Corporate Governance, Debt, and Investment Policy during the Great Depression

Abstract:     
We study a period of severe disequilibrium to investigate whether board characteristics are related to corporate debt, investment policy, and firm value. Before 1930 and after 1938, when many firms plausibly operated with optimal or near optimal governance structures, we find no relation between firm performance and board attributes. During the 1930-1938 Depression era, when the corporate sector was severely shocked by an unprecedented downturn, we document a relation between board characteristics and firm performance that varies in economically sensible ways: Complex firms (that would benefit from board advice) exhibit a positive relation between board size and firm value, and simple firms exhibit a negative relation between board size and firm value (consistent with any benefits of larger boards for simple firms being more than offset by increased costs). Simple firms with large boards also invest more (or shrink less) and use more debt (or reduce debt less) during the 1930s depression. We document similar effects for the number of outside directors on the board. The results are consistent with agency problems existing in simple firms with large boards during the Depression, and these firms not downsizing adequately in response to a severe economic contraction.

Keywords: Corporate Governance, Capital Structure, Investment Policy, Great Depression, Firm Stock Market Value

JEL Classifications: G31, G32, G34

Working Paper Series