Determinants and consequences of board size: conditional indirect effects

• Published date: 05 February 2018
• Pages: 165-184
• DOI: https://doi.org/10.1108/CG-01-2016-0011
• Date: 05 February 2018
• Author: Muhammad Ali
• Subject Matter: Strategy,Corporate governance

Determinants and consequences of board

size: conditional indirect effects

Muhammad Ali

Abstract

Purpose –Board size is an importantdimension of corporate governance.The purpose of this study is to

propose and testindirect effects of organization size on organizationalperformance via board size, in the

contextof industry.

Design/methodology/approach –The study’s predictions were tested in 288 medium and large

organizationslisted on the Australian Securities Exchangeusing archival data.

Findings –The findings of this study suggest the following: organization size is positively

associated with board size and this relationship is stronger in manufacturing organizations; board

size is positively associated with performance and this relationship is conditional on industry; and

organization size has an indirect effect on performance via board size, and this indirect eff ect is also

conditional on industry.

Research limitations/implications –The results provide some support for theresource dependency

theory,agency theory and contingency theory.

Practical implications –The findings suggest that directors should take into account the effects of

board sizeand industry to provide a more precise assessment of the board’sperformance.

Originality/value –It predicts and tests thepioneering moderating effect of industry (manufacturing vs

services) on the organization size–board size, boardsize–organizational performance and organization

size–boardsize–organizational performancerelationships.

Keywords Performance, Industry, Board size, Organization size

Paper type Research paper

Introduction

Corporate governance refers to “the framework of rules, relationships, systems and

processes within and by which authority is exercised and controlled in corporations”

(Owen, 2003, p. 33). The relationships involve board of directors, management,

shareholders and other stakeholders (Department of Social Services, 2010). A

company’s board of directors is an important player in the corporate governance

framework, being primarily responsible for safeguarding the interests of the company

and its shareholders (Australian Institute of Company Directors, 2013). Good corporate

governance cannot be overemphasized for a number of reasons, including the fact that

companies compete with each other for limited financial resources such as investors’

capital (Corporate Governance Council, 2014). Both the push factors (e.g. stricter

corporate regulations like the US Sarbanes Oxley Act 2002) and pull factors (e.g. the

recent global financial crisis and corporate collapses such as HIH insurance group and

Enron) have further highlighted the importance of good corporate governance (Kimber

et al.,2005). The Australian Securities Exchange (ASX) has put forward 8 overarching

principles and 28 specific recommendations that cover a wide range of corporate

governance rules, relationships, systems and processes. The second principle involves

structuring boards to add value, including the dimensions of size, composition and

skills (Australian Securities Exchange, 2012).

Muhammad Ali is Senior

Lecturer at the QUT

Business School,

Queensland University of

Technology, Brisbane,

Australia.

Received 14 January 2016

Revised 9 August 2017

Accepted 18 August 2017

DOI 10.1108/CG-01-2016-0011 VOL. 18 NO. 1, 2018, pp. 165-184, © Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 165

Given the significance of board size as a dimension of corporate governance, a body of

literature has investigated the determinants and consequences of board size, with more

interest shown in the latter (see meta analysis Daltonet al.,1999). The determinants studied

include organization size, organization age, growth opportunities, growth, diversification

and firm complexity (Boone et al.,2007;Coles et al.,2008;Lehn et al.,2009;Linck et al.,

2008). The consequences studied include corporate reputation (Musteen et al.,2010),

capital structure (Abor, 2007) and environmental reporting (Rao et al.,2012), but

predominantly focus on organizational performance using measures such as accounting-

and market-based financial performance measures (Adams et al.,2010;Adams and

Mehran, 2012;Kim et al.,2012). This body of literature provides conflicting findings: positive

impact on performance (Adams and Mehran, 2012;Aggarwal et al., 2012;Dalton et al.,

1999;Dwivedi and Jain, 2005;Ilhan Nas et al., 2016;Kalsie and Shrivastav, 2016;Kathuria

and Dash, 1999;Kiel and Nicholson, 2003;Kim et al.,2012;Larmou and Vafeas, 2010;

Mishra and Mohanty, 2014;Saibabaand Ansari, 2012;Sahu and Manna, 2013;Tanna et al.,

2011;Upadhyay 2008); negative impact on performance (Adams et al.,2010;Afrifa and

Tauringana, 2015;Bai, 2013;Bennedsen et al.,2008;Cheng, 2008;Cheng et al.,2008;

Chintrakarn et al.,2017;Conyon and Peck, 1998;Garg, 2007;Guest, 2009;Kumar and

Singh, 2013;Liang et al., 2013;Mak and Kusnadi, 2005;McIntyre et al.,2007;Mohapatra,

2017;Morekwa Nyamongo and Temesgen, 2013;Nguyen et al., 2016;Pathan and Faff,

2013;Pathan et al., 2007;Shakir, 2008;Ujunwa, 2012); U-shaped impact on performance

(Coles et al.,2008); inverted U-shaped impact on performance (Hartarska and Nadolnyak,

2012;Titova and Titova, 2016;Xie and Fukumoto, 2013); more complex curvilinear impact

on performance (Mayur and Saravanan, 2017); and non-significant impact on performance

(Beiner et al.,2004;Darko et al., 2016;Rodriguez-Fernandez et al.,2014;Farhan et al.,

2017;Yammeesri and Kanthi Herath, 2010).Inconclusive findings have encouraged tests of

moderating effects on the board size–organizational performance relationship (Johns,

2006). Some of the moderating variables studied are: CEO duality (Elsayed, 2011),

organization size (O’Connell and Cramer, 2010), complexity/advising needs (Coles et al.,

2008), for-profit/not-for-profit status (Bai, 2013), organizational form (Adams et al.,2010),

politically connected directors (Menozzi et al., 2012), pre-global financial crisis/post-global

financial crisis and market power (Pathan and Faff, 2013). Moreover, scholars suggest

testing sophisticated models (Murphy and McIntyre, 2007), especially when the past

findings have been inconsistent (vanKnippenberg et al.,2011).

This study advances our knowledgeof determinants and consequences of board size in the

following ways. First, it predicts and tests a positive relationship between organization size

and board size (Oba et al.,2014). Second, it predicts and tests a positive relationship

between board size and organizational performance based on the resource dependency

theory (Pfeffer, 1972) and agency theory (Eisenhard, 1989). Third, it predicts and tests the

moderating effect of industry (manufacturing vs services) on the organization size–board

size and board size–organizational performance relationships, based on contingency

theory (Galbraith, 1973). Industry is an important determinant of various dimensions of

corporate governance, including certain regulations (Lawrence and Stapledon, 1999).

Thus, this study takes Zona et al.’s (2013) recommendation of focusing on contingent

effects a step further by proposing and testing the conditional effects at two stages:

organization size–board sizeand board size–organizational performance. Fourth, the paper

presents and tests indirect effect of organization size on organizational performance via

board size, and how this effect is conditional on industry (Figure 1). These predictions were

tested in 288 medium and large companies listed on the ASX with a one-year time lag

between organization size (Year 2011) and organizational performance (Year 2012). Past

research has not tested these indirect and conditional effects. Thus, this study responds to

Dalton and Dalton’s (2005) call for empirical evidence for best corporate governance

practices by testing determinantsand consequences of board size.

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