Board Independence and Firm Performance: A Contingency Model Based on Shareholders' Proximity to Management

Abstract

Board independence is considered as a key corporate governance mechanism to help preserve the necessary checks and balances between the board and executive management. Despite all the value placed on the independent director by financial market participants and regulators, empirical evidence on the relation between board independence and firm performance is largely inconclusive. This creates an excellent opportunity to revisit the underlying theoretical framework that supports the concept of board independence.

We propose a contingency model that integrates both agency theory and stewardship theory. We hypothesize that the board independence-performance relationship is moderated by shareholders’ proximity to the locus of management. Shareholders’ proximity to management is defined based on the level of ownership concentration and whether or not the dominant/controlling shareholder holds a top executive position in the firm. The lowest level of proximity is evidenced in firms with dispersed ownership, the highest level, in controlled entities, that is, entities where a shareholder owns more than 50% of the votes (legal control). We propose contrasting predictions regarding the board independence-performance relationship along the shareholders’ proximity spectrum.