Boards attributes that increase firm risk – evidence from the UK

• Published date: 04 April 2016
• Pages: 233-258
• Date: 04 April 2016
• DOI: https://doi.org/10.1108/CG-09-2015-0122
• Author: Sudha Mathew,Salma Ibrahim,Stuart Archbold
• Subject Matter: Strategy,Corporate governance

Boards attributes that increase firm

risk – evidence from the UK

Sudha Mathew, Salma Ibrahim and Stuart Archbold

Sudha Mathew is Senior

Lecturer at Department of

Accounting, Finance and

Governance, University of

Westminster, London, UK.

Salma Ibrahim is

Associate Professor at

the Kingston University,

London, UK.

Stuart Archbold is Retired

from the Department of

Finance, Accounting and

Informatics, Kingston

University, London, UK.

Abstract

Purpose –The purpose of this paper is to identify the board attributes that significantly increase firm

risk. The study aims to find whether board size, percentage of non-executive directors, women on the

board, a powerful chief executive officer, equity ownership amongst executive board directors and

institutional investor ownership are associated with firm risk. This is the first study that examines which

board attributes increase firm risk using a UK-based sample.

Design/methodology/approach –This empirical study collected secondary data from Bloomberg and

Morningstar databases. The data sample is an unbalanced panel of 260 companies’ secondary data on

FTSE 350 index in the UK, from 2005 to 2010. The data were statistically analysed using STATA.

Findings –The study establishes the board attributes that were significantly related to firm risk. The

results show that a board which can increase firm risk is one that is small in size, has high equity

ownership amongst executive board directors and has high institutional investor ownership.

Research limitations/implications –The governance culture and regulatory system in the UK is

different from other countries. As the data are a UK-based sample, the results can lack generalisability.

Practical implications –The results are useful for investors who invest in large firms, to have the

knowledge about the board attributes that can increase firm risk. Regulators can also use the results to

strengthen regulatory guidelines.

Originality/value –This study fills the gap in knowledge in UK governance literature on the board

attributes that can increase firm risk.

Keywords Board composition, Decision making, Firm risk, UK corporate governance

Paper type Research paper

1. Introduction

The financial fraud cases in the early 2000s in the USA as well as the geographically broader

financial crisis in 2008 fuelled the debate on risk management and the need to control risk. As

part of the regulatory reforms, the role of corporate governance and risk management has been

highlighted by the Financial Reporting Council (FRC) in the UK. It published a report on “Boards

and Risk”(

FRC, 2011) which outlines the responsibilities of boards of directors for “risk

decision-making”, determining “the company’s approach to risk, setting its culture, risk

identification, oversight of risk management and crisis management”. In the USA, corporate

governance reforms which form part of the Sarbanes–Oxley Act (2002) provide specific

guidance on internal control mechanisms and board attributes to improve corporate

accountability and reduce the risk of firm insolvency. This study contributes to the literature by

providing empirical-based findings on how board attributes may affect firm risk.

Corporate governance deals with identifying potential mechanisms by which shareholders of a

corporation exercise control over management such that their interests are protected. The

board of a firm is seen as an internal control mechanism to oversee the company and help

manage and control the risk facing the firm appropriately on behalf of the investors and

stakeholders (Davies, 2011). The board of directors not only advise and monitor managers but

make strategic decisions which have inherent risk involved. The ability of board members to

Received 14 September 2015

Revised 19 November 2015

23 November 2015

Accepted 24 November 2015

DOI 10.1108/CG-09-2015-0122 VOL. 16 NO. 2 2016, pp. 233-258, © Emerald Group Publishing Limited, ISSN 1472-0701 CORPORATE GOVERNANCE PAGE 233

provide valuable input and challenge decisions depends on the board composition. The

strategic advice is in the shareholders’ interest, and these decisions can have an effect on the

stability of the firm. Poor performance of the board in monitoring the management and inability

of giving strategic advice can lead to instability[1] in firm performance.

The Turnbull Report (2005) advocates UK directors of large firms to inform investors in the

annual reports about risks facing the firm and how it is being managed, making the topic of

risk-taking in corporations relevant to study. Previous literature on board composition has

mostly investigated the effect of board composition on firm performance[2] and only a few

US-based studies have examined the effect of some board attributes on firm risk (Cheng, 2008;

Pathan, 2009;Lewellyn and Muller-Kahle, 2012). As the governance framework and corporate

culture is different in the USA and UK (Franks and Mayer, 2002;Aguilera et al., 2006),

examining board composition in relation to risk-taking (consequently firm risk) using a UK

sample will be useful. Specifically, under the US governance framework, boards of directors

are important in disciplining management and takeovers initiated by blockholder shareholders

are common in poorly performing firms (Franks and Mayer, 2002). On the other hand, power to

enforce fiduciary duties of directors are weaker in the UK and disciplinary takeovers are not

common (Franks and Mayer, 2002). Furthermore, ownership is less dispersed in the UK and

shareholder engagement is higher than in the USA (Aguilera et al., 2006).

The aim of the paper is to find how board size, non-executive directors (NEDs), percentage

of women, powerful chief executive officers (CEOs), executive shareholders and

institutional investor ownership affect firm risk. It contributes to the UK governance literature

by empirically investigating the board attributes that can potentially increase firm risk. This

was done by analysing archival data of 260 large FTSE 350 firms between the years 2005

and 2010. An econometric model was developed which included the control variables of

growth opportunities, financial leverage, firm size and previous firm performance. To

analyse the empirical model, the most suitable estimation method for the panel data was

the generalised least squares random-effects method.

The results show that a board which is small in size has executive directors on the board who

hold a high proportion of firm equity and that has institutional investors with substantial

ownership, increases firm risk. A small board increases firm risk, and this result is consistent

with studies that have used a US-based data sample. This study also found that the presence

of a powerful CEO on the board is linked significantly and positively with one measure of risk,

asset return risk. This is the first study that examines the relation between equity ownership of

executives at board level as well as ownership by institutional investors in relation with firm risk,

and the results show a significant positive relationship. This study found that a higher

percentage of NEDs and presence of women on the board decreases firm risk, although this

relationship was not significant. This study contributes to both the board governance and risk

literature showing board composition measures that impact on firm risk.

The paper is organised as follows: Section 2 discusses the theoretical background for the

study and previous literature on board composition, leading to the hypotheses. Section 3

presents the methodology used for this study that includes information on the data sample;

the dependent, independent and control variables used; the empirical model and the

estimation method chosen. The findings are discussed in Section 4; Section 5 presents the

robustness tests, and finally, Section 6 summarises the findings.

2. Hypotheses development

Risk management in firms is not about continuous corporate risk reduction but about how firms

select the type of risk and the level of risk that is appropriate to them (Crouhy et al., 2006). In

essence, risk management and risk-taking are the “two sides of the same coin”. Successful

companies take risk in relation to the reward and manage the risk (Crouhy et al., 2006).

The board of directors in companies have three main roles which can have an impact on

risk-taking in the firm. These include strategic, monitoring and institutional roles (Stiles and

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