Does Board Expertise Always Enhance Firm Performance?

Monday, May 13, 2019

buildingsPolicy makers and regulators generally believe firms should enlist directors with more expertise. For example, the U.S. Securities and Exchange Commission (SEC) requires that effective February 2010, all public companies "disclose for each director and any nominee for director the particular experience, qualifications, attributes or skills that qualified that person to serve as a director."

Associate Professor Joyce Tian from the School of Accounting and Finance and her co-author, Xiaojing Meng (New York University) find that firms' project investment decisions improved with higher board expertise. However, higher board expertise can also have negative impacts on executive incentives, which are generally neglected by the regulators and the public.

On the one hand, when board expertise is low relative to the CEO’s expertise, they find that "a little knowledge is a dangerous thing." In this case, adding directors with higher expertise only interferes with the project implementation. The firm should choose the directors with even less expertise so that the CEO can focus on his or her own assessment. On the other hand, when board expertise is high enough to supersede the CEO's assessment, it creates incentives for the CEO to misrepresent information about the project quality so he or she will receive higher bonuses. To avoid the perverse incentive problem, the firm should select directors with comparable expertise to the CEO. 

Tian and her colleague argue that a firm's optimal choice of directors' expertise depends on the pool of available corporate directors, which presumably is idiosyncratic. Thus, they are against policies concerning board expertise to be one size fits all. Firms should be given the flexibility to choose directors with the most suitable expertise to fit their different needs.

Xiaojing Meng and Jie Joyce Tian. 2019. Board Expertise and Executive Incentives. Management Science, forthcoming.

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