Academic journal article International Journal of Management

The Relationship between Board Characteristics and Financial Performance: An Empirical Study of United States Initial Public Offerings

Academic journal article International Journal of Management

The Relationship between Board Characteristics and Financial Performance: An Empirical Study of United States Initial Public Offerings

Article excerpt

This study investigates the relationship between board characteristics and financial performance for 223 U.S. firms making initial public offerings from 2000 to 2002. Board characteristics include board independence(i.e., outsiders-dominated boards), board quality(i.e., board expertise and educational background) and venture capital directors. Financial performance is measured by Tobin's Q. Tobin's Q is calculated as the sum of the market value of equity, the book value of preferred stock and the book value of total debt divided by the book value of the firm's assets. The sample firms are obtained from Thompson Financial SDC database. Empirical results show that board independence are negatively related to firm performance. As expected, board quality are positively related to firm performance. However, there is no evidence that venture capital directors are positively associated with financial performance.

Introduction

Because of accounting scandals as Enron and WorldCom, the Sarbanes-Oxley Act addresses the independence of directors and audit committee to align managerial behavior with the interests of shareholders (Klein, 2003). Correspondingly, empirical research investigates the board characteristics and firm performance of large companies (e.g., Agrawal & Knober 1996; Coles, McWilliams, & Sen, 2001). These include board independence and CEO duality. Rosenstein and Wyatt (1990) find that shareholder wealth increases with independent directors. Baliga, Moyer, and Rao (1996) find little evidence that CEO duality affects firm performance.

The initial public offering (IPO) represents the first time that firms raise money from dispersed investors (Jain & Kini, 1999). Firms undergoing an IPO face many important governance decisions, such as how to structure the boards of directors and mitigate conflicts between owners and managers. Studying factors that affect such decisions would increase our understanding about how firms transit from private to public ownership (Engel, Gordon, & Hayes, 2002). Therefore, the IPO setting offers an important advantage for this research.

I investigated the relationship between board characteristics and financial performance in IPO firms. Board characteristics in IPO firms include: board independence (i.e., outsidersdominated boards), board quality (i.e., board expertise and educational background) and venture capital directors. Financial performance is measured by Tobin's Q. Tobin's Q is calculated as the sum of the market value of equity, the book value of preferred stock and the book value of total debt divided by the book value of the firm's assets ( Erickson, Reising,& Shin , 2005).

The rest of this paper is structured as follows: I first review literature and develop the hypotheses. The second section describes the sample data and methodology. I then present the results of the tests and the primary conclusions.

Literature Review and Research Hypotheses

Agency theory suggests that shareholders require protection because managers may not act in the interests of shareholders (Jensen & Meckling, 1976). Therefore, directors exist to protect the interests of shareholders (Dezoot, Hermanson, Archambeault, & Reed, 2002). On behalf of shareholders, boards of directors oversee the firms. They are the experts in their fields such as finance, marketing, technology, and public policy. Therefore, boards narrow the information gap between shareholders and management, and make important decisions such as mergers and acquisitions, capital allotments, and corporate strategies (Petra, 2005). Therefore, I review the monitoring functions of the boards of directors and develop research hypotheses as the following:

Independent Directors

Fama and Jensen (1983) theorize that shareholders delegate the internal control to boards of directors giving the boards the ultimate decision-making roles within organizations. Although boards delegate many decisions to top management, they hold ultimate control over management. …

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