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Board composition and firm performance: some Canadian evidence.

This study examines the relationships between firm financial performance and a variety of characteristics of the boards of directors of the largest 100 (by revenues) Canadian public firms for the years 2005, 2006, and 2007. Following Fiegener, Nielsen, and Sisson's American Business Review (1996) study of the U.S banking industry, the present study distinguishes between board involvement and board effectiveness. With regard to board involvement, the study focuses on the impact of outside director representation on the board together with the level of equity ownership of directors. Inasmuch as indicators of board involvement are not sufficient to explain the impacts of boards on performance, measures of the effectiveness of boards arc also considered. In particular, the tenure characteristics of outside directors and their relationships to performance are examined. These include the average length of tenure of the outside directors, the degree of tenure heterogeneity of the outside directors, and the (hypothesized) eventual diminution of the positive impact of tenure length on financial performance.

The period studied is a fruitful one for observing whatever relationships might exist between tenure characteristics and performance. It was a period when corporate governance was the object of considerable scrutiny by stockholders, regulators and other financial market observers, and, one would expect, active involvement by board members.

A weakness of many board performance studies is that they have relied on bivariate statistical techniques that failed to address the relationships among the measures. The present study uses multiple regression to take account of the inter relationships among outside director variables. The regression estimates are not intended as predictive models of financial performance. Rather, the regression analysis provides the analytical structure for investigating the extent to which outside director tenure characteristics co-vary with financial performance after controlling for the influence of other measures of outside director involvement. Fourteen equations were estimated for each of the two dependent variables: return on assets and return on shareholders' equity.

The results of the study indicate that both the number and proportion of outside directors are positively and significantly related to financial performance, measured as both return on assets and return on shareholders' equity. After controlling for outside director involvement, the results suggest that certain indicators of board effectiveness are related to performance as well. First, outside director tenure is positively related to firm performance. This finding is consistent with research on the relationship between board characteristics and intermediate outcome variables, such as the likelihood of financial statement fraud, reaction to greenmail, adoption of golden parachutes, and membership on board committees. It also supports the argument that the accumulated learning and power effects of long tenure enable directors to be more effective in their various governance roles. At the same time, a negative and significant coefficient in a quadratic term for tenure length is consistent with an inverted U-shaped relationship between performance and tenure. This suggests that the benefits of accumulated learning and power eventually begin to diminish as tenure increases. Also, long-serving outside directors may become entrenched and difficult to dislodge even when the firm is not performing well.

The relationship between the heterogeneity of outside director tenure and financial performance is less clear. On its own, the heterogeneity coefficient is positive and highly significant, but, once other variables are introduced, the heterogeneity turns negative and, in some cases, significantly so. This suggests that heterogeneity is a proxy for some other variable. A positive coefficient is consistent with research showing the benefit of cognitive diversity in group decision-making. At the same time, excepting Fiegener et al, studies of the performance impacts of tenure heterogeneity in top management teams and corporate boards have not shown significant results.

Taken together, the findings of this study offer mixed conclusions concerning board replacement. One finding argues that corporate boards should avoid policies that foster frequent director turnover and should, instead, try to retain effective board members. At the same time, the benefits of the accumulated learning and experience of outside directors eventually begin to diminish. As for the importance of tenure heterogeneity, the results are inconclusive. Inasmuch as a negative relationship with performance is indicated when other variables are considered, they do not support the replacement of some outside directors to make the board cognitively more diverse.

The diminishing values of outside directors after some point might be taken as evidence that the staggered replacement of outside directors is best. Effective outside directors should be retained for long terms of service to take advantage of their knowledge of company operations and experience in board decisions. However, the terms of such directors should not continue indefinitely. Arguably, outside directors should be hired and replaced in small cohorts (possibly cohorts of one) rather than in large blocks so that the board's loss of experience and organizational memory will be minimized.

T. W. Chamberlain ([??])

McMaster University, DcGrootc School of Business, DSB 304, 1280 Main Street West, Hamilton,

ON L8S 4M4, Canada


DOI 10.1007/s11294-010-9271-2
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Title Annotation:RESEARCH NOTE
Author:Chamberlain, Trevor W.
Publication:International Advances in Economic Research
Geographic Code:1CANA
Date:Nov 1, 2010
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