Dirk Jenter is a Professor of Finance at the London School of Economics and Political Science, Thomas Schmid is an Associate Professor of Finance at Hong Kong University, and Daniel Urban is an Assistant Professor of Finance at Erasmus University Rotterdam. This post is based on their recent paper.
Our study (Does Board Size Matter?) exploits a minimum board size requirement in Germany to show that excessively large boards of directors reduce firm performance and value. Boards play a crucial role in corporate governance, and regulators in many countries have tried to improve their effectiveness by discouraging large boards. The academic literature, however, provides little causal evidence on the effects of board size. Empirical studies, going back to at least Yermack (1996), have mostly found negative correlations between board size and firm performance. However, because large boards are a choice, and because this choice is likely to be correlated with other drivers of performance, these correlations are difficult to interpret.
German corporations have a two-tier board, with a management board that runs the firm and a supervisory board that hires, advises, and monitors the management board. Since 1976, the supervisory board’s legally mandated minimum size depends on the size of the firm – it is 12 directors for firms with 2,000 to 10,000 domestic employees (DE), 16 directors for 10,000 to 20,000 DE, and 20 directors above 20,000 DE. These requirements are binding for many firms: most firms just below 10,000 DE have exactly 12 directors, and most firms just above have exactly 16. This suggests that many firms just above this threshold would have chosen a smaller board if permitted, which allows us to test whether forcing them to adopt a larger one is harmful.
