Board Structure and Survival of New Economy IPO Firms

• Published date: 01 March 2012
• Author: Gary Tian,Chandrasekhar Krishnamurti,Nongnit Chancharat
• Date: 01 March 2012
• DOI: http://doi.org/10.1111/j.1467-8683.2011.00906.x

Board Structure and Survival of New Economy

IPO Firms

Nongnit Chancharat, Chandrasekhar Krishnamurti* and Gary Tian

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This study examines the relevance of currently accepted best practice recommendations regard-

ing board structure on the survival likelihood of new economy initial public offering companies. We argue that industry

context determines governance outcomes.

Research Findings/Insights: We study 125 Australian new economy f‌irms listed between 1994 and 2002. Each f‌irm is

tracked until the end of 2007 for monitoring their survival. We f‌ind that board independence is associated with an increase

in the likelihood of corporate survival. We also f‌ind that the benef‌its of board independence increase at a decreasing rate.

Theoretical/Academic Implications: The standard best practice recommendation of board independence stems from the

monitoring role of directors and is based on agency theory. The results from our study suggest that the recommendation

regarding board independence does not work well for new economy f‌irms. While the agency theory based model implies

a monotonic relation between board independence and performance, our research suggests that the relationship is nonlin-

ear. This variation occurs because of increased monitoring costs faced by outsiders due to higher information asymmetry

and complexity of new economy f‌irms. Our empirical results suggest that inside directors play a complementary role to

outsiders in mitigating f‌irm failure.

Practitioner/Policy Implications: Our research offers insights to policy makers who are interested in setting best practice

standards regarding board structure. Our research suggests that f‌irm/industry characteristics play a crucial role in deter-

mining the optimal board structure. In f‌irms/industries where outsiders face signif‌icantly higher information processing

costs, insiders can play a valuable complementary role to outsiders in enhancing the effectiveness of the board. Thus future

hard or soft regulations related to board structure should consider industry context.

Keywords: Corporate Governance, Board Structure, Survival Analysis, New Economy Firms, Informational Asymmetry

INTRODUCTION

One consequence of the high prof‌ile corporate collapse

of f‌irms such as Enron and WorldCom due to corpo-

rate governance failures is the move by regulators to con-

verge to a single model of corporate governance. Recent

regulations, such as the Sarbanes-Oxley Act of 2002 (SOX)

and rules promulgated by the Securities and ExchangeCom-

mission, New York Stock Exchange (NYSE), and National

Association of Securities Dealers (NASD), contained at their

core the independence of a majority of directors on the

board. Furthermore, calls for the separation of chief execu-

tive off‌icer (CEO) and chairperson positions became louder

following the spate of recent corporate scandals. Implicit in

this convergence to a single optimal structure for the board

is the assumption that one board structure should f‌it all

f‌irms.

Financial economists, such as Hermalin and Weisbach

(2003), Linck, Netter, and Yang (2008) and Coles, Daniel,

and Naveen (2008), have questioned the optimality of a

single board structure for all f‌irms. For instance, Faleye

(2007) suggests that a unif‌ied leadership structure is not

appropriate for all f‌irms because of differences in the

specif‌ic circumstances of individual organizations. Duchin,

Matsusaka, and Ozbas (2010) provide empirical support for

the view that outside directors are less effective in moni-

toring and providing advice when the cost of acquiring

information is high. Romano (2005) believes that undue

haste in imposing corporate governance convergence may

lead to “quack governance.”1In a study of the post-IPO

performance of young entrepreneurial f‌irms, Kroll, Walters,

*Address for correspondence: Chandrasekhar Krishnamurti, Accounting, Economics

and Finance, Faculty of Business, University of Southern Queensland, Toowoomba,

Qld 4350, Australia. Tel: 61-7-4631-2941; E-mail: chandrasekhar.krishnamurti@

usq.edu.au

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© 2012 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2011.00906.x

and Le (2007) recommend that a majority of board members

be insiders.

Another feature of the board that has attracted the atten-

tion of corporate governancescholars is the size of the board.

Lipton and Lorsch (1992) and Jensen (1993) suggest that

large boards could be less effective than small boards due to

coordination problems and director free-riding. Coles et al.

(2008) argue that complex f‌irms have greater advising

requirements. Since large boards potentially bring more

knowledge and experience and can therefore offer better

advice, they posit that complex f‌irms should havelarger and

more independent boards. Conversely, they posit that f‌irms,

for which f‌irm-specif‌ic knowledge of insiders is compara-

tively more critical, such as knowledge-intensive new

economy f‌irms, are likely to gain from greaterrepresentation

of insiders on the board.

Our contribution to this literature is based on two inno-

vative aspects of our study. First, we examine the board

structure of new economy f‌irms. By focusing on new

economy initial public offering (IPO) companies, we are

able to incorporate the role of f‌irm- and industry-specif‌ic

characteristics on the board structure. These f‌irms have

characteristics that are different from other f‌irms in several

respects. They tend to employ recently developed tech-

nology which is often not well proven. They tend to be

small f‌irms with high growth opportunities. A number of

researchers (Carlson, Fisher, & Giammarino, 2006; Gaver &

Gaver, 1993; Myers, 1977) posit that f‌irms with high growth

opportunities have more information asymmetry than f‌irms

whose value is mostly comprised of assets in place. Faleye

(2007) characterizes organizational complexity on the basis

of size, asset tangibility, and growth opportunities. Based on

asset tangibility and growth opportunities, new economy

IPO f‌irms can be considered as complex f‌irms. Therefore,

information acquisition costs are likely to be higher in new

economy f‌irms. Since the ability of directors to govern

the f‌irm well is contingent on having access to timely infor-

mation and the ability to process such information, we

believe that the board structure of new economy IPO f‌irms

should take organizational complexity and informational

asymmetry into account.

Second, our performance metric is survival likelihood

rather than traditional measures such as return on assets and

Tobin’s Q used by prior researchers. We focus on survival

rather than measures of performance such as Tobin’s Q for

the following two reasons. First, survival is the primary goal

of the f‌irm. As such, the relevance of appropriate board

structure is more crucial in the context of survival as

opposed to the performance of a f‌irm in a stable state. The

second reason for choosing survival is that it is an unam-

biguous measure of performance.

We develop testable hypotheses regarding optimal board

structure taking into account three unique characteristics of

new economy IPO f‌irms. These are (a) high information

processing costs of outsiders, (b) volatile business environ-

ment and (c) organizational complexity. We posit the follow-

ing hypotheses: (i) the impact of board independence on the

survival likelihood of new economy f‌irms will increase at a

decreasing rate; (ii) CEO duality will increase the survival

likelihood of new economy f‌irms; (iii) a board led by an

executive chairperson will have a higher likelihood of sur-

vival; and (iv) f‌irms with either small boards or large boards

will have a higher likelihood of survival as opposed to f‌irms

with medium-sized boards.

Our research adds further weight to the strand of litera-

ture that argues that industry context is a critical determi-

nant of governance outcomes (see, for instance, Lin, Yeh, &

Li, 2011). Our key insight, from this paper, is that currently

accepted best practice recommendations, which are derived

principally from an agency theory perspective, must be

modif‌ied in the context of new economy f‌irms in high veloc-

ity environments. Boards typically perform several key roles

such as monitoring, advising, resource provision, and con-

tracting. Currently advocated best practice recommenda-

tions stem from the monitoring role derived from an agency

theory perspective. We argue that in a specif‌ic industry

context, such as new economy f‌irms in the post-IPO stage,

some of the other roles besides monitoring are crucial in

ensuring survival.

We conduct our empirical tests on new economy IPO

f‌irms listed in Australia. Australia is chosen because it

follows the English common law tradition that is prevalent

in the US and UK. Also, Australia follows free market poli-

cies like the US. Furthermore, investment f‌lows (i.e., capital

raised by IPOs and secondary market issues) in Australia

are the third largest in the world – US$86.2 billion in 2009.2

In 2003, the Australian Stock Exchange released its Prin-

ciples of Good Corporate Governanceand Best Practice Rec-

ommendations that deal directly with board structure (ASX,

2003). The core recommendation ofASX is that a majority of

the board should be independent directors. In order to

avoid the impact of this exogenous event on board compo-

sition, we restrict our sample to new economy companies

listed on the Australian Stock Exchange between 1994 and

2002.

Sample f‌irms are tracked until December 31, 2007 to cat-

egorize them into companies that are currently trading and

those that are delisted. The Cox proportional hazards model

is then employed to identify the likelihood of survival of a

company after IPO. We conduct further analysis to see if the

same factors inf‌luence the different reasons for delisting –

takeovers and f‌inancialdistress – by applying the competing

risks Cox proportional hazards model. Our resultsshow that

the survival time of new economy IPO companies is posi-

tively related to board independence. But the benef‌its of

board independence increase at a decreasing rate. We also

f‌ind weak evidence indicating that companies with either

small board size or large board size are more likely to

survive than companies with medium-sized boards. In addi-

tion, company size and leverage are found to be negatively

related to new economy IPO f‌irms’ survival. We f‌ind that

CEO duality and independence of chairperson have no

impact on survival likelihood of new economy IPO f‌irms.

The remainder of the paper is organized as follows. First,

we review previous studies relating to corporate gover-

nance structure and IPO f‌irms’ survival and provide the

theoretical background for the development of hypotheses

and identif‌ication of control variables. Second, we present

the details of our data and the methodology. Third, we pre-

sent our empirical results and discuss their implications.

Finally, we offer our conclusions and discuss potential

future extensions.

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