As noted earlier, many of the prior empirical research has highlighted the importance of the internal corporate governance instruments, especially after the recent financial crisis. Many research studies have been interested in examining board composition implications on firm performance. Consequently, an enormous mainstream of academic literature has been conducted on the relationship between the size of the board and firm performance. However, academic literature has not yet reached to answer the question regarding should the board of directors be smaller or larger. Theoretical research seems to have contradictory viewpoints.
For example; Lipton and Lorsch, (1992) argue that large number of directors in the board room would make the board dysfunctional in monitoring management as large number would rarely review firms important polices. Additionally, Jensen, (1993) criticize large number of board members and stated that in order to get more effectiveness and less cost the optimal board members should be around eight. Agency theory argue that large number of board members may become symbolic governance mechanism and eventually a part of the management. Thus, since large board members in board room may question its effectiveness in performing the monitoring role, board characterised with large number may negatively affect corporate financial performance (El- Faitouri, 2014).
On the other hand, there is another school of thought which support the view that large boards may have the ability to put pressure on the firm’s management to pursue lower cost of debt and hence, improves corporate financial performance (Anderson et al., 2004). Furthermore, Klein, (2002) argue that in order to maintain effective monitoring, firms may have to increase their board size. However, Coles et al., (2008) stated that the relationship between board size and corporate financial performance is U-shape relationship implying that the optimal board size is either very small or very large. In consequences, much of the empirical research dedicated to examine this issue, see for example; (Jameson et al., 2014; Elsayed, 2010; Al-Malkawi et al., 2014; Francis et al., 2013; Hillman, 2014; Sun & Shin, 2014; Fraile & Fradejas, 2014) among others. However,
11 It is worth noting that board –duality and CEO–duality is used interchangeably in this research. Both terms refer to
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prior empirical results associated with the relationship between board size and corporate financial performance were inconclusive and limited to developing economies (Ehikioya, 2009).
It’s a worthy of note that, the vast majority of these studies that have examined the effect of board size on corporate financial performance report negative association. For example; Yermack, (1996) was among the first who provide empirical evidence consistent with the assumption that smaller board of director is more effective monitoring device. In the same vein, Eisenberg et al., (1998) report significant negative correlation. Cheng, (2008) assert that corporate board size is negatively associated with corporate financial performance. This implies that board of directors may have weak monitoring role and it perform advisory role instead (Guest, 2009). Similarly, Kumar, (2013) report negative association. However, other scholars have found positive relationship. In terms of risk taking and performance variability, Nakano & Nguyen, (2012) indicate that firms with large board members in the board room have lower performance volatility and lower bankruptcy risk. Recently, Johl et al., (2015) provide evidence that board size is positively associated with corporate financial performance in Malaysia. In the MENA context, governance research is limited and scarce. Thus, this research will add to the current debate on the relationship between board size and firm performance using MENA context −Jordan and UAE− data as a form of small emerging markets.
However, the effect of board size on firm performance seems to be contingent on external governance mechanisms i.e., market for corporate control. There are two competing hypotheses on this matter; the Complement and the Substitute Hypotheses. According to the Complement Hypothesis, board size will have negative relationship on firm performance under an active market for corporate control framework (John & Senbet, 1998). On the other hand, the Substitute Hypothesis predict that the importance of the board will be substitutory depending on the existence of the external governance mechanisms, and hence, expecting positive impact of board size on firm performance in such environments (Williamson, 1983). Cheng, (2008) provide evidence that board size matter for firm performance before the passage of antitakeover laws in the US in the mid-to-late 1980s. In contrast to developed countries and some other large emerging markets i.e., China, the MENA region’s emerging markets has poor and weak external governance mechanisms. The market for corporate control instruments are absent, capital markets are mostly illiquid and equity ownership is concentrated. In this context, the importance of internal corporate governance mechanisms i.e., board size is more valuable. Thus, positive relationship between board size and firm performance might be observed.
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However, empirical evidence seems to be inconclusive and incontinent when it comes to the relationship between board size and firm performance in general. Moreover, the effect of board size on firm performance seems to be contingent on external governance mechanisms i.e., market for corporate control. There are two competing hypotheses on this matter; the Complement and the Substitute Hypotheses. According to the Complement Hypothesis, board size will have negative relationship on firm performance under an active market for corporate control framework (John & Senbet, 1998). On the other hand, the Substitute Hypothesis predicts that the importance of the board will be substitutory depending on the active existence of the external governance mechanisms, and hence, expecting positive impact of board size on firm performance in such environments (Williamson, 1983). Cheng, (2008) provide evidence that board size matter for firm performance before the passage of antitakeover laws in the US in the mid-to-late 1980s.
In contrast to developed countries and some other large emerging markets i.e., China, the MENA region’s emerging markets have poor and weak external governance mechanisms. The market for corporate control instruments is absent, capital markets are mostly illiquid and equity ownership which is concentrated. In this context, the importance of internal corporate governance mechanisms i.e., board size is more valuable. Thus, positive relationship between board size and firm performance might be observed. Drawing on this debate in prior theoretical and empirical literature, the below hypothesis can be formulated regarding the effect of board size on firm performance in this research context:
𝐇𝐲𝐩𝐨𝐭𝐡𝐞𝐬𝐢𝐬𝟒: There is a positive relationship between board size and firm performance.