The impact of company size and multiple directorships on corporate governance effectiveness

Abstract

Prior research provides two opposing theories as to whether having corporate directors that serve on multiple boards is beneficial or harmful to governance effectiveness. One line of prior research tests the ‘Busyness Hypothesis’, which states that as directors accept additional outside directorships, they become overcommitted or distracted, resulting in a decrease in governance effectiveness. Alternatively, the ‘Experience Hypothesis’ predicts that as directors accept additional directorships, they gain valuable experience which results in an increase in governance effectiveness. But past research has provided conflicting results regarding the above two hypotheses. In this article, we predict that both effects may occur simultaneously, but that governance effectiveness will be enhanced for directors who gain what we label ‘beneficial experience’ from outside board service. We maintain that directors may gain beneficial experience by serving on outside boards of companies that are comparatively larger. We further argue that this beneficial experience will be stronger for directors of small companies. Using a company’s reported internal control weaknesses as our proxy for corporate governance effectiveness, we find that governance effectiveness may be enhanced by encouraging directors to serve on outside boards of companies that are comparatively larger. In addition, we find that this increase in governance effectiveness is more pronounced for directors of small companies than for directors of large companies. Such information should be useful to board members, management, investors, or other stakeholders that have an interest in whether members of a board of directors should pursue additional outside board memberships.