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The relation between board size and firm performance in firms with a history of poor operating performance

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Focusing on a sample of smaller firms with a history of poor operating performance, this paper posits that increases in board size will be associated with better share price performance. Notably, board sizes studied here are, on average, much smaller than those typically studied by prior research. Mostly consistent with predictions, board size is found to be positively correlated with firm value in between-firms tests, and changes in board size are found to be positively associated with annual stock returns. Last, event study results suggest that the market responds favorably to board size increases and unfavorably to large board size decreases. Together, these results identify a setting in which larger board sizes appear to be positively related to shareholder value.

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  1. See, for example, Byrd and Hickman (1992), Brickley et al. (1994), Cotter et al. (1997), and Field and Karpoff (2002) for studies conditioning the board-performance relation on a specific corporate decision, and Hermalin and Weisbach (1991), Yermack (1996), Bhagat and Black (1999), Adams and Mehran (2005), and Bebchuk and Cohen (2005) for studies linking boards to firm performance in a general day-to-day sense. Hermalin and Weisbach (2003) and Gillan (2006) provide an overview of this research.

  2. See Lipton and Lorsch (1992) and Jensen (1993) for a discussion on the costs and benefits of larger boards, and Yermack (1996), Eisenberg et al. (1998), and Boone et al. (2007) for related empirical evidence.

  3. See, for example, Gilson (1990), Vafeas (1999), Perry and Shivdasani (2005), and Srinivasan (2005) for the importance of boards when firms are in trouble.

  4. A negative relation between various measures of firm performance and board size, used as a control variable, is also found by Tufano and Sevick (1997), Core et al. (1999), Fich and Shivdasani (2006), and Graham and Narasimhan (2004), among others.

  5. Notably, adding outside directors to the board (Rosenstein and Wyatt, 1990) and, under certain conditions, adding insiders (Rosenstein and Wyatt 1997) is perceived positively by the market.

  6. For example, the average firm in this sample had a board comprising just over six members, only about half the size of the average board in Yermack (1996).

  7. See, for example, Himmelberg, Hubbard, and Palia (1999) and Coles et al. (2003).

  8. In a year-to-year sense, board sizes often remain unchanged. Denis and Sarin (1999) report that in a random sample of firms, board size remained the same in 60.7% of the years studied, the figure rising to 72.6% for boards comprising up to six directors. Denis and Sarin (1999) find that less than 13% of firm-years pertained to a change in board size of more than one.

  9. The sampling method used here is similar to Denis and Kruse (1999) who focus on large operating performance declines and track subsequent managerial discipline and corporate restructuring activity across active and less active takeover periods. Unlike this study, Denis and Kruse (1999) focus on operating performance changes for one year, impose a $100 million floor on asset value, and control for industry performance at the three-digit SIC.

  10. Somewhat differentiated from the conventional view that more outside directors are better, recent theoretical work by Raheja (2005) and Harris and Raviv (2008) shows there are tradeoffs in determining the proper mix between inside and outside directors on a board.

  11. Although there is not a one-to-one correspondence between board and committee meetings, separating the two measures does not alter in any way the results on board size in the tests presented throughout this paper.

  12. See Yermack (2004) for evidence on the importance of director incentive compensation, and Ferris et al. (2003) and Perry and Peyer (2005) on the importance of board seats.

  13. Another approach that has been used in the literature to address endogeneity is to model these relations in systems of equations. This approach is also unlikely to provide adequate remedy for this problem because it is very difficult to definitively eliminate the risk of firm-specific omitted correlated variables in the cross-sectional equations.

  14. The tests in Table 3 were repeated using market-adjusted return as the dependent variable, with substantially similar results. In further tests, board size is found to be positively, albeit weakly, related to one-year changes in accounting return on assets, and unrelated to long-term accounting performance.

  15. All public announcements concerning each sample firm over the sample period that were published in the Wall Street Journal were identified. The search attempted to ascertain the extent to which director turnover was publicly announced prior to a firm’s electronic filing with the SEC, given that director changes could have been impounded on stock prices before the proxy filing date. No announcements of director appointments or departures were identified. The search identified three announcements of CEO appointments and one announcement of a CEO departure over this period.

  16. Yermack (1996) finds negative returns for 6 large board size increases and positive returns for 4 large board size decreases. Differences in results between this study and Yermack (1996), beyond sample size differences, most likely result from the larger board sizes in the Yermack sample.

  17. DeFond et al. (2005) find that the market reaction to director appointments to the board also depends on a director’s accounting financial expertise. Also, Agrawal and Knoeber (2001) find that certain firms benefit from the employment of politically useful directors.

  18. A total of 95 (93) directors join (leave) the audit committee and 23 (30) directors join (leave) the nominating committee. Also, 43 (56) members of financial institutions join (leave) the board, and 40 (43) other financial executives join (leave) the board. These differences are statistically insignificant.


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Funding for this project was provided by the University of Cyprus Research Committee.

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Correspondence to Nikos Vafeas.

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Larmou, S., Vafeas, N. The relation between board size and firm performance in firms with a history of poor operating performance. J Manag Gov 14, 61–85 (2010).

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