An Optimal Proportion for Independent Directors in the Boardroom: An Empirical Study

Abstract

The purpose of the article is threefold: (a) to analyze the causality between board independence and performance of the firm, (b) to examine the impact of board independence on financial performance, and (c) to ascertain whether the legislation of at least 50% of independent directors (IDs) influences the performance of the firm. We have employed a panel data framework for a sample of 442 Indian companies from 2013 to 2019. The estimation analysis has been conducted using panel Granger causality test, fixed effects method, and system generalized methods of moments. We further test whether the relationship differs across two categories of companies: one having IDs up to 50% and more; and second, the proportion is less than 50%. The results of our dynamic panel data analysis indicate that the ratio of IDs is found to have a positive association with the firm performance. Further, we found that firms with more than 50% IDs have a significantly higher firm performance than firms having less than 50% IDs. There should be an adequate ratio of independent members on board to avail benefits from their independent judgments without intervention in the ordinary course of business. It could be used as a preliminary study by the policymakers and regulatory authorities to set additional standards for the number and proportion of IDs.