Firm size and the effectiveness of busy boards in an emerging economy
Introduction
It is well known that developing countries suffer from underdeveloped to nonexistent infrastructure that severely limits the efficiency of their corporate sectors. For India in particular, Gopalan, Nanda, and Seru (2007), Khanna and Yafeh (2007), Khanna and Palepu, 2000, Khanna and Palepu, 2010, and Khanna and Rivkin (2001) have highlighted the absence of adequately functioning institutions, which, in turn, creates unique challenges to firms both large and small involving significant corruption at all levels, legacy-style bureaucracy inherited from the British, and underdeveloped supply chain and transport systems (see Doh, Rodrigues, Saka-Helmhout, and Makhija, 2017), among other problems. Such “institutional voids” suggest that Indian firms have to be especially resourceful in creating pseudo environments to overcome them and flourish.
We argue that firms can compensate for the lack of infrastructure by appointing “resourceful” independent directors with diverse skills in networking, law, accounting, supply chains, and the like. Such directors, who are in high demand and may serve multiple corporate boards as independent directors, are known as “busy” directors.1 Our main intuition is that the collective skills of such busy independent directors would be more useful to smaller firms than to larger ones,2 and this usefulness should be reflected in the relation between board busyness and firm performance. We reason that, given the institutional void, most or all public firms operating in India survive and flourish by creating their own infrastructure or ecosystem. However, while large firms have the financial muscle and political influence to create a multidimensional ecosystem, small firms are more constrained, so the expertise of their independent directors matters more to them. For instance, Cullen and Parboteeah (2013) report that relatively small Indian firms, such as Arvind Mills Limited, Subex Systems, and Zen Tech, possess limited resources and experience to tackle the inefficiencies resulting from a lack of infrastructure at an institutional level.3 Additionally, Indian regulators and industry practitioners have recently acknowledged that small Indian firms tend to have weak corporate governance and scant resources, making them particularly vulnerable to the vicissitudes of market forces.4
Specifically, we hypothesize a significantly positive relationship between board busyness (a proxy for the diversity of board member skills) and firm performance for small Indian firms and an insignificant relationship for large firms. We further hypothesize that, as firms grow over time, the relationship between firm performance and board busyness should diminish in significance. Put differently, the addition of a busy independent director should matter more for small Indian firms and less for large firms.
We test these ideas using a comprehensive data set of Indian firms that were publicly traded in the Bombay Stock Exchange (BSE) over an eight-year period from 2006 through 2013. Measuring size through market capitalization, we classify the 100 largest firms as large and the rest as small. We check our findings with multiple endogeneity tests (3SLS, GMM, and propensity score matching methods) and with alternative measures of board busyness and firm performance. To the best of our knowledge, this paper is the first to explicitly address the role that firm size plays in the relation between board busyness and performance in a developing economy and could well serve as a template of what might actually be happening in other emerging economies around the globe.
The remainder of the paper proceeds as follows. Section 2 discusses relevant literature that helps to build our hypotheses. The data sources and variables are described in Section 3. Section 4 presents the main results of our study. Section 5 addresses causation and endogeneity issues. Section 6 presents our concluding remarks.
Section snippets
Background and hypotheses
There has been much debate about the role of outside directors of the firm and the multiple directorships such directors hold. Earlier studies suggest that boards of directors can efficiently monitor an organization and that busyness can importantly signal a director's reputation (Fama, 1980). Fama and Jensen (1983) argue that outside directors have an incentive to develop a reputation as efficient monitors of the firm (see also Bhagat, Brickley, & Coles, 1987; Gibbs, 1993). Similarly, Ferris,
Data and variables
We use two main sources of data for our empirical analyses. Our first data source is the Center for Monitoring the Indian Economy's (CMIE) Prowess, which provides annual financial data on publicly traded Indian firms. Our sample consists of all the firms that are listed on the Bombay Stock Exchange (BSE) with available financial and market information: a median of 1836 (average of 1842) firms over the years of our sample period (2006–2013). As director-level information is sparse before 2006,
Summary statistics
In Table 1, Panel A reports the descriptive statistics for our overall sample; Panel B distinguishes between busy and nonbusy firms. Each board member in our dataset is classified as independent (outsider) or nonindependent (insider). Panel A shows that 23% of the outside directors are busy, and that the average board for Indian firms has about nine board members, half of whom are outsiders. Outside directors hold about two board seats, and on average 20.3% of firms have busy boards. In a given
Random effects, 3SLS, and GMM tests
To ensure that our findings and conclusions are not driven by unobserved heterogeneity across firms or underlying potential endogeneity among firm performance, board busyness, and board size in our overall sample, we control for unobserved heterogeneity by estimating a random effects model with standard errors clustered by firm, and for endogeneity by using both a three-stage least squares (3SLS) model and a GMM approach. Black et al. (2020) argue that very few corporate governance studies meet
Conclusion
In sum, we find that for small Indian firms the relationship between busy boards and firm performance is positive and statistically significant, while for large firms the same relationship is nonexistent. We further show that among firms that grow from relatively small to large over our sample period, the relationship is positive and significant when the firms are small but disappears when the same firms become large towards the end of our sample period. Collectively, our results suggest that
Funding
This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors. The usual disclaimer applies.
Authorship statement
All persons who meet authorship criteria are listed as authors, and all authors certify that they have participated sufficiently in the work to take public responsibility for the content, including participation in the concept, design, analysis, writing, or revision of the manuscript. Furthermore, each author certifies that this material or similar material has not been and will not be submitted to or published in any other publication. The following authors contributed equally to this work.
Declaration of Competing Interest
None.
Acknowledgements
This paper benefitted hugely from comments by Nick (Nhut) Nguyen. We also thank Renee Adams, Atif Ikram, and John McConnell for helpful suggestions. We thank the seminar participants at the 2016 Conference on the Developments in Financial Institutions, Governance and Misconduct, organized by the Schulich School of Business at York University, and especially the discussant, Blake Phillips, for his comments. We also thank seminar participants at the Financial Management Association's 2016 annual
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