An Analysis of the Association between Firms’ Investment Opportunities, Board Composition, and Firm Performance

According to agency theory the corporate board is an important internal governance mechanism. However, the board’s capacity to monitor is jeopardized if internal members (executives of the corporation or others affiliated with management) dominate the board. Critics of corporate governance suggest that board monitoring will be more effective if boards consist primarily of independent outside directors and from increased shareholdings of directors (Kren and Kerr, 1997). However, the results of previous studies testing board effectiveness have been mixed. The purpose of this paper is to identify the variables that influence the board structure adopted by firms and the subsequent relationship to the firm’s performance. The results of this study show that firms’ investment opportunities are strongly associated with a higher proportion of executive directors on the board. However, when testing the efficiency of the board as a monitoring device, the results show that the negative relationship between a firm’s investment opportunity set and firm performance is weakened at higher levels of nonexecutive director board domination. The results of this study have implications for policy setters and managers of firms with investment opportunities.