Board Effectiveness and Short Termism

Abstract

We examine whether more effective boards in terms of size, experience, shareholding and independence, as discussed in the 2010 UK Corporate Governance Code, limit excessive short-term risk taking or short-termism. We use a state-of-the-art asset pricing model that enables the disentangling of short-term risk (related to short-term returns) and long-term risk (related to long-term returns), and use the former as a proxy for short-termism, where the short-term component not only represents the time horizon for which we are interested but also the risk that is not related to fundamentals (Campbell and Vuolteenaho, 2004).We examine 916 firms in the UK over a possible horizon of 18 years, January 1992-December 2010, and find that more effective boards are associated with lower levels of short-term risk and this result is robust to various types of short-term risk (overall, down side) and specifications.