Friday, 26 March 2010: 14:30
Board Composition and Firm Performance: Some Canadian Evidence
Abstract
This study examines the relationships between firm financial performance and a variety of characteristics of the boards of directors of the largest one hundred (by revenues) Canadian public firms for the years 2005, 2006, and 2007. Following Fiegener, Nielsen and Sisson’s study of the U.S banking industry (American Business Review, 1988) the present study distinguishes between board involvement and board effectiveness. With regard to board involvement, the study focuses on the impact of outside director representation on the board together with the level of equity ownership of directors. Inasmuch as indicators of board involvement are not sufficient to explain the impacts of boards on performance, measures of the effectiveness of boards are also considered. In particular, the tenure characteristics of outside directors and their relationships to performance are examined. These include the average length of tenure of the outside directors, the degree of tenure heterogeneity of the outside directors and the (hypothesized) eventual diminution of the positive impact of tenure length on financial performance.
The study finds that both the number and proportion of outside directors are positively and significantly related to financial performance, measured as both return on assets and return on shareholder’s equity. After controlling for outside director involvement, outside director tenure is also found to be correlated with performance. At the same time, the relationship is found to follow an inverted parabola. This suggests that the benefits of accumulated learning and power eventually begin to diminish as tenure increases. As well, long-serving outside directors may become entrenched and difficult to dislodge even when the firm is not performing well.
The relationship between the heterogeneity of outside director tenure and financial performance is less clear. On its own, the heterogeneity coefficient is positive and highly significant, but, once other variables are introduced, the heterogeneity turns negative and, in some cases, significantly so. This suggests that heterogeneity is a proxy for some other variables.
Taken together, the findings of this study offer mixed conclusions concerning board replacement. One finding argues that corporate boards should avoid policies that foster frequent director turnover, and should, instead, try to retain effective board members. At the same time, the benefits of the accumulated learning and experience of outside directors eventually begins to diminish. As for the importance of tenure heterogeneity, the results are inconclusive. Inasmuch as a negative relationship with performance is indicated when other variables are considered, they do not support the replacement of some outside directors to make the board cognitively more diverse.
Abstract
This study examines the relationships between firm financial performance and a variety of characteristics of the boards of directors of the largest one hundred (by revenues) Canadian public firms for the years 2005, 2006, and 2007. Following Fiegener, Nielsen and Sisson’s study of the U.S banking industry (American Business Review, 1988) the present study distinguishes between board involvement and board effectiveness. With regard to board involvement, the study focuses on the impact of outside director representation on the board together with the level of equity ownership of directors. Inasmuch as indicators of board involvement are not sufficient to explain the impacts of boards on performance, measures of the effectiveness of boards are also considered. In particular, the tenure characteristics of outside directors and their relationships to performance are examined. These include the average length of tenure of the outside directors, the degree of tenure heterogeneity of the outside directors and the (hypothesized) eventual diminution of the positive impact of tenure length on financial performance.
The study finds that both the number and proportion of outside directors are positively and significantly related to financial performance, measured as both return on assets and return on shareholder’s equity. After controlling for outside director involvement, outside director tenure is also found to be correlated with performance. At the same time, the relationship is found to follow an inverted parabola. This suggests that the benefits of accumulated learning and power eventually begin to diminish as tenure increases. As well, long-serving outside directors may become entrenched and difficult to dislodge even when the firm is not performing well.
The relationship between the heterogeneity of outside director tenure and financial performance is less clear. On its own, the heterogeneity coefficient is positive and highly significant, but, once other variables are introduced, the heterogeneity turns negative and, in some cases, significantly so. This suggests that heterogeneity is a proxy for some other variables.
Taken together, the findings of this study offer mixed conclusions concerning board replacement. One finding argues that corporate boards should avoid policies that foster frequent director turnover, and should, instead, try to retain effective board members. At the same time, the benefits of the accumulated learning and experience of outside directors eventually begins to diminish. As for the importance of tenure heterogeneity, the results are inconclusive. Inasmuch as a negative relationship with performance is indicated when other variables are considered, they do not support the replacement of some outside directors to make the board cognitively more diverse.