Abstract
This study seeks to understand the relation between firm size and supervisory board composition. Specifically, we ask if and how firm size influences occupational and international background diversity in supervisory boards. Relying on resource dependence theory and theories of organizational behavior, we hypothesize that board diversity with respect to directors’ occupational background will increase with firm size, while the relation between firm size and board diversity with respect to directors’ international background will be concave. Using archival data for supervisory board members of 151 German firms listed in the German stock exchange indices DAX, MDAX, SDAX and TecDAX for the business year 2005, we find empirical support for our hypotheses: Both, occupational and international background diversity increase with increasing firm size, but international background diversity does so at decreasing rates.
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Notes
To the contrary, agency theory suggests a role of the board of directors that is distinctly different from the role highlighted by resource dependence theory. Agency theory emphasizes the separation of ownership and control in public corporations, arguing that the board’s role is to monitor and ratify management decisions in order to mitigate the conflict of interest between managers and shareholders (Fama and Jensen 1983; Jensen and Meckling 1976). In this context, the independence of a director from management is regarded as the key board member characteristic. Independent directors are asserted to be more objective in their assessment of management decisions and, therefore, more likely to protect the interests of shareholders. While directors might perform both roles, assigned by resource dependence theory and by agency theory, simultaneously (Johnson et al. 1996), resource dependence theory emphasizes director characteristics that are distinctly different from directors’ independence central to the agency perspective.
While resource dependence theory emphasizes the general benefits of board diversity, our subsequent argumentation will (1) provide theoretical reasoning for the alleged benefits and (2), in Sect. 2.2, also discuss potential costs of board diversity.
For example, when deciding about establishing and operating an organizational division to serve a new geographical market (i.e., firm size increases), the firm most likely needs to consider trade terms, labor laws, or accounting rules that apply to the new market. Accordingly, establishing (additional) links between directors and resource providers such as local suppliers, wholesalers, or retailers can be beneficial for firm performance.
Harrison and Klein (2007) argue that demographic diversity such as nationality can be conceptualized as separation, variety, or disparity, where the latter refers to differences among unit members in their possession of a valued resource. In the context of board diversity, we focus on separation and variety, neglecting issues of disparity that may result, e.g., from a director’s “job” in the boardroom (e.g., the chairman of the supervisory board). These jobs follow from the firm’s corporate governance and are not subject to shareholders’ decision.
For an overview of the benefits and costs of diversity see Horwitz and Horwitz (2007).
The widespread evidence on the relation between board diversity and firm performance suggests that the alleged benefits and costs of board diversity relate to different “settings” such as countries and types of corporate governance. For example, while Siciliano (1996), Hambrick et al. (1996), Erhardt et al. (2003), and Kang et al. (2007), among others, consider the relation between board composition and firm performance for firms in developed countries (i.e., US, UK, and Australia), Mahadeo et al. (2012) explore the relation between board composition and firm performance for firms from an emerging economy (i.e. Mauritius).
For example, non-German board members are most likely less familiar with the German two-tier system and, particularly, may struggle when dealing with employee representatives in the supervisory board.
In contrast, given the arguably lower costs of occupational background diversity relative to international background diversity and the difficulty to securing the access to the information provided by directors’ diverse occupational background via a separate organizational unit, we do not expect to observe a concave relation between firm size and occupational background diversity.
Both, the number and composition of employee representatives on German boards are highly regulated. First, concerning the number of employee representatives, smaller companies with less than 500 employees are not required to have employee representatives on the supervisory board, companies with an intermediate size of 500–2,000 employees have one third of its directors as employee representatives (One-Third Codetermination Act 2004—Drittelbeteiligungsgesetz). In companies with more than 2,000 employees half of the board consists of employee representatives (Codetermination Act 1976—Mitbestimmungsgesetz). Secondly, the composition of employee representatives on the supervisory board concerning the number of union representatives from outside the firm and employee representatives from inside the firm is highly regulated.
As our international background variable comprises only two categories (German versus non-German), the proportion of non-German board members represents an alternative measure of international background diversity which we used in a robustness check.
For the very same reason, within our robustness checks, we include occupational background diversity in our estimation of international background diversity and vice versa.
One company falls under the Steel & Coal Codetermination Act 1951. In the supervisory board of this company, shareholder representatives occupy 10 of the overall 21 seats. Since supervisory board members are roughly assigned equally by shareholders and employees and to simplify the analysis, we classify this company as being characterized by parity of shareholders and employee representatives.
As a company’s board size follows from the number of employees and the extent of codetermination and is further closely tied to our main explanatory variable firm size, including board size as a control variable would potentially result in a multi-collinearity problem. To rule out a potential bias of our parameter estimation, we opted to not include board size as a control variable in our baseline estimation, but we included it within our robustness checks.
To give an impression of what a Blau Index of 0.66 with respect to occupational background might look like, the following example might help: A supervisory board where “business experts” and “support specialists” each comprise half of the members of the board and where there are no “Insiders” and no “Community Influentials” would be characterized by a Blau Index of 0.66.
In the study, 1 billion EUR = 1,000,000,000 EUR. To obtain interpretable coefficients in our regressions, we scale firm market value and total assets by 1 trillion EUR = 1,000,000,000,000 EUR.
We tested for differences between the 117 companies entering the OLS regression and the 151 companies in our sample with respect to the dependent and explanatory variables used in the regressions. Differences, if any, were statistically insignificant.
We tested for differences between the 89 companies entering the TOBIT analysis and the 151 companies in our sample and found no statistically significant differences.
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We thank Roberto Di Pietra (the Editor) and three anonymous referees for helpful comments and suggestions.
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Arnegger, M., Hofmann, C., Pull, K. et al. Firm size and board diversity. J Manag Gov 18, 1109–1135 (2014). https://doi.org/10.1007/s10997-013-9273-6
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DOI: https://doi.org/10.1007/s10997-013-9273-6
Keywords
- Corporate governance
- Board composition
- Occupational background diversity
- International background diversity