Board Composition and Performance in Indian Firms: A Comparison

(ProQuest: . denotes formulae omitted.)IntroductionFama and Jensen (1983) defined residual claimants as the ones who bear residual risk, i.e., the difference between stochastic inflows of resources and promised payment to agents. When the managers, who take decisions, are not the major residual claimants, and hence do not bear a major share of the financial effects of their decisions, agency problems arise.To address agency problems, internal, as well as external, corporate governance mechanisms have been put into place, like the board of directors, proxy fights, large shareholders, hostile takeovers and financial structure (Hart, 1995). The most important internal corporate governance mechanism is the board of directors (Subramanian and Swaminathan, 2008). The role of the board is not simply to fulfill its legal requirements. The board of directors of a company provides strategic guidance and leadership; objective judgment, independent of management, to the company; and exercises control over the company, while at all times remaining accountable to the shareholders. An effective corporate governance system is one which allows the board to perform these dual functions efficiently. However, shareholders do not escape agency problems by leaving them to the board of directors, since the directors are themselves agents, whose interests are not necessarily aligned with the shareholders (Hermalin and Weishbach, 1991). Although allowing management to choose their own overseers might lead to agency problems related to independent directors, nonetheless, there are many good reasons to believe that outside directors will exhibit some checks on the top managementThere are many widely studied board characteristics like board composition, which includes board size and the proportion of independent directors, board committees, as well as remuneration to the directors.Review of LiteratureBoard CompositionResearch works indicate that board composition plays a substantial role in corporate performance. Board composition refers to the number of directors (board size) and the type, as determined by the usual insider-outsider classification. Insiders are the current members of top management teams, and employees of the company or its subsidiaries. Outside directors have no such association, but are further classified into affiliated or non-affiliated (independent). Affiliated outsiders are not members of the current management, or employees of the company, but have some influential link with the firm, for example, as consultants. Non-affiliated outsiders are usually referred to as independent directors. These independent directors are recruited primarily because of their expertise, name, recognition and skills (Pearce and Zahra, 1992). Board SizeThere are different schools of thought when it comes to linking board size with corporate performance. One school of thought suggests a positive association between board size and firm performance. Proponents of this view (Pearce and Zahra, 1992; and Dalton et al., 1999) argue that, as board size increases, the strategic decision making capabilities of the board increases. This is due to the knowledge and intellect that is brought to the board by members coming from varied backgrounds. Golden and Zajac (2001) argued that smaller boards are assumed to have inadequate confidence and unclear understanding in making strategic changes.The counter view also prevails, which argues that larger boards are less effective than smaller boards. It is mainly based on group dynamics and social psychological research. When board size increases, the costs associated with it, like coordination cost and communication costs, also increase. (Raheja, 2005). As a result, the board becomes more of a symbol and less as a part of the management process (Hermalin and Weisbach, 1988). Many researches provide empirical evidence which supports the view that a negative relationship exists between board size and firm performance. …