A Theory of Board Control and Size

We extend the traditional view of corporate boards as monitors to include a role for outside board members as suppliers of expertise or information. Indeed, both outsiders and insiders may have private information relevant to the decision. Because of the agency problem between managers and owners (who are assumed to be represented by the outside directors), neither party will communicate his or her information fully to the other. Outsiders in our model control agency problems by making some decisions themselves. When they do, the refusal of insiders to communicate their information fully becomes costly. Therefore, shareholders can sometimes be better off by having boards controlled by insiders. We characterize whether the board is optimally controlled by insiders or outsiders, the optimal number of outsiders, and resulting profits as functions of the importance of insiders’ and outsiders’ information, the extent of agency problems, and some other factors. This leads to an endogenous relationship between profits and the number of outside directors that furthers our understanding of some documented empirical regularities.

[1]  Philip H. Dybvig,et al.  Consensus in Diverse Corporate Boards , 2006 .

[2]  Chester Spatt.  Executive Compensation and Contracting , 2006 .

[3]  Anup Agrawal,et al.  Corporate Governance and Accounting Scandals* , 2005, The Journal of Law and Economics.

[4]  Charu G. Raheja,et al.  Determinants of Board Size and Composition: A Theory of Corporate Boards , 2005, Journal of Financial and Quantitative Analysis.

[5]  Yaniv Grinstein,et al.  The Role of the Board of Directors in the Capital Budgeting Process - Evidence from S&P 500 Firms , 2004 .

[6]  Eliezer M. Fich,et al.  Are Busy Boards Effective Monitors? , 2004 .

[7]  R. Romano,et al.  The Sarbanes-Oxley Act and the Making of Quack Corporate Governance , 2004 .

[8]  Samuel H. Szewczyk,et al.  Board Composition and Corporate Fraud , 2004 .

[9]  J. Graham,et al.  Corporate Survival and Managerial Experiences During the Great Depression , 2004 .

[10]  Xia Chen.  Agency Problems and Conflicts of Interest in Financial Intermediaries , 2004 .

[11]  N. Persico.  Committee Design with Endogenous Information , 2004 .

[12]  Daniel Ferreira,et al.  A Theory of Friendly Boards , 2007 .

[13]  Stuart L. Gillan,et al.  Boards of Directors, Audit Committees, and the Information Content of Earnings , 2003 .

[14]  Andrew J. Felo,et al.  Audit Committee Characteristics and the Perceived Quality of Financial Reporting: An Empirical Analysis , 2003 .

[15]  M. C. Jensen,et al.  The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems , 1993, A Theory of the Firm.

[16]  M. Harris,et al.  Allocation of Decision-Making Authority , 2005 .

[17]  Peter J. DaDalt,et al.  Earnings Management and Corporate Governance: The Roles of the Board and the Audit Committee , 2001 .

[18]  David Yermack,et al.  Remuneration, Retention, and Reputation Incentives for Outside Directors , 2002 .

[19]  J. Bedard,et al.  Corporate Governance and Earnings Management , 2001 .

[20]  Wouter Dessein.  Authority and Communication in Organizations , 2002 .

[21]  April Klein,et al.  Audit Committee, Board of Director Characteristics, and Earnings Management , 2002 .

[22]  Ann B. Gillette,et al.  Corporate Board Composition, Protocols, and Voting Behavior: Experimental Evidence , 2002 .

[23]  Renée B. Adams.  The Dual Role of Corporate Boards as Advisors and Monitors of Management: Theory and Evidence , 2000 .

[24]  Benjamin E. Hermalin,et al.  Boards of Directors as an Endogenously Determined Institution: A Survey of the Economic Literature , 2000 .

[25]  M. Beasley.  An Empirical Analysis of the Relation between Board of Director Composition and Financial Statement Fraud , 1998 .

[26]  Martin T. Wells,et al.  Larger board size and decreasing firm value in small firms 1 We wish to thank Asiakastieto Oy for fu , 1998 .

[27]  Vincent A. Warther.  Board effectiveness and board dissent: A model of the board's relationship to management and shareholders , 1998 .

[28]  D. Yermack,et al.  CEO Involvement in the Selection of New Board Members: An Empirical Analysis , 1998 .

[29]  Sanjai Bhagat,et al.  The Uncertain Relationship between Board Composition and Firm Performance , 1997 .

[30]  J. Tirole,et al.  Formal and Real Authority in Organizations , 1997, Journal of Political Economy.

[31]  Benjamin E. Hermalin,et al.  Endogenously Chosen Boards of Directors and Their Monitoring of the CEO , 1998 .

[32]  D. Yermack.  Higher market valuation of companies with a small board of directors , 1996 .

[33]  R. Romano.  Corporate Law and Corporate Governance , 1996 .

[34]  Hamid Mehran,et al.  Executive compensation structure, ownership, and firm performance , 1995 .

[35]  D. Hirshleifer,et al.  Managerial performance, boards of directors and takeover bidding , 1994 .

[36]  Jay W. Lorsch,et al.  A Modest Proposal for Improved Corporate Governance , 1992 .

[37]  Benjamin E. Hermalin,et al.  The Effects of Board Composition and Direct Incentives on Firm Performance , 1991 .

[38]  Stuart Rosenstein,et al.  Outside directors, board independence, and shareholder wealth☆ , 1990 .

[39]  Benjamin E. Hermalin,et al.  The Determinants of Board Composition , 1988 .

[40]  J. Sobel,et al.  STRATEGIC INFORMATION TRANSMISSION , 1982 .