The Superior Performance of Companies with Small Boards of Directors

Abstract

This paper evaluates recent proposals in the legal and finance literature for limiting the sizes of boards of directors. After controlling for firm size and industry membership, I find evidence of an inverse association between board sizes and firms’ market values in a sample of 792 large U.S. public corporations between 1984 and 1991. Using Tobin’s Q as an approximation of market valuation, I find a negative association with board size over the range between four and ten directors, after which the relation levels off. Ratios measuring profitability and operating efficiency have similar associations with board size. More tentative results indicate that CEOs’ compensations incentives operate more powerfully when boards are small. The evidence suggests that smaller boards of directors serve as more effective monitors of top managers.