Boards attributes that increase firm risk – evidence from the UK

Author:Sudha Mathew, Salma Ibrahim, Stuart Archbold
Publication Date:04 Apr 2016
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.
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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