Using Geographic Density of Firms to Identify the Effect of Board Size on Firm Value and Corporate Policies

• Published date: 01 February 2020
• DOI: http://doi.org/10.1111/ajfs.12285
• Date: 01 February 2020

Using Geographic Density of Firms to

Identify the Effect of Board Size on Firm

Value and Corporate Policies*

Pandej Chintrakarn

Business Administration Division, Mahidol University International College, Thailand

Shenghui Tong

Department of Finance, Siena College, United States

Pornsit Jiraporn

Great Valley School of Graduate Professional Studies, Pennsylvania State University, United States

Young Sang Kim**

Haile/US Bank College of Business, Northern Kentucky University, United States

Received 13 December 2018; Accepted 23 September 2019

Abstract

Prior research shows that firms tend to recruit directors from the geographically proximate

area. Due to a limited supply of qualified individuals in a given area, firms located in close

proximity have to share a limited pool of talented individuals. As a result, the more firms

there are in the same area, the fewer directors each firm in the area is able to obtain on aver-

age. We exploit the variation in the numbers of firms across zip codes and estimate the

effects of board size on various corporate outcomes: accounting profitability, leverage, divi-

dend payouts, and merger and acquisitions.

Keywords Boards; Corporate governance; Instrumental variable; Firm value; Capital struc-

ture; Dividend policy

JEL Classification: G14, G32, G34

*Part of this research was carried out while Pornsit Jiraporn served as Visiting Researcher at

The National Institute of Development Administration (NIDA) and at SASIN School of Man-

agement, Chulalongkorn University, both in Bangkok, Thailand.

**Corresponding author: Professor of Finance, Haile/US Bank College of Business, Northern

Kentucky University, Nunn Drive, Highland Heights, KY 41099, United States. Tel: +1-859-

572-5160, email: kimy1@nku.edu.

Asia-Pacific Journal of Financial Studies (2020) 49, 36–66 doi:10.1111/ajfs.12285

36 ©2020 Korean Securities Association

1. Introduction

The board of directors is crucially important as it serves as the paramount gover-

nance mechanism that safeguards shareholders’ interests. Not surprisingly, the aca-

demic literature in the past few decades is replete with studies examining the board

of directors. The significance of the board, however, transcends academics. Legisla-

tors and regulators also pay close attention to the board, as evidenced by the Sar-

barnes-Oxley Act and the associated exchange requirements requiring public firms

to have a majority of independent directors on the board. Board quality has been

traditionally measured by two dominant attributes: board independence and board

size. One important challenge that has plagued empirical research in this area is the

issue of endogeneity. Many earlier studies did not account for endogeneity. The

more recent literature has recognized that board independence and size are endoge-

neously determined.

A large number of studies in the literature have explored the effects of geogra-

phy on corporate outcomes and policies. For instance, geographic location has been

found to influence stock ownership (Becker et al., 2011; Gasper and Massa, 2006),

dividend policy (John et al., 2011; Becker, Ivkovic and Weisbenner, 2008), venture

capital financing (Gupta and Sapienza, 1992; Norton and Tenenbaum 1993; Soren-

son and Stuart 2001; Cumming, 2006), equity financing (Loughran, 2008), mergers

and acquisitions (Uysal, Kedia, and Panchapagesan, 2008), bond markets (Butler,

2008; Francis, Hasan, and Waisman, 2008), systematic risks of stocks (Pirinsky and

Wang, 2006), stock liquidity (Loughran and Schultz, 2005), capital structure and

dividend policy (Gao, Ng, and Wang, 2011), bank financing (Beck, Demirguc-Kunt,

and Maksimovic, 2004; Maurer and Haber, 2003; Cetrorelli and Strahan, 2006;

Degryse and Ongena, 2005), managerial entrenchment (Chintrakarn, Jiraporn,

Tong, and Chatjuthamard, 2015), and corporate social responsibility (Jiraporn

et al., 2014; Chintrakarn, Jiraporn, Jiraporn, and Davidson, 2017). Despite the large

number of studies in this area, the effect of geographic density on board size has

not been examined in the literature. We intend to fill this void in the literature.

Our study is the first to explore the effect of geography on board size.

In this paper, we hypothesize that board size is partly determined by the num-

ber of firms in the geographically proximate area. Knyazeva, Knyazeva, and Masulis

(2013) suggest that firms tend to recruit directors from geographically proximate

areas. It also makes practical sense for prospective directors to accept appointments

from firms located close by than from firms much further away, both for travel

convenience and for reduced information asymmetry. In general, directors are

appointed from individuals with exceptional qualifications and professional experi-

ence. Given a limited supply of such qualified individuals in a specific area, firms in

the same area have to share them. In an area with a large number of firms, each

firm is able to get fewer such individuals, making their board size smaller on aver-

age. On the contrary, in an area with only a few firms, each firm is able to appoint

Geographic Density, Board Size, and Firm Value

©2020 Korean Securities Association 37