Understanding Change in Board Composition: Determinants of board composition and effects of outside directors

This paper examines the determinants of board composition and the effects of outside directors using a sample of Japanese firms listed on the Tokyo Stock Exchange (TSE) first section from 2005 to 2010. Our empirical results are mainly consistent with the hypothesis that firms choose board composition based on the benefits and costs of advising and monitoring. Together, our results show that the effects of outside directors depend on the difficulty of their acquisition of information. Further, we find that some firms with low information cost tend not to appoint outside directors voluntarily for managerial entrenchment reasons, although such directors are strongly associated with better performance when appointed to firms whose cost of acquiring information is low. We conclude that certain measures that encourage firms to appoint outside directors are indispensable. However, the finding that regulations imposing uniform requirements on board composition entail not only benefits but also costs suggests that the one-size-fits-all approach of board regulations may be misguided.