Firm Complexity and Board Size

With a plug for Outsourcing the Board

A new paper by Tim Loughran, Bill McDonald, and Jun Yang revisits the debate over whether there is a correlation between a firm’s complexity and the size of the firm’s board of directors (summary on CLS Blue Sky Blog and actual paper).

Loughran et al. collected 75,000 firm-year observations from annual reports filed between 1995-2022, to which they applied a specialized lectionary of 53 "complexity words.” A firm’s complexity is measured by the proportion of these words appearing in its annual report.

Rather than using a single complexity measure, they arranged the lexicon into six distinct categories: Finance, Legal, Accounting, Hedging, International, and Organizational Form. They assert that this approach allowed them to investigate whether different forms of complexity require different optimal board sizes, which in turns allowed them to evaluate the trade-off between the advisory benefits of larger boards versus the monitoring advantages of smaller ones.