Determinants of Board Size and Composition: A Theory of Corporate Boards

Journal of Financial and Quantitative Analysis, Vol. 40, No. 2, pp. 283-306, June 2005

40 Pages Posted: 31 Mar 2004  

Charu G. Raheja

Wake Forest University

Abstract

This paper models the interaction of firm insiders and outsiders on a corporate board and addresses the question of the ideal size and composition the board board. In the model, the board is responsible for monitoring projects and making CEO succession decisions. Inside directors are better informed regarding the quality of firm investment projects, but outsiders can use CEO succession to motivate insiders to reveal their superior information and help the board in implementing higher value projects. The optimal board structure is determined by the tradeoff between maximizing the incentive for insiders to reveal their private information, minimizing the cost to outsiders to verify projects, and maximizing outsiders' ability to reject inferior projects. I show that optimal board size and composition are a function of the directors' and firm's characteristics. I also develop testable implications for the cross-sectional variations in the optimal board structure across firms.

Keywords: Boards, insiders, outsiders, governance, monitoring

JEL Classification: G30, G34, G38

Suggested Citation

Raheja, Charu G., Determinants of Board Size and Composition: A Theory of Corporate Boards. Journal of Financial and Quantitative Analysis, Vol. 40, No. 2, pp. 283-306, June 2005. Available at SSRN: https://ssrn.com/abstract=522542 or http://dx.doi.org/10.2139/ssrn.522542

Charu G. Raheja (Contact Author)

Wake Forest University ( email )

P.O. Box 7659
Winston-Salem, NC 27109-7659
United States

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