Corporate Board of Directors

Structure and Efficiency

Ismail Lahlou

• Publisher: Palgrave Macmillan
• Year: 2018
• ISBN:
  9783030050177
• Topic: Business
• Subtopic: Corporate Finance
• Index: Business

Corporate governance, a subject that a few decades ago escaped the attention of allbut a handful of academics and shareholders, has gradually become a central concernworldwide. This book contributes to the existing literature on the structure and effectiveness of corporate boards. It comprises three topics that address distinct research questions on board structure, the deployment of board resources to monitoring and advisory duties, and the use of equity-based incentives in the compensation packages of directors. Firstly, the book provides strong new evidence on the importance of corporate board functions in value creation. Secondly, it provides some evidence of the potential conflict between the two primary functions of corporate boards. The results indicate that while the board's advising quality weakens when the board is principally devoted to monitoring duties, the presence of advisory directors on the board does not have any impact on the effectiveness of board oversight, which offers a more complete view on the tradeoffs between the board's two major functions. Finally, the results suggest that the closer directors' compensation is tied to the firm's stock, the more consistent corporate acquisition decisions are with shareholder interests.

© The Author(s) 2018

Ismail LahlouCorporate Board of Directorshttps://doi.org/10.1007/978-3-030-05017-7_1

Begin Abstract

1. The Impact of Corporate Board Characteristics on Firm Value: A Literature Survey

Ismail Lahlou¹

(1)

University of Burgundy, Auxerre, France

Ismail Lahlou

Email: [email protected]

Keywords

Firm performanceBoard characteristicsBoard structureGender diversityBoard businessStaggered boards

End Abstract

1.1 Introduction

The board of directors is made up of individuals who are elected according to the legal requirements to protect and preserve the interests of shareholders . It is therefore responsible for the company’s overall performance. Because of the crucial importance of its role within the company, the board of directors has been a prolific area of research during the last decades. Studies in this area have largely been motivated by the question of how corporate boards may affect firm performance . Several studies have attempted to assess the impact of various board characteristics on firm performance . However, the results from these studies are often not conclusive.

Moreover, one major problem confronting such field studies is that of endogeneity . In their review article, Roberts and Whited (2013) provide a number of techniques aimed at thwarting endogeneity concerns in corporate finance and argue that “endogeneity leads to biased and inconsistent parameter estimates that make reliable inference virtually impossible”. Indeed, while many empirical studies suggest that certain board characteristics are related to firm performance , most of these studies are inherently plagued with endogeneity issues. Nevertheless, a great deal of progress has been made in the last few years in order to overcome these issues (see, e.g., Wintoki et al. 2012).

This chapter provides a brief review of the theoretical and empirical literature on the relationship between the characteristics of boards of directors and firm performance . We propose to focus on board characteristics that have been most extensively studied, namely, board size, board independence , board leadership , gender diversity , board busyness and staggered boards .

1.2 Board Size

The size of corporate boards has received considerable attention from academic researchers over the past years. From a theoretical standpoint, two opposing views are held regarding the impact of board size on firm performance .

Some authors argue that larger boards may provide a wealth of knowledge and expertise to the firm, which may improve the firm’s performance (see, Dalton et al. 1999). Moreover, a larger number of directors on the board may also enhance the monitoring capacity of the board as well as the firm’s ability to establish external linkages (Goodstein et al. 1994).

However, many other authors suggest that as boards grow in size a number of problems arise, which can overshadow the potential benefits of having large corporate boards. For example, larger boards may suffer from both agency problems and coordination/communication problems (Lipton and Lorsch 1992; Jensen 1993). Indeed, directors are expected to be less likely to criticize top management policies and this problem is even more pronounced when the board size is large (Lipton and Lorsch 1992; Cheng 2008). Likewise, Jensen (1993) argues that when it exceeds seven or eight members, the board is less likely to function effectively and is easier to control by the chief executive officer (CEO). Also, according to the same author, larger boards are more likely to face coordination and communication problems because, as board size increases, it becomes more difficult to organize board meetings and to achieve a consensus, which may result in slower and less efficient decision-making. Furthermore, increasing the number of directors on the board may also exacerbate free-rider problems (Harris and Raviv 2008). That is, as a board becomes larger, incumbent directors view the importance of their contribution as being reduced and may consequently exert less effort in performing their duties.

An examination of the extant literature tells us that the vast majority of empirical studies in this area has documented an inverse relationship between board size and firm performance . The first empirical research that investigates this relationship was conducted by Yermack (1996) who studies a sample of 452 large US firms between 1984 and 1991. Using Tobin’s Q to approximate a company’s market valuation, he documents a negative association between board size and firm value . Similarly, Eisenberg et al. (1998) find, in a sample of approximately 900 small and medium-sized Finnish firms, that board size is negatively related to profitability. Conyon and Peck (1998) demonstrate that the negative effect of board size on firm performance also holds across a number of European countries including Denmark, France, Italy, the Netherlands, and the UK. Loderer and Peyer (2002) and Mak and Kusnadi (2005) also reveal an adverse board size effect for Swiss and Malaysian firms, respectively. De Andres et al. (2005) report similar findings in a sample of 450 non-financial firms located in 10 OECD countries. Moreover, focusing on a sample of 1252 US firms listed in the S&P 1500 index, Cheng (2008) provides evidence that the number of directors on the board is negatively related to the variability of monthly stock returns, annual return on assets and Tobin’s Q. Using a sample of almost 7000 small and medium-sized Danish companies, Bennedsen et al. (2008)’s results lend further support to the theoretical arguments advanced by Lipton and Lorsch (1992) and Jensen (1993), by showing a negative effect of board size on firm performance when boards get beyond six members. Also consistent with that, Guest (2009) finds a strong negative effect of board size on share returns in a sample of 2746 UK listed companies over the period 1981–2002. Likewise, Kumar and Singh (2013) analyze a sample of 176 Indian companies listed on the Bombay Stock Exchange over the period 2008–2009, and observe that the size of a firm’s board is negatively related to firm value .¹

In contrast to the above findings, few other studies report either positive or no effect of board size on firm performance . Using a sample comprised of the 348 largest publicly traded companies in Australia in 1996, Kiel and Nicholson (2003) show that the number of directors on the board is positively related to firm value . Similarly, Larmou and Vafeas (2010) investigate a sample of 257 US companies experiencing weak operating performance in 3 consecutive years ending between 1996 and 2000, and document a positive correlation between board size and firm value . More recently, Husted and de Sousa-Filho (2018) analyze a sample of 176 firms from four Latin American countries (Brazil, Chile, Columbia, and Mexico) over the period 2011–2014 and find that board size has a positive impact on ESG disclosure, which refers to corporate reporting on environmental, social and governance performance.

Wintoki et al. (2012) point out that an important concern that may plague empirical studies examining the relationship between boards and performance is that of endogeneity . According to these authors, the appropriate empirical model that should be used in order to alleviate endogeneity issues inherent in this type of investigation is a “dynamic” model of the following form:

Thus, using the Generalized Method of Moments (GMM) estimator in a panel of 6000 US companies from 1991 through 2003, Wintoki et al. (2012) document no causal relation between board size and firm performance .

1.3 Board Independence

It is widely acknowledged that monitoring and advising management on key decisions are the two primary functions of corporate boards. In the wake of corporate scandals that seriously undermined investor confidence, the effectiveness of boards in carrying out these functions, especially the monitoring function , has been called into question. In response, policy-makers throughout the world have introduced a range of codes aiming to improve corporate governance practices and revive investor confidence (e.g., the Sarbanes Oxley Act in the United States, the Cadbury Report in the UK and the Financial Security Law in France). The independence of corporate board...

Table of contents

• Cover
• Front Matter
• 1. The Impact of Corporate Board Characteristics on Firm Value: A Literature Survey
• 2. Determinants of Board Size, Composition and Leadership
• 3. The Monitoring and Advisory Functions of Corporate Boards
• 4. Director Compensation Incentives and Acquisition Outcomes
• Back Matter