little understanding of the wider context within which dyadic relationships take place. As LMX theory focuses upon each individual dyad, the theory does not take into account the influence of the group or organisational context.