Why Do Firms with Larger Boards Have Lower Market Values? Evidence from the Investment Behavior of Japanese Firms
36 Pages Posted: 18 Mar 2014
Date Written: December 1, 2013
We show that large boards are detrimental to the performance of Japanese firms. Unlike in the US, this effect is concealed by the fact that Japanese firms that have performed well are more likely to increase the size of their boards. Using an instrumental variable approach to address this endogeneity problem, we find that larger boards result in both lower market values and operating profits. One explanation for the negative effect on firm performance is that larger boards exhibit a greater propensity to overinvest and expand the firm’s balance sheet beyond its optimal scale. The evidence also shows that larger boards are less willing to undertake divestitures despite the potential value they might be able to extract from the sale of underutilized assets. Overall, board size appears to affect the firm’s ability to manage its assets in the most effective way. The adoption of US-style officers does not mitigate the negative board size-firm performance relationship.
Keywords: board size, performance, governance, investment decisions, asset growth, divestitures
JEL Classification: G31, G32, G34
Suggested Citation: Suggested Citation