What’s more profitable? A corporate firm with a large board of directors, one with a small board of directors, or a board composed of company insiders?
That’s a question Harbert College of Business McLain Family Professor in finance Jung Chul Park asked in the co-authored paper, “Corporate Governance and Bankruptcy Risk,” which was recently accepted for publication in the Journal of Accounting, Auditing and Finance.
Park co-authored the paper with Ali F. Darrat, a professor in economics at Louisiana Tech, Stephen Gray, a professor in finance at the University of Queensland, and Yanhui Wu, an assistant professor in finance at Queensland University.
“We examine how firm characteristics, particularly the degree of firm complexity and the firm’s need for specialty knowledge, affect the relationship between corporate governance and the risk of bankruptcy,” Park said.
Park believes a company’s respective corporate climate, or the core product of a company, often determines whether or not it would best be served by a large board of directors, a small board of directors, or a board of directors consisting of insiders. The research found having larger boards might reduce the risk of bankruptcy, but only for complex firms.
“Smaller boards can be more efficient, but larger boards can be more functional with more specialized people in certain areas who can give better service,” he said. “If you have a large group, a complex business, then a larger group is better.”
Too many insiders can be a problem as well, Park suggested, particularly for non-complex firms. He believes a good mix of “outside, independent” board members is more efficient.
“The more insiders, then company does not do well,” he said. “They can create a lot of problems because they are connected to each other and are less objective in monitoring the company. For a regular (unsophisticated) firm, too many insiders can be a headache.
“However, if a company has difficult products, for instance high-level information technology, the board needs some kind of specialist – an insider who is involved in the company – on the board. We need someone who knows about the business. We would need some expertise here.”
Park says that the effect of governance is not uniform across all firms and that one-size-fits-all governance practices can be counter-productive. Therefore, academicians and practitioners need to carefully look at firm characteristics first to determine the effect of corporate governance.