IMPACT OF BOARD SIZE AND BOARD DIVERSITY ON FIRM VALUE: AUSTRALIAN EVIDENCE
3. Empirical Findings
3 See Yermack (1996) for a discussion of the chairman and CEO duality and Lang and Stuz (1994) for empirical evidence on industrial diversification
marginal benefits. Therefore it is reasonable to expect that the relationship between board size and firm value is non-monotonic. We test for the possibility of a non-linear relationship by employing a quadratic term. Specifically, we run the following regression:
Second, the relationship between firm value and board gender diversity is tested by running the following equations:
WOMDIR is measured as a dummy variable equaling to unity if a company has a woman director and a continuous variable indicating the percentage of woman directors on the board. Y is a vector of explanatory variables which include BOARDSIZE, OUTDIRPER, DUALITY, CAPEX, INDSEG, ROA, LNTA, EXEOP and EXESH. Z is also a vector of explanatory variables which include BOARDSIZE, OUTDIRPER, DUALITY, ROA and LNTA. The definitions of these variables are the same as above.
Carter et el (2003) and Prevost, et el (2002) argue that corporate governance research that attempt to establish a relationship between firm value and board composition may suffer from endogeneity problem where one or more variables on the right hand side are correlated with the disturbance term. This situation may arise if there are endogenously determined variables on the right hand side of the equation. To correct for this biasness and inconsistency of the OLS estimators, two-stage least squared (2SLS) can be used. Our OLS estimators, however, do not appear to be affected by endogeneity as our OLS results are highly similar to 2SLS results although the coefficients of the WOMDIR variables are more economically significant in 2SLS results. We therefore choose to report OLS results.
3. Empirical Findings
a. Descriptive Statistics
In Table 1, we report the descriptive statistics of the board of directors for our sample firm. On average, an Australian listed corporation has a board of director that comprises of 6.3 directors, of which 0.31 (4.52%) is woman and 1.71 (28.34%) are directors who concurrently hold a full time executive position with the company. The median value of board size (median = 6) suggests that the distribution of the number of directors is fairly normal. The largest board has 17 members while the smallest one has a mere 3 directors. The highest number of women directors on the board is 3 while a majority of firms have a board of directors that are made up of entirely males. The mean value of the
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chairman/executive duality variable is 0.1617 which means that 16.17% of the firms have a non-independent chairman. Directors are approximately 55 years old and on average they hold 2.33% of options and 18.22% of shares relative to the total number of shares outstanding. Our descriptive statistics highlight the institutional difference between US and Australian corporation. Yermack (1996) reports that the mean board size of his Forbes magazine sample is 12.25 while Fortune 1000 firms have a mean board size of 10.98 (Carter et el 2003).
Our statistics are however similar to that obtained from New Zealand. According to Prevost et al (2002), the mean number of directors for a sample of firms listed on the New Zealand Stock Exchange is 6.6 with a min of 2 and a max of 14. While differing in size, board composition of US and Australian firms appear to be fairly similar: 36% of inside directors reported by Yermack (1996) and 26.2% by Carter et el (2003).
A comparison of board characteristics and firm characteristics of boards with no women directors and boards with women directors is presented in Table 2. Boards with women directors, in general, are larger which makes intuitive sense as a larger board is more likely to have a woman director on it.
Boards without women directors, however, are characterized by a higher incidence of chairman and executive duality, a higher percentage of directors’
option and equity ownership and a larger proportion of inside directors compared to boards with female directors. The existing literature suggests that boards of directors where the chairman is also the CEO and the number of inside directors is significant tend to be less effective in controlling agency behaviors of executive officers. Boards with and without woman directors, however, are not distinguishable from each other with respect to the average age of directors.
In terms of financial characteristics, firms with women directors have a statistically higher ROA ratio suggesting that profitable firms are more likely to appoint a female director. Female directors are also more likely to be appointed in larger firms that are more industrially diversified (operate in more industry segments). Nevertheless, these univariate analyses do not reveal any differences between boards with and without woman directors with respect to firm value as measured by the Tobin’s Q ratio and future growth opportunities as proxied by capital expenditure.
In Table 3, we report the board size and gender diversity statistics according to industry sector as classified by the Australian Stock Exchange (ASX).
We observe that on average utilities firms have largest boards (mean = 7.75) while firms in the Information Technology industry sector have smallest boards (mean = 5.67). In terms of gender balance, the Health Care industry sector has the highest number of women directors (mean =0.52). In relative terms, the Heath Care industry also has the
highest score for women directors with approximately 8% of the board being female members. On the other hand, women are least likely to be appointed as directors in the Materials industry (mean percentage = 2.96%).
b. Board size and firm market value
Regression results of Equation [1] are presented in Column (1) of Table 4. According to the results, there is no significant relationship between firm market value and board size. We argue above that the residual relationship between firm value and board size depends on the interactive strength of two opposing factors: the marginal benefits of an extra director’s skills, experience and expertise and the marginal cost arising from potential conflicts and slower decision making. The strengths of these two forces may vary as the number of directors changes.
Therefore, the initial insignificant relationship between board size and firm value does not necessarily mean that board size has no impact on firm value. The lack of a significant relationship is more likely to be attributable to non-linearity.
Consistent with our expectation, the results of Equation [2], which are presented in Column (2) of Table 4, indicate that the relationship between firm value and the number of directors on the board is non linear. As the coefficient of the main variable BOARDSIZE is negative and the coefficient on the quadratic term is positive, it appears that firm value takes on a V shape as board size increases. While both the linear and quadric coefficients are statistically significant at the 1% level, economically, the coefficient on the linear term far overpowers the coefficient on the quadric term. As a result, the cutoff number of directors (the benchmark number of directors above which an increase in board size will result in an increase in firm value) appears to be so large that it is unrealistic in practice to pursue a value enhancing strategy by increasing board size.
For instance, other things being equal, our estimation shows that the board needs to comprise of at least 26 members for any subsequent member appointment to add value. Given the largest board in our sample only consists of 17 directors, we conclude that for our sample firms an increase in board size hurts firm value. The marginal cost of adding one extra director appears to be greatest when board size increase from 4 to 5, after that the decline in firm value takes place at a decreasing rate as board size increases. Our findings indicate that despite differences in board size between the US and Australia, in both countries larger boards are associated with a lower firm value.
Contrary to the common belief that an additional director appointment to a small board will add value, our results show that in all instances the cost of communication and coordinating the decision making process of a large number of directors outweigh the benefit that additional directors bring.
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Our regression results also show that the presence of woman directors is associated with higher firm value. We will endeavor to examine this relationship in more detail in the next section. Consistent with Lawrence and Stapledon (1999) we fail to find a significant correlation between the percentage of outside directors and firm value. Australian firms are neither valued more highly when they have more outside directors on the board nor when the chairman of the board is separate from a full time executive officer. Contrary to our prediction that growth opportunities are related to higher firm value, we find no such significant relationship. Industrial diversification, on the other hand, hurts firm value as theorized by Lang and Stulz (1994). In particular, as a company operates in one more industry segment, Tobin’s Q declines by 0.0936 which is equivalent to a 4.93% reduction in firm value based on the mean Tobin’s Q of 1.8999. The results also support the notion that more profitable firms have higher market value while, other things being equal, the market values smaller firms more highly than larger firms.
Despite the belief that option and stock compensation should align directors’ interest with that of shareholders and result in a higher firm value, we find no evidence that directors’ option and equity holdings have a positive impact on firm value.
c. Board gender diversity and firm value
The case for a positive relationship between board diversity and firm value has recently emerged and thus the body of empirical knowledge in this field is relatively limited. Board diversity, however, is believed to benefit corporations for the following reasons.4 First, diversity allows a better understanding of the marketplace; the more diverse the market place, the more diversity is expected to add value in a corporate context. Second, diversity is associated with creativity and innovation. Third, diversity produces more effective problem-solving.
Fourth, diversity enhances the effectiveness of corporate leadership and finally diversity promotes more effective global relationships. In this paper, we only examine the value enhancing property of one diversity aspect – gender diversity. In particular, we test the hypothesis that firms with women directors on the board (dummy variable) and firms with more women directors on the board (continuous variable) are associated with higher firm value. The results of our regression on the inter-relationship between firm value and gender diversity are reported in Table 5.
First, it is observed that firms with women directors are associated with higher market value. The coefficient is both statistically and economically
4 These propositions are provided by Cox and Blake (1991) and Robinson and Dechant (1997) and recited by Carter, Simkins and Simpson (2003). The propositions provided by Cox and Blake (1991) and Robinson and Dechant (1997) are in the context of corporate diversity but they have implications for board diversity.
significant. On average, if two firms are similar in every aspect, the firm with woman directors has a Tobin’s Q which is 0.7149 higher than that of a firm with all male directors. Hence, it appears that a market value premium exists for the appointment of female directors. Using a continuous variable to proxy for the presence of women on board of directors, we also find that not only the incidence of woman directors is associated with higher market value but the proportion of women directors relative to men directors also adds value. In particular, as the number of women directors increases by 1, Tobin’s Q increases by 0.0360, an increase of 1.89% in firm value. Our findings suggest that women play an essential role in maintaining the effectiveness of a board of directors.
In the 2nd and 4th columns of Table 5 we report the results of regressions where the dependent variable are a dummy variable and the percentage of women directors on the board respectively. We find that Tobin’s Q is positively related to both the incidence of woman director appointment and the proportion of them on the board. This result further supports the view that board gender diversity and firm value are positively related to each other. We are also able to draw conclusions about the factors that determine the appointment of women directors and the number of them on the board. It appears that a firm is more likely to have a female director if it is larger and has a bigger board. The findings are consistent with our expectation that larger firms are more likely to have larger boards and hence more likely to have a woman director. Not only are firm size and board size important in determining the appointment of women directors, they also play a crucial role in determining the number of women directors on the board. Generally, a firm is more likely to have a larger percentage of woman director representation if it is larger and has a bigger board of directors. Our overall results suggest that board diversity leads to an increase in firm value and the appointment of female directors is a practice that should be encouraged in the corporate world.
4. Conclusion
In this paper we address the issue of whether characteristics of a board of directors are instrumental in promoting shareholders’ wealth in a sample of Australian publicly listed companies.
Specifically, we examine the impact of board size and board gender diversity on firm value. Using a simple Tobin’s Q as a measure of firm market value, we find that larger boards are generally value destructive as the costs of resolving conflicts and coordinating communication flows and decision making significantly outweigh the benefit of having an additional director. Gender balance in the board of directors, on the other hand, is associated with higher market value. Firms with woman directors are
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rewarded with a value premium and the higher the proportion of women directors, the higher the firm value. The implication of our findings is shareholders’ value is best preserved when board size are small and partly represented by female directors.
References
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‘Corporate governance and the board of directors: Performance effects of changes in board compositions’, Journal of Law, Economics and Organization, 1, 101-124.
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2003, ‘Corporate Governance, Board Diversity and Firm Value’, The Financial Review, 38, pp.
33-53.
4. Cox, T.H. and Blake, S. 1991, ‘Managing cultural diversity: Implications for organizational competitiveness’, Academy of Management Executive, 5, 45-46.
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7. Lang, L. and Stulz, R. 1994, ‘Tobin’s Q, corporate diversification and firm performance’, Journal of Political Economy, 102, 1248-1280.
8. Lawrence, J. and Stapledon, G.P. 1999, ‘Is board composition important? A study of listed Australia companies’, University of Melbourne working paper.
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Evidence form the East Asian financial crisis’, Journal of Finance, 58, 1445-1468
10. Lewellen, W. and Badrinath, S. 1997, ‘On the measurement of Tobin’s Q’, Journal of Financial Economics, 44, 77-122.
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“Management ownership and market valuation:
an empirical analysis’, Journal of Financial Economics, 27, 259-612.
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13. Prevost, A.K. Rao, R.P. and Hosssain, M. 2002,
‘Determinants of board composition in New Zealand: a simultaneous equations approach’, Journal of Empirical Finance, 9, 373-397.
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17. Yermack, D. 1996, ‘Higher market valuation of companies with small board of directors’, Journal of Financial Economics, 40, 185-211.
Appendices
Table 1. Descriptive Statistics of Board of Directors
This table details the statistics of the boards of director for our sample firm. The number of directors and number of woman directors are gathered from the individual firms’ financial reports as of reporting date. Chairman and executive duality is a dummy variable equaling unity if the chairman holds an executive position in the firm. Executive options (shares) are measured as the numbers of options (shares) held by directors scaled by the total number of shares outstanding. An insider director is defined as a director who holds a full time executive position with the firm. The remaining directors are classified as outside directors. Average age is the mean age of all directors.
Mean Median Maximum Minimum SD Observations
Number of directors 6.2993 6.0000 17.0000 3.0000 2.1380 832 Number of woman directors 0.3153 0.0000 3.0000 0.0000 0.5518 793
% of woman directors 4.5234 0.0000 50.000 0.0000 8.5109 793 Chairman and executive duality 0.1617 0.0000 1.0000 0.0000 0.3684 810 Executive options 2.2329 0.3719 66.5369 0.0000 8.6876 830 Executive shares 18.1191 7.0039 94.7946 0.0000 22.9613 830 Number of insider directors 1.7086 1.0000 7.0000 0.0000 1.1443 810
% of insider directors 28.3382 25.0000 100.0000 0.0000 18.4182 810 Number of outsider directors 4.6086 4.0000 14.0000 0.0000 2.0779 810
% of outsider directors 71.6619 75.0000 100.0000 0.0000 18.4182 810
Average age 55.0831 56.0000 82.0000 39.0000 4.8578 373
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Table 2. Comparison of boards with no woman directors and board with woman directors
This table details the statistics of the boards of director with woman directors and boards with no woman directors. The number of directors and number of woman directors are gathered from the individual firms’ financial reports as of reporting date. Chairman and executive duality is a dummy variable equaling unity if the chairman holds an executive position in the firm. Executive options (shares) are measured as the numbers of options (shares) held by directors scaled by the total number of shares outstanding. An insider director is defined as a director who holds a full time executive position with the firm. The remaining directors are classified as outside directors. Average age is the mean age of all directors. Tobin Q is measured as the sum of market value of equity and book value of total liabilities divided by book value of total assets. ROA is the return on assets calculated as profit after interest and tax divided by total assets. Ln(Total Assets) is the natural log of total assets. Capital expenditure is the expenditure spent on fixed assets in a particular financial year. Number of industry segment indicates the number of industry segments that the firm operates in
Board with woman directors N=256
Board with no woman directors
N=575 p-value
Mean SD Mean SD
Board characteristics
Number of directors 7.2891 1.9610 5.8594 2.0665 0.0000
Chairman and executive duality 0.1205 0.3262 0.1800 0.3846 0.0337
Executive options 1.4205 5.6587 2.7400 9.7083 0.0430
Executive shares 14.5018 21.7380 19.8701 23.3124 0.0018
Number of insider directors 1.7390 1.1289 1.6952 1.1518 0.6157
% of insider directors 24.3663 15.0807 30.1010 19.4736 0.0000 Number of outsider directors 5.5542 1.9505 4.1889 1.9946 0.0000
% of outsider directors 75.6337 15.0807 69.8990 19.4736 0.0000
Average age 55.6639 4.3382 54.8008 5.0754 0.1075
Firm characteristics
Tobin Q 1.9929 2.1294 1.8587 2.3395 0.4330
ROA 0.0276 2.0027 -0.7117 4.7292 0.0163
Ln(Total Assets) 19.9873 1.9187 18.7349 1.6473 0.0000
CapEx/Total Revenue 0.4109 4.0840 1.1570 7.5320 0.1462
Number of industry segment 1.9063 1.2676 1.5625 0.9831 0.0000
Table 3. Board Size and Woman Directors by Industry Classification
This table reports the board size and woman directors of firms according to industry classification. The industry sectors are classified according to the Global Industry Classification Standard (GICS) adopted by the Australian Stock Exchange (ASX) from March 31, 2002
Industry sector Observation Board size Observation
Average number of woman director
Average percentage of woman directors
Energy 35 6.1429 33 0.2424 3.9960
Materials 158 5.8797 152 0.1974 2.9613
Industrials 121 6.5372 117 0.2735 4.0612
Consumer Discretionary 141 6.9220 132 0.4091 5.4567
Consumer Staples 55 6.7091 54 0.3704 5.5511
Health care 83 6.2048 82 0.5244 8.0213
Financials 151 6.0795 137 0.2774 3.5732
Information Technology 58 5.6724 56 0.2500 4.1490
Telecommunication Services 18 5.8889 18 0.3333 3.7037
Utilities 12 7.7500 12 0.4167 5.2976
Total 832 6.2993 793 0.3153 4.5234
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Table 4. Board Size and Firm Value
This table presents the results of the following regressions
] 2 [ ]
1 [
1 2 3
2 1
1 1
0
δ β β
β β
ε α α
α
+ Χ +
+ +
=
+ Χ +
+
=
∑
∑
=
=
n
j j i
i n
i i i
BoardSize BoardSize
TobinQ
BoardSize TobinQ
where TobinQ is measured as the sum of market value of equity and book value of total liabilities divided by book value of total assets.
Board Size is the natural log of the number of directors at the reporting date.. X is a vector of control variables. The control variables are: WOMANDUM (a dummy variable equalling to unity if a company has a woman director), OUTDIRPER (percentage of outside directors on the board), DUALITY (a dummy variable equaling to unity if the Chairman of the board also holds an executive position
Board Size is the natural log of the number of directors at the reporting date.. X is a vector of control variables. The control variables are: WOMANDUM (a dummy variable equalling to unity if a company has a woman director), OUTDIRPER (percentage of outside directors on the board), DUALITY (a dummy variable equaling to unity if the Chairman of the board also holds an executive position