Board of Directors: A Literature Review

In the relationship involving ownership structure and control of public corporations, a crucial role may be played by the board of directors. The board of directors of a corporation., among other things, should play a monitoring role on the possible opportunistic behavior of the management of the firm (Fama and Jensen, 1983)

The board of directors performs multiple functions that concern, for example, the replacement of managers, financial policies, the preparation of strategic plans, and other actions that affect the performance of the company. The board plays an impartant role since on the one hand it oversees and can redirect the actions of management and on the other it advises

management regarding the strategics to be adopted due to its wealth of knowledge (Fama and Jensen. 1983).

Firms that aim to have a qualified board should prefer a board of directors who have multiple positions since they have thereby more experience (Perry and Peyer, 2005). Many empirical studies have examined the relationship between firm performance, board size and the characteristies of the board.

Hennalin and Wcisbach (2UU3) emphasize the existence of an endogenous relationship between the characteristics of the board, the actions of the board, and the firm's performance.

They analyzed the economic literature regarding ownership arid board structure and how their characteristics can affect firm performance. They mention the notorious surveys demonstrating that there is a negative relationship between board size and company profitability and that both hoard compensation and hoard size have a significant relationship with the primary board decisions, such as a CFO replacement. Finally, Hermalin and Weisbach (2003, p. 20) suggest that the board is "... an institution that has arisen endogenously in response to the agency problem inherent in agoverning any organization".

Agrawal and Knocber (2013) point out that boards of directors have often been measured on the basis of two characteristics: size and composition. Both theory and empirical

evidence have long debated the effectiveness of the optimal size of the board and therefore the relationship between performance and board size. A more diverse board may, on the one hand, be less advantageous because less cohesive and coordinated (Lipton and Lorsch, 1992), whereas on the other it may be more effective as it brings together a greater breadth of knowledge thanks to the diversity of gender and background components. The optimal board size and composition is the one that can maximize the value of the firm by finding the right trade-off between greater knowledge in decisions made and greater ability to make collective

decisions (Agrawal and Knoeber, 2013).

Jensen (1993) argues that a smaller board is more effective in carrving out monitoring activities. Iie recomends that to be most effective a board must be composed of a maximum of seven or eight members. On the same topic, Yermack (1996) empirically investigates the relationship between board size and "fobin's C,) and finds that the smallest boards have a positive impact on performance, He analyzed 454 companies in the US between 1984 and 1991 and noticed an inverse relationship between Tobin’s Q and board size. An increase a board size leads to higher costs and a reduction in value for the enterprise, The loss of value for the company, which goes from six to twelve members, is the same as that which is estimated when the board goes from twelve to twenty-four members. Both profitability and operational efticiencv decrease with the increase in board size. Moreover. companies that announce a reduction in board size actually experience excess returns around the announcement date, which is in contrast to what happens to firms that announce an increase in board size.

Raheja (2005) asserts that the structure of an optimal board 1S one that results from the optimal trade-off between maximizing the incentives for insiders to disclose additional information in their possession on the enterprise, minimizing costs far outsiders in design verification and maximizing outsiders' ability to reject unprofitable investment projects.

Coles, Naveen and Naveen (2008), however, studied a sample of 8,165 observations during the period 1992-2001 and observed that board size depends on the complexity of the enterprise and that there is no standard size. Both large and small boards can be optimal for firnmalue. Thus, the empirical evidence on the relationship between board size and performance has produced mixed results.

Likewise, there are mixed results on the relationship between board characteristics and firm performance. For example, Hermalin and Weisbach (1991) investigated the relationship between the proportion of outsiders and Tobin's Q but could not find any relationship.

Hart (1995) doubts the effectiveness of the board in practice. Assuming that the board is composed of executives, who are members of the management team and non-cxecutives, who are the outsiders, he finds it difficult for various reasons for them effectively to effectively fiffill the role of monitoring. The executives should actually monitor themselves and the non ­executive may not be incentivized, since they have no significant financial interests in the firm or because they are involved with other boards and therefore may have little time to take care ;f the interests of the company.

Agrawal and hnoeber (1996) studied the relationship between insider ownership and firm performance in a sample' of American firms in 1987. In this study_ seven variables of governance are introduced, including board outsiders. They observed a negative and statistically significant relationship between board outsiders and -robin's Q.

Raghat and Black (2002) documented that firms with more independent members in the board do not record better performance and that the increase in the numbers of independents on the board is more common in enterprises with weak or poor performance records. Baghat and Bolton (2008), however, by studying a sample of firms during the period 1990-2004, noticed a negative relationship between board I\independence and operating performance as measured b~ Return on Assets (ROA).

On the other hand, many researchers have investigated the relationship between board characteristics and performance using the event-study methodology in order to measure the stock market reaction to the announcement of changes in boards. The pioneering study in this area is that of Rosenstein and Wyatt (1990), who analyzed 1,251 announcements during the period 1981 to 1985 and observed that the appointment of an outsider in the board provides a wealth of relevant knowledge and increases the value of the firm. They find a positive reaction from the market, which translates into an increase in stock prices on average by about 0.2% when the company appoints an additional outside director, especially if he/she comes from a financial institution. Instead, on average there is no reaction if the additional member of the board is an insider. Rosenstein and Wyatt (1990) hypothesize that the appointment of independent directors may be interpreted as signaling a change in strategy by companies.

DeFond, Hann and Hu (2005) examined 85() new appointments for the 1993-2002 period of outsider directors with financial accounling experience, findings that the CARs are positive during the three days around the announcement date only when the outsiders are independent.

Perry and Peyer (2005); for the period 1994-1996. analyzed '149 announcements regarding the appointment of new directors, with the result that the average cumulative abnormal returns are negative but not statistically significant for those defined as "sending firms" in which executives hold a lower share ownership and when the board of the sender companies does not have a majority of independent directors. By contrast, however, the CARs not negative for the sender firms in which the executives hold two or more outside directorships.

Farrell and Hcrsch (2005) examined 111 appointments of only women directors for the L'S during the period 1990-1999 and found no significant reaction by the stock market. By contrast. Kang, Ding and Charocnwong (2010) investigated the reaction of the stock market in Singapore using a sample of 53 appointments of women directors made during the period 1994­-2004, Between the day of the announcement and the following one they observed positive and statistically significant CAAR equal to 1.22%. Furthermore; Campbell and Minguez-Vera (2010) also observed that cumulative abnormal returns are positive and significant; after studyng 47 appointments of women directors in Spain in the period 1989-2001. Interestingly, ',Jams, Grav and Nowland (2011) did research on 1,126 appointments of outside directors between 2004 and 2006 in Australia and the CARs are positive and statistically significant in the three days around the announcement date. They divided the sample into two sub-samples consisting of 67 annourrcements of women directors and 1.059 of men directors and noticed that the announcement of outside women directors generates higher., always positive and

Statistically significant CARs in all time frames observed, unlike what takes place with the appointment of men.

An original and interesting work belong to Koch; Fenili and Cebula (2011), who -researched the reaction of the security prices of Apple; Inc. stock shares during the period of illness of Steve Jobs, founder and CEO of the company. The authors studied nine events during the period 2004-2009 to test the stock market reaction of the Apple stock, since Steve Jobs was one of the best-known CEOs in the world and -the mind" that had revived the company by increasing it is market capitalization from 2.4 billion to 210.1 billion dollars between 1997 and 2010 many analysts and commentators attributed its growth to Steve Jobs and believed that company was dependent on its CEOs more than any other company. The impact of the announcement on the price of the Apple securities is mixed and the results achieved do not a definite explanation. The authors reported almost always negative but never statistically significant cumulative abnormal returns. The only event where there is a negative and statistically significant CARs equal to -10.5% is the day when Steve Jobs took part in the worldwide Developers Conference and presented the new iPhone with more functions and in the meantime Apple announced a new price strategy. The combination of events makes it impossible to accurately determine which of the two -Steve Jobs' health or his announced new business strategy - is the more significant event. Although they found negative abnormal returns, the authors cannot attribute these results to a single event, and in particular it is not clear which of the events take precedence over the other. Koch, Fenili and Cebula (2011) conclude that Jobs' health had an impact on the market capitalization of the company but that this impact was not always negative and also not so strong as many believed.

More recently, however, f3aghat and Bolton (2013) studied the irnpact of the Sarbanes­-Oxley Act on the relationship between corporate governance and performance during the period 1998-2007, on a sample of 13,000 firm-year observations, and found a negative relationship between board independence and operating performance for the period 1998-2001 and a positive and statistically significant relationship for the period 2003-2007. In addition, they also tested the reaction of the market through market-adjusted cumulative abnormal returns and discovered that during the three days around the announcement date the CARs were positive (0.48%) for the companies that complied with the Sarbanes-Oxley Act and increased the independent directors. This finding is consistent whith the Renas and Cebula (2005) prediction that public corporations shown to be visibly complying with the Sarbanes-Oxley Act would reap benefits for thir shareholders.

In Italy, the situation is arguably much more complex than in the U.S. Most companies have a high ownership concentration and both the share of independents and women is lower w,an in most other countries. The presence ofwomen on boards is still marginal/minimal even if the relative share of'women board members has grown over the last ten years. Interestingly, in 2011 Parliament passed a law which provides that from 2015 a third of the boards must be

composed of women.

Undoubtedly. Italy has accelerated the pace of its reforms in the realm of corporate governance, starting from the Legislative Decree of 1998 (also known as L)raghi Reform) and vrven the Corporate Governance Code of 1499, including its 2011 and 2014 rrevision. The orporate Governance Code in its present fornn recommends the adoption of a set of best -ractices regarding governance with the inclusion of the principle "comply or explain".3

The numerous efforts made regarding regulation and the compliance with the Code of amosl all listed companies have not however eliminated the skepticism that is apparent in much of the literature on the quality of Italian corporate governance and this may be due to the gap between the level of compliance and what is stated in the report (Blanch] et a1., 2011).

Bianco, Ciavarella and Signoretti (2011) investigated the gender composition of the hoards of directors of listed companies in Italy and reported that only 6.8% of the boards is composed of women and that 55.6% of the companies, in which there is at least one woman, apcrates in the Information Technology sector and high-tech industries. In addition, they observed that in 47.3% of the companies in which at least one woman sits on the board there is a family control model. The analysis did not suggest any relationship between the presence women in boards and Tobin's Q; however. it was found that the presence of women on boards :nereases the number of board meetings. especially in companies that have a non-family ownership.

Among the studies on the Italian context, the contributions of Fiarontini and Caprio (2002), Belcredi and Rigamonti (2008) and Celenza,Manfredi and Rossi (2014) can be highlighted.. Barontini and Caprio (2002) examined the relationship between the composition, the turnover of the board., and the performance of a sample of listed companies in Italy over the period 1976-1996. The results show, for the sample of firms studied, that there is a positive and tatistically significant relationship between board size and firm size, while the relationship ;enveen board size and ow~nership concentration is always statistically significant and negative, board like the relationship between board turnover and firm performance.

Belcredi and Rigamonti (2008) analyzed the relationship between ownership structure, board structure and performance of a large sample of Italian listed companies, finding that board ;izc is larger in bigger firms and when the parent company holds a smaller share of cash flow rights. They also observed a strong relationship between the structure of the board and the proprietary model as well as between ownership concentration and firm valuation.

in other words, family firms, or at least high ownership concentration firms, tend to compose the board of directors "on a human scale".

Celenza, Manfrcdi and Rossi (2014) researched the relationship between the owership , the board of directors, and the performance of a sample of listed companies in Italy tor the period 2002-2012. In addition to the performance measures widely used in the literature. the authors also included the efficiencv of' intellectual capital as an additional variable. The results obtained do not appear to be particularly significant. The relationship between performance and the fraction-al' women directors alternates the signs and when it is positive it Is highly significant. Greater interest seems to be found in the statistically significant positive relationship between the ROA and non-executive directors and between the ROA and the third block-holder for two sub-periods out of four. The relationship between performance and board is almost always negative, but, with the exception of one sub-period, it is never statistically significant

3. Sample and Survey Methodology

The research sample in the present study consists of 100 announcements of boards of director made by 100 companies listed on the Italian stock market during the period 2012-2014 Most of the announcements were made between April and June of each year. The Information on the announcement was acquired from various sources and subsequntly the minutes of the Board of Directors of each company in the sample were checked for verification.

For the construction of the selected sample, the following criteria were adopted :

a) The availability of the announcement date4 of the appointment of the Board and the possibility to observe the dat found on the corporate minutes.

b) The availability of data on the composition of the board, namely : size of the board, the number of independents on the board, the number of executive on the board, the number of non-executive on the board, the number of women on the board, and the number of men on the board:

c) The availability of the time series of stock prices for each company included in the sample whoses data were acquired by Datastream:

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