I haven't been blogging much lately, mainly because I've been working away on meeting the looming 9/15 deadline for submitting my forthcoming book, The Complete Guide to Sarbanes-Oxley, to the publisher. In working on the book, I've learned a lot about SOX. One tidbit, which I found interesting because it relates to work I've done on group decision makning by boards of directors, is the impact SOX and related stock exchange listing standards is having on the size of boards of directors.
There’s a very famous 1913 industrial psychology study that confirms the old adage “too many cooks spoil the broth.” The researcher measured how hard subjects pulled on a rope. Members of two-person teams pulled to 93% of their individual capacity, members of trios pulled to only 85%, and members of groups of eight pulled to only 49% of capacity. The researcher named the phenomenon “social loafing.” It’s attributable partially to the difficulty of coordinating group effort as group size increases. Social loafing is also attributable, however, to the difficulty of motivating members of a group where identification and/or measurement of individual productivity is difficult —i.e., where the group functions as a team.
While board decision making differs rather dramatically from tug-of-war, members of a multi-member board nevertheless likely engage in a certain amount of social loafing. To be sure, unlike a team in a tug-of-war game, board members probably do not get into each other’s way. Accordingly, it is unlikely that there will be physical coordination problems. Yet, because social loafing is also attributable to the difficulty of motivating members of a team with non-separable outputs and non-observable inputs, it nevertheless also can be expected with respect to the workings of a relational team like the board.
Although the social loafing phenomenon suggests that smaller boards probably are more effective, there are considerations cutting in the other direction. For example, larger boards may facilitate the board’s resource-gathering function. Having more directors usually translates into more interlocking relationships with other organizations that may be useful in providing resources, such as customers, clients, credit, and supplies. Board interlocks may be especially helpful with respect to formation of strategic alliances. Firms considering a joint venture need access to credible information about the competencies and reliability of prospective partners. Almost by definition, however, this information is asymmetrically held and subject to strategic behavior. Interlocks between prospective partners provide both access to such information and, by analogy to hostage taking, a credible bond of the information’s accuracy.
Larger boards with diverse interlocks are also likely to include a greater number of specialists—such as investment bankers or attorneys. This is relevant not only to the board’s resource gathering function, but also to its monitoring and service functions. Complex business decisions require knowledge in such areas as accounting, finance, management, and law. Providing access to such knowledge can be seen as part of the board’s resource gathering function. Board members may either possess such knowledge themselves or have access to credible external sources who do. Larger, more diverse boards likely contain more specialists, and therefore should get the benefit of specialization.
So is there an optimal board size? This is yet another situation in which one size likely does not fit all, but corporate governance experts generally agree that seven to nine members is the right size for most boards.