The board of directors and firm performance: empirical evidence from listed companies

DOIhttps://doi.org/10.1108/CG-06-2018-0211
Pages508-551
Published date28 March 2019
Date28 March 2019
AuthorAlessandro Merendino,Rob Melville
Subject MatterStrategy
The board of directors and f‌irm
performance: empirical evidence
from listed companies
Alessandro Merendino and Rob Melville
Abstract
Purpose This study aims to reconcile some of the conflicting results in prior studies of the board
structurefirm performance relationship and to evaluate the effectiveness and applicability of agency
theory in the specificcontext of Italian corporate governancepractice.
Design/methodology/approach This researchapplies a dynamic generalised method of moments on
a sample of Italian listed companies over the period 2003-2015. Proxies for corporate governance
mechanisms are the board size, the level of board independence, ownership structure, shareholder
agreementsand CEOchairman leadership.
Findings While directors elected by minority shareholders are not able to impact performance,
independent directors do have a non-linear effect on performance. Board size has a positive effect on
firm performancefor lower levels of board size. Ownershipstructure per se and shareholder agreements
do not affect firmperformance.
Research limitations/implications This paper contributes to the literature on agency theory by
reconciling some of the conflicting resultsinherent in the board structureperformance relationship.
Firm performance is not necessarily improved by having a high number of independent directors on
the board. Ownership structure and composition do not affect firm performance; therefore,greater
monitoring provided by concentrated ownership does not necessarily lead to stronger firm
performance.
Practical implications This paper suggests that Italian corporate governance law should
improve the rules and effectiveness of minority directors by analysing whether they are able to
impede the main shareholders to expropriate private benefits on the expenses of the minority. The
legislator should not impose any restrictive regulations withregard to CEO duality, as the influence
of CEO duality on performance may vary with respect to the unique characteristics of each
company.
Originality/value The results enrich the understanding of the applicability of agency theory in listed
companies, especiallyin Italy. Additionally, this paper provides a comprehensive synthesis of research
evidenceof agency theory studies.
Keywords Italy, Corporate governance, Board of directors, Agency theory, Company performance,
Listed companies
Paper type Research paper
Introduction
The active role in company affairs that boardsof directors play (Judge and Reinhardt, 1997;
Coles et al.,2001) can provide a platform (Aluchna, 2010) and an essential mechanism for
mitigating the agency problem thatarises between shareholders and management (Jensen
and Meckling, 1976;Monks and Minow, 2004). Given that boards are responsible for the
direction and leadership of their enterprises, it seems reasonable to conclude that directors
actively influence firm performance (Dalton et al., 1999;Stiles and Taylor, 2001), and that
they are therefore responsible (on behalf of shareholders) for deciding on the types of
Alessandro Merendino is
based at the Centre for
Business in Society, Faculty
of Business, Environment
and Society, Coventry
University Faculty of
Business Environment and
Society, Coventry, West
Midlands, UK. Rob Melville
is based at Cass Business
School, London, UK.
Received 27 June 2018
Revised 25 October 2018
Accepted 17 December 2018
PAGE 508 jCORPORATE GOVERNANCE jVOL. 19 NO. 3 2019, pp. 508-551, ©Emerald Publishing Limited, ISSN 1472-0701 DOI 10.1108/CG-06-2018-0211
board structure that may enable them to maximise shareholders’ wealth (O’Connell and
Cramer, 2010;Knauer et al., 2018).
For many years, the major theoretical context of corporate governance research has been
agency theory (Seal, 2006), and the method for evaluating the relationship between board
features and firm performancehas typically been return on assets. Furthermore,the majority
of agency theory studies are based on quantitative methodologies and analyse
AngloAmerican listed companies (Yermak, 1996; Dalton et al.,1998;Raheja, 2005);
emerging and developing markets(Ehikioya, 2009); and selected European countries, such
as Spain, Germany and France (De Andres and Vallelado, 2008;Donadelli et al., 2014;
Bottenberg et al.,2017). Little attention is paid to the case of Italy, in spite of its place as a
large European economy with a corporate governance model that presents some features
in common with two archetypes in the existing literature: the AngloSaxon and
GermanJapanese models. However, the Italian model has some distinctive characteristics
which differentiate it from the two main corporate governance models. These include
ownership concentration; the limited role of financial markets; and the prevalence of family-
owned listed companies. Therefore, it is important to understand whether and how
corporate governance mechanisms affect the performance of Italian listed companies, as
these mechanisms are the main drivers of corporate governance best practice in Europe
(Melis and Zattoni, 2017).
Additionally, prior research on the performance of Italian companies (Melis, 2000;D’Onza,
Greco and Ferramosca, 2014;Allegrini and Greco, 2013;Zona, 2014) has identified some
conflicting results regarding the impact on firm performance of a range of board
characteristics, including the board structure, the role of independent directors, the CEO
leadership and ownership concentration,. For instance, Di Pietra et al. (2008) found no
relationship between the board size and performance, whereas Romano and Guerrini
(2014) found a positive relationship, especially in the water utility sector. Research on CEO
duality (whether the CEO simultaneously serves as board chairman [CM]) also appears to
generate ambiguous results in the Italian context. In particular, CEO duality has negative
effects (Allegrini and Greco, 2013) or positive effects (Zona, 2014) or no significant effects
on performance (Fratini and Tettamanzi, 2015) . As a consequence, it is still unclear if and
how the assumptions of agency theory are verified in the Italian context. Therefore, this
research seeks to reconcile some of the conflicting findings in prior studies of the board
structure/firm performance relationship and to evaluate the effectiveness and applicability
of agency theory in the specific context of Italian corporate governance practice. In
particular, this study measures and quantifies the relationship between the board of
directors’ structure and the performance of Italian firms listed on the STAR segment of the
Italian stock exchange over the period 2003-2015. We take into account those aspects
which are considered to be fundamental to agency theory (Jensen, 1993): board size,
independent directors, CEO/CM duality (when the CEO acts simultaneously as chairman)
and ownership. This research resolves the contrasting results of previous studies by finding
a non-linear relationship between independent directors and firm performance; a positive
effect of board size on firm performance only for lower number of directors; and a lack of
influence of directors appointedby minority shareholders on performance.
The paper proceeds as follows: theory and hypotheses development are explain ed in Section
2. Section 3 addresses the Italian context and the research design. The core findings from the
empirical study are outlined in Section 4. Section 5 discusses our conclusions.
Theory and hypothesis development
The impact of board size on firm performance
The board of directors is considered to be oneof the primary internal corporate governance
mechanisms (Brennan, 2006;Aguilera et al.,2015). A well-established board with an
VOL. 19 NO. 3 2019 jCORPORATE GOVERNANCE jPAGE 509
optimum number of directors should monitor management effectively (Bhimani, 2009) and
drive value enhancement for shareholders (Brennan, 2006). The board size, therefore, is a
key factor that influences firm performance (Kumar and Singh, 2013). The board of
directors, acting on behalf of shareholders, plays a central role as an internal mechanism
and is viewed as a major decision-making body within companies. Different and opposing
theoretical evidence is presented to support the efficacy of both large and small board
dimensions on firm performance. A minor stream of researchadvocates that a larger board
size could improve the efficacy of the decision-making process because of information
sharing (Lehn et al., 2009). A larger board can take advantage of greater potential variety,
with directors being appointed from diverse professional fields, with different expertise and
different skills (Pearce and Zahra, 1992). Against this, supporters of the mainstream of
agency theory (Jensen, 1993;Einsenberg et al., 2008;de Andres et al.,2005) suggest that
a larger board is less effective in enhancing corporate performance because new ideas
and opinions are less likely to be expressed in a large pool of directors, and the monitoring
process is likely to be less effective (Kamran et al., 2006;Dalton et al., 1999).Larger boards
increase the problems of communication and coordination (Jensen, 1993;Bonn, Yoshikawa
and Phan, 2004;Cheng, 2008) and higher agency costs (Lipton and Lorsch, 1992;Cheng,
2008). Furthermore, larger boards could face problems of greater levels of conflict
(Goodstein et al., 1994) and lower group cohesion (Evans and Dion, 1991). Poor
coordination among directors leads to slow decision-making and delays in information
transfer, as well as inefficiencies in firms with larger board size (Goodstein et al., 1994). In
fact, several empirical studies confirm that when board size increases, firm performance
decreases progressively (Mak and Kusnadi, 2005;O’Connell and Cramer, 2010). For
instance, Conyon and Peck (1998) find a negative association between board size and
return on equity (ROE) fora sample of European companies.
Table I outlines the empirical research conducted at an international level. We, therefore,
define H1 as:
H1. There is a negative relationship between the boardsize and firm performance.
The impact of independent directors on firm performance
While it is clear that all directors, whether executive (those who hold positions within the
enterprise) or nonexecutive (those who are appointed from outside), should be treated
equally in terms of their board responsibilities, a crucial role of the latter is to ensure that the
interests of all shareholders are protected.A further distinction may be made between those
who act as nonexecutive directors (NEDs) on behalf of specific investors and shareholder
groups and those who might be defined as independent directors and have no affiliation
with the firm except for their directorship (Clifford and Evans, 1997). The role of both NEDs
and independent directors is to monitor management decisions and activities by corporate
boards and to ensure that the executive is held to account. (Fama, 1980) This implies that
they are highly responsive to investors, because they have to ensure that management
decisions are made in the best interests of shareholders. Independent directorsare reliable
instruments of their companies in terms of monitoring the management while remaining
independent of the firm and its CEO (Daily et al.,1998). This role has been seen as a vital
element in corporate governance codes and guidance since the earliest publications, and
the role and duties of independent members of a board are clearly defined in corporate
governance codes from all parts of the world and for all sizesof enterprise[1].
Only a fraction of empirical agency theory research finds a negative relationship (Kuma r and
Singh, 2013)ornorelationship(Bhagat and Black, 2002) between the proportion of
independent directors and firm performance. On the other hand, the majority of empiri cal
(Brickley et al.,1994;Anderson et al.,2004) and theoretical (Beasley, 1996) agency
theory-focussed research suggests that independent directors have a positive effect on firm
PAGE 510 jCORPORATE GOVERNANCE jVOL. 19 NO. 3 2019

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