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Introduction
A Board of Directors is an elected group of people on the corporate board representing the company’s shareholders. They make decisions as fiduciary on behalf of shareholders. The Corporate Board is a governing body that usually meets at regular intervals to discuss and set policies, goals for management and oversight of the corporation. They have a crucial role in corporate management, thus essentially the central means to run the company efficiently. Some of the board of directors’ major functions include hire and fire of senior executives, options policies, dividend policies and payouts, executive compensation, and set broad corporation broad goals and ensuring the corporate has well-managed and adequate resources at its disposal.
General Corporate Board Structure
The bylaws of a corporate ideally determine the general structure and powers of a corporate board. The corporation’s bylaws can set the board of directors, how the board members are elected, and how often the board meets. It is pertinent to mention that though there is no set number of board directors, most of the corporate board comprises 3 to 31 board members.
The board members should represent both shareholder interests and the management and simultaneously include both internal and external members.
An inside director is a board member who has the interest of employees, major shareholders, other personnel in mind and whose experience within the organization adds value to its operation. An inside director doesn’t usually get compensated for its role in board activities. They are often already a major shareholder, a C-level executive, or another stakeholder, such as a union representative. On the other hand, Independent or outside directors are not involved in the company’s day-to-day operations and get reimbursed in the form of additional pay for attending board meetings. The Outside directors bring an objective and independent view to goal-setting and settling disputes concerning the company.
Considering the independent role of some board members, it becomes critically important to strike a balance of board directors, including both internal and external board directors. Therefore, every public corporation must have a board of directors consisting of both inside and outside members.
Number of the board of directors
There is not straightjacket convenient formula for determining how many members should be on board of directors. However, in some jurisdiction, company law specifies a minimum and/or a maximum number of board directors for different company types. Few large corporations examples are: Swire Pacific Limited, a prominent Hong Kong conglomerate, has 18 board directors. Tesco plc, a large multinational supermarket company, and 13 board directors. On the other side, small listed companies are composed of fewer directors, usually ranging from six to eight persons.[1]
The board of directors is divided into main parts, namely Executive directors and non-executive directors. Executive directors are full-time employees of the company, having sets of duties and responsibilities. They work in a senior capacity on policy matters and functional business areas of major strategic importance. Large corporations tend to have executive directors who are majorly responsible for marketing, financing, and so on. Executive directors are usually recruited by the board and generally engage with the larger companies, generally under fixed-term contracts.
The Non-executive directors are not employees of the company, hence not involved in the day-to-day business activities. The majority of non-executive directors should be independent in their business, financial, and other commitments, other shareholdings and directorships, and involvement in any business in connection to the company.
The recognition of best practices suggests that a public company should have more non-executive directors than its executive directors.
Size of the Board
The corporate board’s size should comprise enough members to function properly, keeping conflict of interest of members at bay and should not be too cumbersome in the number that makes the company’s functioning less effective. While there is no universal agreement on the board members’ optimum size, many board of directors indeed becomes challenging for the company in terms of using their role effectively or having meaningful participation from such number.
According to the Corporate Library’s study, the average size of a board of directors is 9.2 members, and most corporate boards have 3 to 31 members. Expert analysts[2] think that the ideal size of the board is even.
Moreover, two critical board committees must be set up and the board members, having all independent members. The board committees are: i) The Compensation committee, and ii) The audit committee. The maximum number for each of the mentioned committee is three, meaning a minimum of six-board members should be on the board so that no member is on more than one committee. The number of boards and committees a board member is on is a significant consideration when judging a board member’s effectiveness. The reason behind is that a member having a double duty and responsibility in the board may compromise the key wall between the effective working of the audit and compensation.
So, it is better to avoid conflicts of interest at any cost because it is majorly possible that members serving on different boards may not devote the required adequate time towards fulfilling their duty.
The seventh member on the board of directors is the chairperson of the board. The chairperson of the corporate board has the responsibility to ensure the board’s proper functioning. The company’s CEO is fulfilling his/her duty and obligations, following the board’s directives. It is important to note that the probability of arising a conflict of interest is more if the CEO is also the board’s chairperson.
For some companies, staffing of additional committees such as nominating or governance committee for the board may necessarily take up additional members. Nonetheless, if it comprises more than nine-members, the board may make its size too big to function effectively.
Determinants of the size of the board of directors
The size of the board of directors stems from agency theory of corporate governance. Agency theory says that the board of directors is responsible for monitoring, supervising, and coordinating with the management. The size and structure of the board are central to keep a check on the management’s activity. The board fulfils their duties of advising and monitoring managers by choosing the board size and composition appropriately.
Several management scientists and sociologists argue that boards’ large size increases its diversity in terms of experience, gender, skill, nationality, and management style. Large board size has a fruitful diversity in improving the overall planning with different views, experienced opinions and skilled members, which result in the company’s superior performance.[3]
On the contrary, some also believe that large board size is less effective because of the supposed coordination and process problem in large team sizes; hence, fewer members are more effective.[4]
Raheja, 2005 examined that the idea that the ideal size of board and structure may vary with the firm’s characteristics, the same has to be answered by determining particular associations. Whether there is an association between the size of the board of directors and firm characteristics? The question can be answered in consideration of following four determinant factors[5]:
- Association between the size of the board of directors and firm’s size
- Association between the size of the board of directors and firm’s age
- Association between the size of the board of directors and the firm’s leverage ratio
- Association between the size of the board of directors and the firm’s performance
Size of the board of directors and firm’s size
There were different views about the association of the board of directors’ association with the firm’s size. One argument says that as the firm’s size increases, it facilitates an increase in external contracting relationship requirements, complexity and advising, operating in different product and geographical markets. This benefits the firm from extra monitoring by having more members on its board of directors. Moreover, for smaller firms’ success, the directors’ strategic guidance becomes essential to offset managers’ limited knowledge and experience. Essentially, there is no significant relationship between the board size and firm’s size, but the need for experienced board directors reflects in smaller firms.
Size of the board of directors and firm’s age
The younger firms are more likely to be concerned with resolving critical strategic issues for the first time, and managers in newer firms are less likely to engage in strategic planning. As a result, they may have less knowledge and experience in comparison to executives of older firms. The difference predominantly occurs because of the lack of organizational resources to younger firms, and here board of directors can play a major role in providing strategic management consultations to these firms to achieve a higher level of performance. Conversely, older firms’ management already has a structured mechanism and may less likely need the board in strategic influence.
Size of the board of directors and the firm’s leverage ratio
It is seen that larger boards put pressure on management to follow lower gearing levels, so it can be said that there is a negative relationship between the board size and leverage ratios.[6] However, it is also true that a larger board may find difficulty in arriving at a consensus in the decision-making process which can affect the quality of corporate governance and ultimately a higher financial leverage levels.
Size of the board of directors and the firm’s performance
Undoubtedly, there is a positive association between the size of board of directors and the firm’s performance or profitability. The argument is in line with the argument that large board size increases the board diversity, i.e. age, gender, nationality, skills, etc., which improves the company’s performance. A fewer number of board of directors yet sufficient in number results in the company’s superior performance compared to firms with crowded boards.
Conclusion
A board of directors’ composition and performance is a key indicator in the company’s functioning, particularly about the board’s responsibility towards the company’s shareholders. The number of board of directors in a company should not be too many and not too less to compromise the company’s effective operation. It is also necessary that there is a balance between the number of independent directors and inside directors on the board; otherwise, the board loses its credibility of reaching the set goals and objectives.
References:
[1] Corporate governance: the board of directors and standing committees, last assessed Jan 16th 2021, at file:///C:/Users/singhal/Downloads/sa_oct12-f1fab_governance.pdf.
[2] Adam Hayes, Investment Analyst, last assessed Jan 16th 2021, at https://www.investopedia.com/terms/a/analyst.asp.
[3] Alnaif, Khaled. (2014). “The Relationship between Corporate Governance and Bank’s Performance: Evidence from Arabian Countries.” INTCESS14- International Conference on Education and Social Eciences. OCERINT- International Organization Center of Academic Research. 3rd to 5th Feb 2014. Istanbul, turkey.
[4] Lipton, M., & J.W., Lorsch, (1992), “A Modest Proposal for Improved Corporate Governance”, Business Lawyer, vol. 48, 59-77.
[5] Raheja, Charu G., Determinants of Board Size and Composition: A Theory of Corporate Boards. Journal of Financial and Quantitative Analysis, Vol. 40, No. 2, pp. 283-306, June 2005, Available at SSRN: https://ssrn.com/abstract=522542 or http://dx.doi.org/10.2139/ssrn.522542.
[6] Hasan, Arshad, (2009), “Impact of Ownership Structure and Corporate Governance on Capital Structure of Pakistani Listed Companies”, International Journal of Business and Management Vol (4) (2).
