Corporate Governance Structural Attributes of the Board of Directors

Corporate Governance: Attributes of the Board of Directors

Board Size

Finding an optimal number of directors to sit on the board of a company is not an easy job in corporate governance. Generally speaking, both large boards and small boards have advantages and disadvantages. Large boards provide the diversity that can bring greater specialization to the board. However, this comes at a cost. Large boards increase compensation and agency costs. They also bring in communication and decision-making problems. Small boards, on the other hand, give better coordination between board members, but fewer ideas and skills among directors. Consequently, there is a trade-off between diversity and coordination when it comes to choosing between small and large boards.

Many studies have found that there is a relationship between board size and firm performance over the years. Nevertheless, the results are mixed. Some articles showed that the relationship between board size and firm performance is negative. In other words, those articles believed as board size gets bigger, firm performance goes down. For example, Yermack (1996) discovered that as board size goes up, Tobin’s Q as an estimate of market valuation goes down. Jensen (1993) concluded that companies should have a relatively small board to be effective in their monitoring. On the contrary, there were also studies in favor of large boards. The relationship between board size and firm performance is likely to be influenced by other factors, such as complexity. Complex firms might benefit from large boards (Coles, Daniel, and Naveen, 2008). In addition, Rechner and Dalton (1991) stated that stronger performance is connected with large boards. Finally, Connelly and Limpaphayom (2004) indicated that there is no correlation between board size and firm performance. As can be seen clearly, the findings are somewhat inconclusive. There have also been studies trying to determine the optimal board size. Lipton and Lorsch (1992) suggested that the number of directors should not exceed 10. Jensen (1993) proposed that the optimal number of directors should be 8.

It is noteworthy that firm performance also affects board size in corporate governance. When a company does not perform well, studies have concluded that preferences of the current board directors decide whether board size should increase or decrease. Tri-Valley Growers, which was a leading food processor in the US, raised the number of its directors from 11 to 13 when the company went through a restructuring in the 1990s after a period of bad performance. Conversely, Rice Growers Association, which was another company in the same industry, reduced the number of its directors from 25 to 15 to deal with the company’s financial crisis in 1986.

To conclude, the optimal number of directors sitting on the board of a company should depend on the company conditions. For small and medium-sized firms, board size should be small enough so that they can get the most out of board directors without having to pay the directors a fortune. On average, firms with annual revenues of $10 million or less have seven directors. For complex firms that have operations in different industries or countries, adding more directors with the right knowledge and expertise to the board will bring more benefits than the additional costs. On average, big firms with annual revenues of more than $10 million have 11 directors. Board size also depends on industry-specific. Adams and Mehran (2003) found that firms that are held by financial institutions have a larger board than firms in the manufacturing industry. Discovering the right number of directors is a trade-off between the advantages of having sufficient expertise and the additional costs of communication and compensation.

Corporate Governance: Board Diversity

Diversity on board of directors has attracted increasing attention in recent years. Spencer Stuart reported that the number of women sitting on the board in S&P 500 companies increased from 16% in 2004 to 19% in 2014, and the proportion of minorities has been 5% for the last couple of years. As in the case of board size, board diversity can bring both advantages and disadvantages. Diversity boards have access to a full pool of skills and knowledge. Furthermore, diversity also helps the board avoid groupthink problem and promote healthy debate. Having said that, diversity boards also bring some disadvantages to companies. First of all, women and minorities are often lack of managing experience. The primary way to become a board director is to have experience as a CEO of a corporation. Women and minorities have far less representation in top executive positions. According to, women only accounted for 3.5% of CEOs in Fortune 1000, and only 4.6% of CEOs in Fortune 500 are minorities. As a result, women and minorities often don’t have enough experience and knowledge when selected as board directors. In addition, the opinions of women and minorities are less likely to be heard equally because of tokenism. This creates information-sharing and communication problems.

With all the strengths and weaknesses of diversity boards in corporate governance, it’s not surprising that studies on this subject have provided mixed results. Luckerath-Rovers (2013) found that companies with high proportions of women and minorities performed better than those with lower proportions by 53% in ROE, 42% in ROS, and 66% in ROIC. Another study by Credit Suisse Research Institute in 2012 stated that the share price performance of companies that had annual revenues greater than $10 billion with female-male boards was 26% higher than comparable companies that had only male on their boards. On the contrary, Adams and Ferreira (2009) discovered a negative relationship between gender diversity and both ROA and Tobin’s Q. Hussein and Kiwia (2009) found no correlation between Tobin’s Q and female boards.

Given the benefits and drawbacks that diversity boards bring to companies, one should neither overestimate nor underestimate the role of diversity. In order to solve the problems that diversity may have on board, appropriate strategies need to be implemented on both individual and legal level. For individual strategies, mentoring and networking programs or leadership workshops should be held frequently to assist qualified applicants in choosing their career paths, improving their skills, building their resumes, and promoting them to corporate boards. The focus is to enhance the qualifications of women and minorities.

For legal strategies, the government should demand transparency around the process of searching for women and minority candidates. The government also needs to raise resources for anti-discrimination laws. If the government decided to impose quotas on board membership, consideration should be seriously taken as quotas can bring some problems, as in the case of Norway. Ditmar (2010) argued that an increasing number of Norwegian women had done little in improving firm performance. The shortage of qualified women has created the ‘golden skirts’ problem in Norway. Imposing quotas just simply translates into a rising number of unqualified directors. Researchers have introduced ‘comply-or-explain’ to address the problems of imposing quotas. Companies that are not able to meet the required proportions of women and minorities have to give reasons for the lower rates in their financial reports. More efforts need to be made in order for board diversity to progress further.

Corporate Governance: Board with Busy Directors

As with other board attributes in corporate governance, busy directors bring both benefits and drawbacks to the board. According to a survey by Equilar in 2013, the percentage of directors who serve on more than two boards is 15.3%, and that of more than three boards is 4.5%. While it is true that busy directors have less time to focus on one single board, one should not underestimate the benefits they bring to the firm. Busy directors are often talented and reputable directors. Because they are more experienced and more qualified directors, the demand for them is higher. It’s not surprising that they are busy. Furthermore, busy directors have broader social and professional connections, which can be beneficial to firms in many aspects. The question is whether the costs of recruiting busy directors are worth the benefits they bring.

Existing studies provided mixed results. Field, Lowry, and Mkrtchyan (2013) revealed that busy directors are linked with higher company valuations among IPO companies because they give better advisory services than other directors. Fama and Jensen (1983) suggested that busy directors are viewed as a certification of directors’ capabilities. On the contrary, Fich and Shivdasani (2006) stated that busy directors are connected with lower market-to-book ratios. Core, Holthausen, and Larcker (1999) concluded that excessive CEO pay and higher attendance issues at board meetings are connected with busy directors. Overall, the studies against multiple directorships found that busy directors are less productive when serving as monitors and advisers.

Despite the inconsistent results of empirical evidence, companies and shareholders tend to have a negative view of busy directors. A survey conducted in 2014 presented that the percentage of S&P 500 companies putting a restriction on the number of busy directors increased from 27% in 2006 to 74% in 2014. At the same time, the Institutional Shareholder Services (ISS) also suggests limitations on the number of busy directors.

The relationship between busy directors and firm performance is associated with the dual role of monitoring and advising in corporate governance. Busy directors are more effective in their advisory role because of their talents and experience but ineffective in their monitoring role because of their lack of time and dedication. Whether or not busy directors can bring benefits to a firm depends on what type of firm it is. For newly public firms, their managers have little experience in communicating with shareholders, analyzing market conditions as well as dealing with media. Board directors who can give valuable advice are really important. Busy directors, who have a lot of experience with those issues, can bring more benefits than costs for these firms. Besides, managers in newly public firms may own a high percentage of shares. It means their interests are likely to align with those of shareholders. The fact that busy directors have less time for their monitoring role is not really important for those companies. As it happens, the percentage of busy directors in IPO firms is 45%, and nearly half of IPO firms have busy directors (Field, Lowry, and Mkrtchyan, 2013). This proves that busy directors are beneficial to IPO firms. In contrast, busy directors may not be as helpful to mature firms as they are to IPO firms. For mature firms, independent directors and the board are already busy, adding more busy directors makes the problem worse. Nevertheless, some mature firms may have high growth opportunities and low agency problems. The benefits of busy directors of these firms may still outweigh the costs.

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