The Uncertain Relationship between Board Composition and Firm Performance

Abstract

We survey the evidence on the relationship between board composition and firm performance. Boards of directors of American public companies that have a majority of independent directors behave differently, in a number of ways, than boards without such a majority. Some of these differences appear to increase firm value; others may decrease firm value. Overall, within the range of board compositions present today in large public companies, there is no convincing evidence that greater board independence correlates with greater firm profitability or faster growth. In particular, there is no empirical support for current proposals that firms should have "supermajority-independent boards" with only one or two inside directors. To the contrary, there is some evidence that firms with supermajority-independent boards are less profitable than other firms. This suggests that it may be useful for firms to have a moderate number of inside directors (say three to five on an average-sized eleven member board). We offer some possible explanations for these results, based on board dynamics, the informational advantages possessed by inside (and, often, affiliated) directors, and the value of interaction between different types of directors who bring different strengths to the board.

Note: An earlier version of this article was announced as Stanford Law School, Olin Law and Economics Working Paper No. 175; and Columbia Law School, Law and Economics Working Paper No. 137.

JEL Classification: G32, G34