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ABSTRACT Environmental jolts are temporary disruptions that cause a hostile transformation
in the level of resources available in a given system. Using the 2008 financial crisis as a moderator
factor in the relationship between board structure and firm value, we assess whether there are any
changes in board governance practices as a result of firms adaptation to the changes caused by the
crisis. Our results show that in this new reality where resources are scarce and growth opportu-
nities are scant a new board configuration is required. During the crisis period, the relationship
between board size and firm performance is such that larger boards are more capable of respond-
ing to a crisis, the presence of independent directors prevents firms from increasing financial
leverage and managers get entrenched at higher levels of board ownership. The study has useful
implications for practitioners as it compares the impact of the adoption of best board governance
practices on firm value in times of munificence and during environmental jolts.
International Journal of Disclosure and Governance advance online publication, 18 June 2015;
doi:10.1057/jdg.2015.6
Keywords: environmental jolts; board governance; firm value; dynamic panel data
© 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21
www.palgrave-journals.com/jdg/
Perez-de Toledo et al
the value of investments. Directly, better gov- of governance practices in creating firm value in
ernance structures imply better mechanisms of times of munificence and during environmental
management. Indirectly, better investor protec- jolts in Europe.
tion is associated with higher valuation by the Our results show that the optimal board size
stock markets (La Porta et al, 2002). The during the crisis period (2008–2010) is larger
adoption of specific governance structures by than during times of munificence and that
firms was driven mainly by institutional factors, boards with more independent directors have
for instance, the practices imposed by the created (destructed) more (less) value than firms
national Codes of Best Practices. Nonetheless, with less independent board members. More-
most codes were introduced in times of munifi- over, independent boards have more financial
cence or economic prosperity when firms do leverage in times of economic prosperity;
not face serious obstacles in achieving growth. however, in times of crisis boards with more
However, in times of adversity and hostility independent directors take on less debt than
when traditional mechanisms fail, the use of companies with less board independence.
best governance practices should be reinforced. We also find evidence of a concave relationship
From a research perspective, economic crises between board ownership and firm value and
offer a powerful setting for testing the effective- that, during a jolt, managers get entrenched at
ness of good governance practices. Environ- higher levels of inside ownership.
mental jolts (for example, economic crises, The article is structured as follows. The next
social and political turmoil) affect and influence section gives an overview of the Spanish govern-
management practices (Meyer, 1982; Meyer ance model and defines environmental jolts. In
et al, 1990; Meyer et al, 2005). The destabiliza- the Section ‘Theoretical predictions and hypoth-
tion caused by environmental jolts can take to a eses’, the hypotheses are constructed and the
re-examination of institutionalized logics and rational for our study is given based on a review
practices and to a reorientation of organiza- of the literature. Data, sample and methodology
tional strategies and processes (Oliver, 1992; are described in the Section ‘Methods’. Results
Venkataraman and Van de Ven, 1998). In this are discussed in the Section ‘Results’ and the
article we analyze and compare the effectiveness Section ‘Conclusion’ concludes the paper.
of governance practices in creating firm value in
times of stability (2003–2007) and in avoiding
the destruction of firm value in times of envir- THE SPANISH GOVERNANCE
onmental jolts (2008–2010). SYSTEM
The setting for exploring these interrelations In Spain, the Aldama Report and the Olivencia
is Spain, a western European country character- Code set the basis for the Spanish Code of Best
ized by high ownership concentration, a great Practices (Unified Code) that, in the case of
number of family businesses, a high degree of board structure, recommends boards to be
bureaucracy, low participation of individual composed mostly by external independent
investors in stock markets and a banking sector directors, but the adoption of such provision is
that has great importance in providing financing left to companies’ self-regulation. However,
to the firms. Moreover, the main mechanism of self-regulation has proved to be absolutely
governance is the concentration of ownership ineffective in making companies adopt the
and external governance mechanisms (that is, necessary provisions that consist in an efficient
market for corporate control) are unusual corporate governance structure. The decision
(Leech and Manjón, 2002). Nonetheless, these by Spanish regulators of adopting a more
are common characteristics of other Western lenient normative is because the Spanish code
European countries. Therefore, this study con- is closely aligned to the British Cadbury
tributes to the literature on the effectiveness Report. The main focus of the British code is
2 © 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21
The effect of environmental jolts on board governance practices and its impact on firm value
© 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21 3
Perez-de Toledo et al
during a jolt and to firm’s success in the after- performance before and after the 2008 financial
crisis period. crisis, we are able to gauge the moderating
From a strategic perspective, the design of effect of an environmental jolt in this
corporate governance structures is directly relationship.
related to the competitive advantages that the
firm needs to exploit. Outside directors or
independent board members represent a critical THEORETICAL PREDICTIONS
element that strengthens external relations and AND HYPOTHESES
provide information about and access to valu- Board composition is used in this study as a
able resources. Among the intangible assets that proxy for governance practices because of its
outsiders can provide are advice and counseling, importance in the Spanish corporate govern-
legitimacy, a channel for the communication of ance system. The board of directors has a
information between the firm and external fundamental role in a corporate governance
entities, and assistance in obtaining resources system, considered a major internal mechanism
and commitments from important entities out- along with ownership concentration; it is used
side the firm (Hillman et al, 2000; Lynall et al, to reduce agency costs. As argued by Fama and
2003; Pfeffer and Salancik, 2003). Outside Jensen (1983) the board of directors is one of
directors can reduce the uncertainty that is the most important organizational controls. It
created by the environment, and can help the separates the management function from the
firm to achieve a better competitive position control aspect of the decision-making process,
(Pfeffer, 1972; Hillman et al, 2000). Salancik and have the potential to mitigate agency
and Pfeffer (1978) argue that when a firm adds a conflicts between shareholders and executives,
new member to its board, there is an expecta- but also between controlling and minority
tion that the new member will support the shareholders in a concentration of ownership
firm's interest in trying to solve its most pressing environment, as in the case of Spain. Board
problems. Board effectiveness can be enhanced composition is a crucial factor in this regard,
with the inclusion of more independent direc- since independent directors are entitled to
tors as they are not colluded with executives or watch over the separation between manage-
main shareholders, which can improve firm ment and control, assuring an effective mon-
performance (Kor, 2006; Jackling and Johl, itoring function of the board. If the board is
2009; Musteen et al, 2009). McNulty and composed primarily by executives and other
Pettigrew (1999) argue that boards play an insiders and the duality CEO-Chairman is
active and central role in strategy formulation present, it is fair to suppose that the monitoring
which contributes positively to firm perfor- function will not fully work, compromising its
mance. The effective management of uncer- role as an important governance mechanism.
tainty provides firms with more power and Next, we provide a literature review of each
therefore increases their chances of survival and board structure component and its relationship
success in the marketplace (Singh, 1986). with firm performance in times of munificence
We argue in this article that board structure is and during environmental jolts.
an important governance mechanism that
makes companies adapt to the breakthrough
changes caused by a jolt through its impact on BOARD INDEPENDENCE
firm performance. More specifically, board Independent directors are assumed to improve
independence, board size and board ownership the monitoring and control functions of the
are key strategic factors in the process of firm board and increase firm value as their presence
adaptation and performance achievement. By potentially increases the degree of convergence
comparing the effect of board structure on firm among board members, and help prevent the
4 © 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21
The effect of environmental jolts on board governance practices and its impact on firm value
entrenchment effect. As independent board practices around the world recommend that the
members are less concerned with preserving majority of board members ought to be inde-
their positions, they have more autonomy in pendent directors, given the potential of inde-
judging the leadership skills and other high- pendent directors to positively influence firm
level competences of senior executives performance (for example, the Australian,
(Renneboog, 2001). In addition to improving Canadian, French, Spanish, the United King-
the control function, independent directors dom and the United States codes). In theory,
bring experience and expertise to the company independent directors are in a better position
(Donaldson and Davis, 1991; Hillman and than insiders to protect the interests of all
Dalziel, 2003) and also contribute more effec- stakeholders based on their presumed experi-
tively to firm success as they provide intangible ence and respect for ethical and legal obligations
resources that also protect and enhance firm (Rodriguez-Dominguez et al, 2009). The
value (Huse, 2009). The active involvement of expected contributions of outsiders to firm
boards in the formulation of firm’s strategy is performance is manifested through the roles or
currently viewed as sine qua non to firm’s value functions they perform, including the role of
creation (Demb and Neubauer, 1992; Pugliese monitoring and control of management, as
et al, 2009; Machold et al, 2011). The presence emphasized under the agency theory (Zahra
of independent directors is aimed at enhancing and Pearce, 1989; Johnson et al, 1996; Daily
the representation of diverse groups of et al, 2003) and the role of provider of advice
stakeholders, and in special, of minority share- and other resources emphasized under the
holders. They also contribute to the develop- resource dependency theory (Pfeffer, 1972;
ment of the firm’s strategy by bringing an Hillman et al, 2000). The role played by
external perspective to the discussions. Pathan independent directors is expected to have a
(2009) finds that the presence of independent positive impact on firm value creation, as a
directors hinders banks’ risk-taking behavior, as stronger monitoring function should be trans-
independent board members may try to achieve lated into greater control by the board over the
a balance between shareholders expectations activities in which the organization is produc-
and stakeholders’ interests. Similarly, Yeh et al tively and commercially engaged, thereby help-
(2011) argue that in the case of financial institu- ing to improve firms’ internal performance. In
tions independent directors can help improve addition, by having a greater percentage of
performance by reducing risk-taking behavior. independent directors, the company sends a
The presence of outside directors also has an signal to external entities that are likely to
important signaling effect, as it allegedly believe that management is being properly
improves the monitoring function of the board, supervised. This could generate a better general
thus reducing agency problems. This signaling appreciation of the firm by the market, autho-
effect has important implications as it can rities and regulators (Huang et al, 2008). How-
increase firms’ access to resources and reduce ever, the effect of board independence on firm
the cost of acquiring such resources (that is, performance is still unclear in the literature.
external capital). Anderson and Reeb (2004) Hermalin and Weisbach (1991) do not find a
show evidence that a larger number of outside significant relation between board structure and
directors is related to lower costs of debt. performance. Baysinger and Butler (1985b) find
Ertugrul and Hegde (2008) extend his findings weak evidence of an association between board
by considering the form of compensation independence and firm performance in the long
offered to outside directors (that is, equity- run. Agrawal and Knoeber (1996) test the
based compensation), and find that it also low- impact and the interrelations of a set of govern-
ers the cost of debt, especially for lower-rated ance mechanisms on Tobin’s q and, after using a
debt firms. For this reason, most codes of best system of simultaneous equations, the only
© 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21 5
Perez-de Toledo et al
6 © 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21
The effect of environmental jolts on board governance practices and its impact on firm value
independent leadership structure are larger than suffer from the free-rider problem (Hermalin
the benefits achieved (Baliga et al, 1996; Brickley and Weisbach, 2003). As a result, some board
et al, 1997). members may be able to entrench themselves as
In times of environment jolt, CEO duality the ‘free rider’ members fail to supervise the
may be beneficial as, according to organizations executives. Some authors relate the effectiveness
theories, it improves unity of command and of board size to other factors. Lehn et al (2004)
sends a signal to stakeholders of assurance that and Bennedsen et al (2008) argue that board size
an unambiguous leadership is in place. and board structure are endogenously deter-
Therefore, the arguments above lead us to mined by firm size and industry complexity.
propose the following hypotheses: Large firms, because of the scope and scale of
their business, require specialized information
Hypothesis 2a: CEO duality has a negative
from the environment, which can be more easily
effect on firm performance in times of
obtained with a larger number of outside direc-
munificence.
tors. In this case, the relationship between board
Hypothesis 2b: The negative effect of CEO size and firm performance may be positive albeit
duality is reversed in times of environ- quadratic, as the literature has consistently
mental jolts. shown, with its effect becoming ‘negative after
an optimal size is achieved. Therefore, we
propose the following hypotheses:
Hypothesis 3a: Board size has a quadratic
BOARD SIZE relationship with firm performance and
Board size is an important governance mechan-
the positive effect of board size on firm
ism because of the relevance of the decisions
performance is reversed after an optimal
taken by the board to firm’s strategy and
size is achieved.
performance (Zahra and Pearce, 1989; Palmer
and Barber, 2001). The empirical evidence on Hypothesis 3b: In times of environmental
board size shows a general negative association jolts, there is a shift to the left in the
between the size of the board and firm perfor- quadratic effect, and the optimal board
mance (Eisenberg et al, 1998; Carline et al, size during environmental jolts is smaller
2009; de Andres et al, 2005; Mak and Kusnadi, than in times of munificence.
2005). However, the negative effect is better
explained as a quadratic relationship as the
positive impact on performance is reversed after BOARD OWNERSHIP
a certain size is achieved (Yermack, 1996). Board ownership is measured as the percentage
Lipton and Lorsch (1992) are among the first of total shares held by all board members
to indicate that directors rarely criticize the divided by the total number of shares outstand-
policies of top managers and to recommend ing. In the case of Spain, dominical directors
limiting the membership of boards to 10 peo- represent the main shareholders; therefore,
ple. In theory, larger boards can reduce the board ownership can be used as a proxy for
dominance of the CEO and mitigate the active shareholders or the shareholders that
entrenchment effect. Nonetheless, in practice, actually exert active control over the firm.
oversized boards may be informally divided into There are two possibilities for the effect of
groups with differing or even opposing points board ownership on firm value in institu-
of view or even agendas that negatively affects tional environments where concentration of
the decision-making process and make boards ownership is the rule, as is the case of Spain:
less effective. Boards with an excessive number (i) the controlling shareholder(s) get entrenched
of members may neglect its monitoring role and (the entrenchment effect), in which case a
© 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21 7
Perez-de Toledo et al
negative effect of board ownership on firm levels of ownership; therefore, the turning
performance is expected or; (ii) the presence of point is displaced to the right.
large shareholder(s) on the board increases the
monitoring and control over the managers (the
converge-of-interests hypothesis) positively LEVERAGE
affecting firm value. The majority of studies As described by Jensen (1986), the service of
assumes insider/board ownership as exogenous debt creates a fixed cost that reduces the
to the firm and find a non-monotonic relation- amount of free cash flow mitigating the agency
ship between insider ownership and firm value problem. Leveraged companies have less free
(Morck et al, 1988; Mcconnell and Servaes, cash flow available reducing thus the degree of
1990; Hermalin and Weisbach, 1991; Kole, perquisite consumption by managers, as
1995; Ødegaard and Bøhren, 2004). However, the service of debt creates the so-called ‘disci-
some studies using simultaneous equations do pline of debt’. On the other hand, debt can
not support the hypothesis that insider owner- cause the underinvestment problem described
ship is an exogenous variable but rather endo- by Myers and Majluf (1984). At high levels of
genously determined (Cho, 1998; Hermalin financial leverage, debt holders capture most of
and Weisbach, 1998; Himmelberg et al, 1999; the net present value (NPV) of an investment
Demsetz and Villalonga, 2001). In the case of project. Thus debt can create an incentive for
Spain, de Miguel et al (2004) provide evidence controlling shareholders to give up positive
of the convergence-of-interest and the NPV projects and cause the underinvestment
entrenchment effects for Spanish firms during problem. In this regard, financial leverage can
the 90s. Using a robust methodology they be seen as an alternative mechanism of govern-
document a positive impact on firm value ance and act as a substitute of other mechan-
for board ownership ranging from 0 to isms. However, in this study we are more
35 per cent, then insiders get entrenched in the interested in testing the hypothesis formulated
range between 35 and 70 per cent, and again by Anderson et al (2004) that the presence of
the converge-of-interest effect seems to drive independent directors enhances the validity of
the increase in firm value for proportions accounting statements, which may be of great
exceeding 70 per cent. On the basis of the importance to creditors when granting debt to
findings of de Miguel et al (2004) we put the companies. For this reason, we expect board
forward the following hypotheses. independence to be positively related to lever-
age in times of munificence. During environ-
Hypothesis 4a: Board ownership has a con-
mental jolts, this effect may be relaxed as
cave relationship with firm value and, as
independent directors tend to be more conser-
board ownership increases the negative
vative and actively prevent companies to take
effect on firm value associated with
on excessive debt levels. Hence, our hypotheses
the entrenchment of manager-owners
are formulated accordingly:
starts to exceed the incentive benefits of
board ownership. Hypothesis 5a: In times of munificence board
During environmental jolts managers have an independence has a positive effect on the
incentive to avoid firm value destruction, and degree of financial leverage adopted by the
for this reason they get entrenched at higher firm.
levels of ownership, which takes to following
hypothesis: Hypothesis 5b: During environmental jolts,
the presence of independent directors pre-
Hypothesis 4b: In times of environmental vents firms from increasing financial
jolts, managers get entrenched at higher leverage.
8 © 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21
The effect of environmental jolts on board governance practices and its impact on firm value
© 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21 9
Perez-de Toledo et al
ROA 1
LSALES 0.0783** 1
LEVER −0.1269*** 0.2036*** 1
BSZ 0.0269 0.3686*** 0.1631*** 1
CEO Duality 0.0174 −0.1904*** −0.0118 −0.1022** 1
BIN −0.0087 0.2215*** −0.0275 −0.0692* −0.2059 1
BOwn 0.0439 −0.2609*** 0.0127 −0.0759** 0.184*** −0.2445*** 1
Tobin’s Q −0.0145 −0.0316 −0.0642* 0.1092** 0.0521 −0.0194 −0.0079
This table reports Pearson correlation coefficients between the research variables used in the study. All variables
are for years 2003–2010. The variables are described in Table 4. Significance at the 10%, 5% and 1% levels is
indicated by *, ** and *** respectively.
Spanish economy, which is largely dominated variables are influenced by the variable they try
by construction and services activities. to explain (endogeneity). Moreover, as far as
Table 3 provides a correlation matrix for the corporate governance is concerned, endogene-
main variables used in the study. A simple ity is always present, as the decisions taken by
analysis of the correlations show that board size the board produce results after a certain period
is the only variable that is significant and of time (Börsch-Supan and Köke, 2002).
positively related to Tobin’s q. Lever presents a Unobservable heterogeneity occurs when the
negative significant correlation with q, as estimators are biased by the tendency of every
expected. On the other hand, a lack of any individual to act in a certain unobservable way
significant relationships between the other vari- over time, and as such, it must be controlled for.
ables and the dependent variable of our main Furthermore, these individual-specific unobser-
specification (q) is a good sign as it prevents vable effects may be correlated with other
multicollinearity problems in the dependence explanatory variables (Hausman and Ruud,
model. 1986). Dynamic panel data methodology not
only controls for endogeneity, but it is also
consistent under unobservable heterogeneity, as
MODEL shown by Arellano and Bond (1988), Arellano
Several studies in corporate governance have and Bover (1995) and Blundell and Bond
pointed out to the endogeneity of governance (1999). It also gives general estimators designed
and to the possibility of reverse causality bet- for datasets with ‘small T, large N’ panels, as is
ween governance and performance (Demsetz our case. The unobservable heterogeneity is
and Lehn, 1985; Cho, 1998; Bhagat and Jefferis, controlled through the individual effect, ηi. dt
2002; Börsch-Supan and Köke, 2002; Hermalin is the time variable, included to control for the
and Weisbach, 2003; Ødegaard and Bøhren, effect of macroeconomic factors on the perfor-
2005). The classical approach of ordinary least mance of the firms. Consequently, the error
squares regressions does not address the problem term is split into three components: the time
of endogeneity inherent to governance studies. effect, dt; the individual effect, ηi; and the
For example, board size and board ownership random disturbance, vit (εit = dt +ηi +vit).
are among the determinants of firm perfor- As mentioned above, we use dynamic panel
mance; however, it is also possible that these data methodology and control for the problems
10 © 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21
The effect of environmental jolts on board governance practices and its impact on firm value
© 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21 11
Perez-de Toledo et al
Q Tobin’s q Ratio of the market value of equity plus the book value of debt to book
value of total assets
BSZ Board Size Total number of board members
BIN Board Percentage of independent and external directors
Independence
CEO- Duality CEO/ Dummy variable: 1 if the CEO and the Chairman are not represented by the
CHAIR Chairman same person; 0 otherwise
BOwn Board Ownership Percentage of shares owned by all board members
LEVER Capital Structure Long-Term Debt / Market Value of Equity plus Long-Term Debt
ROA Return on Assets Net income / Total assets
Control Variables
CRISIS Effect of Dummy variable: 1 for years 2008–2010, and 0 for years 2003–2007
environmental
jolt
INDUSTRY Industry sector Six dummy variables
SIZE Firm Size Natural logarithm of net sales as a proxy to firm size
BETA Firm beta (β) One-year firm beta (from Datastream database)
Panel A shows the regressions of board structure the period of crisis, for every 1 per cent
components on Tobin’s q during the period of increase in the percentage of independents,
munificence (2003–2007) and during the envir- Q increases by 0.78 per cent, while in times of
onmental jolt (2008–2010). The moderating munificence Q increases 0.81 per cent for
effect of the crisis on the relationship between every 1 per cent increase in the percentage of
board structure and firm performance is mea- independents. This effect is shown in Figure 1
sured by the interaction variables (BOARD × and it is consistent with the results of Baysinger
CRISIS). Panel B reports the results of the and Butler (1985a), Hermalin and Weisbach
regressions of board structure components (1988), Prevost et al (2002) and Weisbach
(board independence and board size) on own- (1988).
ership concentration and leverage. Model 3 tests the effect of board size on firm
Our results support our first hypothesis, performance. The results support the hypothesis
which positively associates the percentage of of a quadratic relationship and show that firm
independent directors to firm performance. performance is positively impacted until an
At increasingly larger percentages of indepen- optimal board size is achieved, and that after
dent directors more value is created (Model 1). this point performance is negatively affected.
Moreover, board independence is considered in This result is consistent with the hypothesis that
association with duality CEO-Chairman, and larger boards have a negative impact on firm
we find that the absence of duality enhances value and that there is an optimal range for
firm value (positive coefficient of CEO- board size. The moderation effect of the crisis is
CHAIR in models 1 and 2). When considering included in model 4 and it shows that during a
the moderation effect of the crisis (model 2), jolt, larger boards seem to be more beneficial to
we observe that the role of the independents performance as the breakpoint moves to the
in creating value is less pronounced. During right. Figure 2 shows this moderating effect of
12 © 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21
© 2015 Macmillan Publishers Ltd. 1741-3591
The effect of environmental jolts on board governance practices and its impact on firm value
Panel A Relationship between board structure and firm performance
Dependent variable: Tobin’s q
Independent variables (1) (2) (3) (4) (5) (6) (7) (8)
Perez-de Toledo et al
© 2015 Macmillan Publishers Ltd. 1741-3591
Table 5: (Continued )
Panel A reports the results from dynamic panel-data estimation, two-step difference GMM regressions of each board variable (board independence, board size,
CEO Duality and board ownership) along with the control variables and instruments on Tobin’s q (Q). Panel B reports the results from dynamic panel-data
estimation, two-step difference GMM regressions of board independence (BIN) on board size and leverage. The definition of each variable is provided in
Table 3. The data is relative to the period between years 2003–2010. Dummy variables that control for the crisis period (2008–2010) were included. The
interpretation for each coefficient is the change in Q associated with a one-unit change in its determinant. Hansen test of over-identifying restrictions,
asymptotically distributed as χ2 under the null hypothesis with degrees of freedom in parentheses is reported. The numbers in parentheses are probability
values for two-sided F test. ***, **, * denotes statistical significance at the 1%, 5% and 10% level respectively.
1–21
The effect of environmental jolts on board governance practices and its impact on firm value
Tobin’s q
relationship with firm performance which
In times of munificence
implies that at lower levels of insider ownership
performance is positively affected because of the
converge-of-interests. However, at a certain
level of inside ownership managers become
During environmental jolts
entrenched and it then negatively influences
performance. Models 5 and 6 assess this rela-
Percentage of tionship and we find evidence of a concave
independents
effect as proposed by de Miguel et al (2004).
Figure 1: The moderating effect of During the crisis the breakpoint is displaced to
environmental jolts on board independence. the right as the sign of the interaction is positive.
Tobin’s q
Thus, in times of environmental jolts the
monitoring effect not only remains, but is
enhanced, and there is a delaying in the expro-
With environmental
jolts priation effect as illustrated by Figure 3. This
result is interpreted as evidence that, during a
jolt, managers have an incentive to avoid taking
on risky projects (as companies are at a higher
risk of bankruptcy), and for these reason they
get entrenched at higher levels of ownership.
Board
11 members 13 members Size Models 7 and 8 assess the relationship
between leverage and Tobin’s q and the mod-
Figure 2: The moderating effect of
environmental jolts on board size.
eration effect of board independence in this
relationship. The results show the negative
effect of leverage on firm performance and
the crisis and how the optimal board size during how the crisis intensifies this effect as the slope
a jolt moves from 11 to 13 members. is steeper (the coefficient of leverage in the crisis
Our results indicate that the breakpoint for regression is higher) as illustrated in Figure 4:
board size during times of munificence is Panel B reports the results regarding hypoth-
11 board members. However, during the crisis esis 5 that relates the level of financial leverage
there is a shift to the right and the optimal board to the presence of independent directors.
size increases to 13 members. We interpret this We have test this effect by finding the slope of
result as evidence that during environmental the moderating effect between the percentage
jolts, when the level and availability of resources of independent directors and the variable crisis
is compromised, companies have to adapt and (BIN × CRISIS) with leverage. As shown in
react quickly. Hence, the board assumes a
fundamental role in providing the necessary Tobin’s q
resources, counseling, expertise, coordination
and leadership to develop a new strategy and Monitoring Expropriation
survive the jolt. Yet, boards get more united
and cohesive in order to tackle the problems in
a more efficient way; therefore, the optimal With environmental jolts
© 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21 15
Perez-de Toledo et al
CONCLUSIONS
The objective of the present study is to compare
the effectiveness of board governance practices
in creating firm value in times of munificence
Leverage and in avoiding value destruction during envir-
onmental jolts. Previous studies have focused
Figure 4: Interaction between leverage and
firm performance.
on the effect of board characteristics on firm
performance, but few consider the external
Leverage environment and macroeconomic context as a
With environmental jolts factor that may affect this relationship. Firms
benchmark their practices and adopt specific
governance structures driven by institutional
factors such as the Codes of Best Practices.
Institutionalized policies and institutional fac-
tors are focused on searching for processes that
Percentage of
independents
identify potential structures and practices that
have been considered legitimate and that had
Figure 5: Interaction between board
previously been taken for granted. Nonetheless,
independence and leverage.
most codes were introduced in times of eco-
nomic prosperity, when achieving growth is less
Figure 5, the slope is flatter in times of munifi- challenging. Organizational structures and prac-
cence and stepper in times of an environmental tices that work effectively in times of munifi-
jolt. Moreover, model 1 shows that the presence cence are tested in times of environment jolts.
of independents enhances the level of financial Economic crises offer a powerful setting for
leverage of the sample firms in times of munifi- testing the effectiveness of good governance
cence. However, in times of crisis (model 2) the practices, as the destabilization caused by the
presence of independent directors acts as a jolt can be viewed as an opportunity to re-
deterrent to the adoption of higher levels of examine institutionalized management and
leverage. Our results suggest that independent governance practices.
directors exert a monitoring role over leverage, Our findings support the idea that during
and that during periods of environmental jolts environmental jolts, when resources are scarce
this role is even more pronounced. and firms need to adapt, the board of directors
Model 3 relates board size to board indepen- assume an important role in steering firm’s
dence and shows that larger boards have a strategy and leading the company during the
positive impact on firm value creation. How- adaptation process needed to survive the jolt.
ever the positive effect of board size on firm In this context, board structure has a greater
value is intensified by the moderating effect of importance in the preservation/avoidance of
board independence. In other words, larger firm value destruction during environmental
boards with a majority of independent directors jolts than in times of munificence.
create more value than large boards com- The relationship between board indepen-
pounded by a majority of non-independent dence, board size and board ownership with
16 © 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21
The effect of environmental jolts on board governance practices and its impact on firm value
firm value has changed during the 2008 finan- show evidence in support to the argument that
cial crisis. Our findings indicate that during the implementing best standards of board govern-
crisis period (2008–2010) the optimal board size ance is rewarded by the market through higher
shifted from 11 to 13 members, indicating that firm valuation.
larger boards may play an important role during
a jolt as they provide resources, expertise,
coordination and leadership to the company. LIMITATIONS AND FUTURE
Similarly, boards with more independent direc- RESEARCH
tors have created (destructed) more (less) value Our study provides a starting point for future
than their counterparts with less independent research on how the external environment and
board members; however, the effect of board the macroeconomic context may affect govern-
independence is more pronounced in times of ance practices and board structure and its rela-
munificence. We also show that companies tion with firm performance and value creation.
with more independent board members present As we offer evidence from a Western European
higher financial leverage in times of economic country, it would be fruitful to extend this
prosperity, evidence that the presence of inde- study to different institutional environments
pendent board members has a signaling effect (that is, common law countries, different bank-
that enhances the creditworthiness of the firm. ing systems, different predominant ownership
However, in times of crisis boards with more structures) and stages of development (that is,
independent directors take on less debt than extend the study to emerging markets).
do boards with less independent directors.
An important result that shows the monitoring
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