Brief

The article seeks to examine the contradictory evidence on whether board size enhances or hinders corporate performance, concluding that while larger boards can improve monitoring and bring diverse expertise, they may also suffer from coordination problems and slower decision making, making the optimal board size dependent on a company’s specific needs and context.

Introduction

Board size is one of the most important elements of effective corporate governance and performance. It is the number of directors on the board of an organization. The decision-making of a firm can influence its corporate performance, and therefore, it is necessary to analyse the impact that the size of a board has on its decision-making. There has been no homogeneity in findings of whether a smaller board size is more advantageous to the company than a larger board size. Numerous findings have pointed out a decrease in profitability, Tobin’s Q, and stock return from the company with a larger size of the board, however, with an increase in the monitoring ability of the board. On the other hand, there are studies that point out the benefits of a larger board, such as reduced workload and a reduced burden of fundraising, as the responsibility is divided among many members. Some studies have found a positive influence of a larger board size on the performance of the firm and advocate that Indian companies require a larger board size that will enhance the company’s ability to respond to diverse stakeholders, enhance the performance of the firm by better monitoring and also by bringing a wide variety of expertise and knowledge in diverse fields and thereby improving the firm’s ability to generate external linkages. Some studies have also found the impact of a larger board size to be contrary to the above. Certain studies have shown that larger boards usually underperform consistently with worse M&A deals, and that the effectiveness of a board decreases as it grows too large because of free-riding and coordination problems.

Applying Theories of Corporate Governance on Board Size

The size of the board is explained with many theories, such as the agency theory, the stewardship theory, and the resource dependency theory. The agency theory in corporate governance explains the relationship between the shareholders and agents (directors and managers). Based on this theory, it is believed that there exists a positive relationship between the two, since with a larger board, there can be better management of the company. According to the Stewardship Theory, managers and directors are trustworthy stewards who prioritize the best interests of shareholders and the organization, rather than pursuing their self-interest.  This theory looks at the positive side of a smaller board size as it allows for more coordinated interpersonal communication, better participation from the members, and aids in social cohesion. A large board size, as per this theory, would make it difficult to reach a consensus. Resource dependence theory, developed by Pfeffer and Salancik, explains that organisations are influenced by their reliance on external resources, which shapes their behaviour and strategies as they seek to manage and reduce this dependence. This theory encourages a larger board size since that is seen as a “bank of resources,” which increases the firm’s ability to form linkages and obtain resources needed for survival and success. A larger board, as per this theory, can be effective in managing and monitoring operational activities easily. Thus, we see that agency and resource dependency theory maintain that a larger board size increases the performance of the firm, while the stewardship theory maintains that a larger board negatively impacts the performance of the firm.  There is no homogeneity in the results of the studies made as to which is the better way to go for the size of the board. The impact of the board size has been analysed on certain key aspects that are important for the efficient functioning of the firm, namely, strategic change, corporate performance, risk taking, investment decisions, dividend policy, and innovation.

Effect of Board Size on various aspects of a firm

Corporate performance

As per findings by Manna, Sahu and Pandey, in their research, a larger board size has a significant positive relationship with both the CEPS and Tobin’s Q. A positive relationship between a larger board size and a better corporate functioning is underlined with the example of Microsoft wherein the company decided to increase its board size, in 2017, because the presence of new directors with leadership experience would benefit the company. Similarly, studies point out that as the number of directors increases, the corporation becomes more profitable as boards have many responsibilities and to cater to each requirements, there is a need for diverse talents and any increase in the board will happen only on the availability of such talent which in turn will increase the firm performance. This signifies that a larger board size increases the performance of the firm by enhancing control and monitoring.

Strategic change

An increased size of the board helps with the inclusion of a variety of perspectives on corporate strategy. However, it has been found that a larger board size can significantly inhibit the ability of the board to reach a consensus on important decisions because larger boards are less cohesive and are often marked with less satisfaction and motivation because of a lack of participation. Moreover, there is a difficulty in the coordination problem that comes with a larger board. According to research findings, it has also been discovered that larger groups have a higher likelihood of forming factions and coalitions, which can lead to conflicts. Olson’s research found that there are higher chances of faction creation based on special interests within the group, with each faction promoting its own agenda rather than working towards the group’s goals. Therefore, an inverse relation has been found between board size and the ability of the board to make strategic changes.

Risk Taking

Risk-taking is an important aspect of the functioning of the firm as it contributes to the functioning of the firm. For a firm to be able to efficiently take risks, the board size must be compact, since with a larger board size, there are more external directors who will avoid taking risks to uphold their image, and this, in turn, will deter the firm’s innovation ability. It is the smaller boards that give a larger incentive to the directors to bear more risks and force them to make riskier decisions. Larger boards have a tougher time reaching a conclusive compromise and thereby tend to adopt less risky decisions. This proves why forcing firms to have a larger board is detrimental to the performance and value of the firm.

Investment Decisions

There are numerous benefits of a larger board when it comes to making investment decisions. With the presence of more directors, there is a creation of a wider pool of knowledge and expertise, which in turn, enables a better sharing of ideas and advice. Empirical research studies have suggested that with an increase in the board size, there is less accounting discretion and therefore the information quality is improved, which in turn reduces the risk of overinvestment or underinvestment.

However, in a significant move by Toyota Motor Corporation (TMC) in reducing its board size from 27 in 2010 to 10 in 2025, to accelerate decision-making and aid the company respond faster and better to changing market conditions, points to the contrary that a smaller board size aids in effective decision-making. TMC’s governance reports highlight that the previous larger board size was one factor in slower management, and the reforms were aimed at overcoming this limitation.

Dividend Policy

It is one of the most important components of a corporate policy, as it reflects a company’s operating performance and shareholders’ interests, and also has a significant impact on the firm’s prospects.  Dividend policy decisions keep a company’s finances in check and are an important tool to adjust the stock price to balance the interests of all the parties. As per the empirical research done on 360 non-financial and non-utility companies listed in the Bombay Stock Exchange 500 Index, board size tends to have a significant negative impact on the dividend payout ratio. However, there have been findings that point towards a significant positive relationship between the board size and the tendency to pay a dividend. This is based on the suggestion that when the board size is increased, there is an increase in the independent directors and therefore the managers are guided to distribute the dividend among the shareholders rather than utilising it for personal purposes. Studies have also pointed towards an improvement in the rationality of policy formulation and the willingness of companies with a larger board to accept supervision of external institutions, such as capital markets, banks, etc., to reduce the agency costs of the company by issuing cash dividends.

Conclusion

The impact of board size on corporate governance and performance is debated, with research showing both advantages and disadvantages to larger and smaller boards. Larger boards can improve monitoring, bring diverse expertise, and enhance resource access, but may suffer from coordination issues, free-riding, and slower decision-making. Smaller boards often foster better communication and risk-taking but might lack diversity and oversight. Theories like agency and resource dependence support larger boards for better management and resource access, while stewardship theory favours smaller boards for improved cohesion and participation. The empirical evidence is mixed about the optimal size, with some studies showing larger boards boost profitability and performance, while others find they underperform due to inefficiencies. Therefore, the optimal board size depends on the company’s specific needs and context, affecting key areas such as strategic change, risk-taking, investment decisions, and dividend policy. There seems to be a positive correlation between the board size and corporate performance, and when it comes to deciding the dividend policy, as it enhances monitoring and accountability. Research also suggests that there is a notable negative correlation between the size of a board of directors and the willingness of the organization to engage in risk-taking, make investment decisions, and implement strategic changes. A smaller, more compact board tends to operate with greater cohesiveness, which facilitates more efficient decision-making. This improved efficiency allows them to respond promptly to opportunities and challenges in the market. In contrast, larger boards may struggle with coordination and consensus-building, leading to delays and indecision that can hinder the company’s ability to adapt and innovate effectively.