a1 [email protected], Owen Graduate School of Management, Vanderbilt University, 401 21st Ave. South, Suite 304, Nashville, TN 37203.
This paper models the interaction of firm insiders and outsiders on a corporate board and addresses the question of the board's ideal size and composition. In the model, the board is responsible for monitoring projects and making CEO succession decisions. Inside directors are better informed regarding the quality of firm investment projects, but outsiders can use CEO succession to motivate insiders to reveal their superior information and help the board implement higher value projects. The optimal board structure is determined by the trade-off between maximizing the incentive for insiders to reveal their private information, minimizing coordination costs among outsiders and maximizing the ability of outsiders to reject inferior projects. I show that optimal board size and composition are functions of the directors' and the firm's characteristics. I also develop testable implications for crosssectional variations in the optimal board structure across firms.