The Effect of Board Size and Composition on Corporate Performance

Abstract

The modern corporation is characterized by the separation between shareholders, the owners of the company, and managers who control the assets and activities of the firm (Berle and Means, 1932). This separation implies the existence of conflicts of interests between managers and shareholders as managers may have the power to pursue their own objectives at the cost of shareholders. In order to lower the negative impact of managerial discretion on shareholders’ wealth, several devices are intended to control managerial actions. These devices include the market for corporate control (Jensen and Ruback, 1983), managerial compensation systems, based on incentives that tie managers’ wealth to corporate performance (Jensen and Murphy, 1990b) and the monitoring exercised by major shareholders (Shleifer and Vishny, 1986) and the Board of Directors (Fama, 1980; Baysinger and Butler, 1985). The Board of Directors is an internal governance mechanism, one of its functions being to control divergences between managerial and shareholders’ interests and to discipline managers who indulge in opportunistic behaviour. In this sense, the efficiency of the Board of Directors is crucial, especially, when the conflicts of interests between managers and equity holders are severe.