Original Article

The effect of environmental jolts on board

governance practices and its impact on firm
value
Received (in revised form): 12th May 2015

Eloisa Perez-de Toledo

is Associate Professor, Accounting and Finance Department at MacEwan University in Edmonton (Alberta), Canada. Her research is focused
on the dynamics of environmental, social and governance (ESG) practices and its impact on firm overall performance; and, on public
governance. She has papers published in the International Journal of Business and Finance Research, Corporate Ownership and Control,
International Journal of Sociology and Social Policy.

Maria Pilar Giraldez-Puig

is a Lecturer at the Department of Financial Economics and Accounting at Pablo de Olavide University in Seville (Spain), where she teaches
Finance. She has been a visiting lecturer at the DBHW Baden Wuttemberg Cooperative State University (Germany). She is currently working
on SMEs internationalization, with a particular emphasis on corporate governance. She has articles published in several journals including
Ethics and Journal of Financial Management. She holds a PhD from the University of Seville and can be contacted at mpgirpui@upo.es.

Jose Manuel Hurtado-Gonzalez

is Associate Professor of Strategic Management at Pablo de Olavide University in Seville (Spain). His main research and teaching interests
are in the areas of strategic management, corporate governance and innovation. His research has been published in several journals
including Business ethics: An European Review, Technovation and TQM & BE. He can be contacted at hurtado@upo.es.

ABSTRACT Environmental jolts are temporary disruptions that cause a hostile transformation
in the level of resources available in a given system. Using the 2008 financial crisis as a moderator
factor in the relationship between board structure and firm value, we assess whether there are any
changes in board governance practices as a result of firms adaptation to the changes caused by the
crisis. Our results show that in this new reality where resources are scarce and growth opportu-
nities are scant a new board configuration is required. During the crisis period, the relationship
between board size and firm performance is such that larger boards are more capable of respond-
ing to a crisis, the presence of independent directors prevents firms from increasing financial
leverage and managers get entrenched at higher levels of board ownership. The study has useful
implications for practitioners as it compares the impact of the adoption of best board governance
practices on firm value in times of munificence and during environmental jolts.
International Journal of Disclosure and Governance advance online publication, 18 June 2015;
doi:10.1057/jdg.2015.6

Keywords: environmental jolts; board governance; firm value; dynamic panel data

Correspondence: Eloisa Perez-de Toledo,

INTRODUCTION
MacEwan University, Accounting and Finance Corporate governance practices have been
Department, Rm 5-225K, Edmonton, AB, Canada established in order to increase the degree of
10700 104 investor protection and consequently enhance

© 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21
www.palgrave-journals.com/jdg/
 Perez-de Toledo et al
the value of investments. Directly, better gov-
ernance structures imply better mechanisms of
management. Indirectly, better investor protec-
tion is associated with higher valuation by the
stock markets (La Porta et al, 2002). The
adoption of specific governance structures by
firms was driven mainly by institutional factors,
for instance, the practices imposed by the
national Codes of Best Practices. Nonetheless,
most codes were introduced in times of munifi-
cence or economic prosperity when firms do
not face serious obstacles in achieving growth.
However, in times of adversity and hostility
when traditional mechanisms fail, the use of
best governance practices should be reinforced.
From a research perspective, economic crises
offer a powerful setting for testing the effective-
ness of good governance practices. Environ-
mental jolts (for example, economic crises,
social and political turmoil) affect and influence
management practices (Meyer, 1982; Meyer
et al, 1990; Meyer et al, 2005). The destabiliza-
tion caused by environmental jolts can take to a
re-examination of institutionalized logics and
practices and to a reorientation of organiza-
tional strategies and processes (Oliver, 1992;
Venkataraman and Van de Ven, 1998). In this
article we analyze and compare the effectiveness
of governance practices in creating firm value in
times of stability (2003–2007) and in avoiding
the destruction of firm value in times of envir-
onmental jolts (2008–2010).
The setting for exploring these interrelations
is Spain, a western European country character-
ized by high ownership concentration, a great
number of family businesses, a high degree of
bureaucracy, low participation of individual
investors in stock markets and a banking sector
that has great importance in providing financing
to the firms. Moreover, the main mechanism of
governance is the concentration of ownership
and external governance mechanisms (that is,
market for corporate control) are unusual
(Leech and Manjón, 2002). Nonetheless, these
are common characteristics of other Western
European countries. Therefore, this study con-
tributes to the literature on the effectiveness
2 © 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance
of governance practices in creating firm value in
times of munificence and during environmental
jolts in Europe.
Our results show that the optimal board size
during the crisis period (2008–2010) is larger
than during times of munificence and that
boards with more independent directors have
created (destructed) more (less) value than firms
with less independent board members. More-
over, independent boards have more financial
leverage in times of economic prosperity;
however, in times of crisis boards with more
independent directors take on less debt than
companies with less board independence.
We also find evidence of a concave relationship
between board ownership and firm value and
that, during a jolt, managers get entrenched at
higher levels of inside ownership.
The article is structured as follows. The next
section gives an overview of the Spanish govern-
ance model and defines environmental jolts. In
the Section ‘Theoretical predictions and hypoth-
eses’, the hypotheses are constructed and the
rational for our study is given based on a review
of the literature. Data, sample and methodology
are described in the Section ‘Methods’. Results
are discussed in the Section ‘Results’ and the
Section ‘Conclusion’ concludes the paper.
THE SPANISH GOVERNANCE
SYSTEM
In Spain, the Aldama Report and the Olivencia
Code set the basis for the Spanish Code of Best
Practices (Unified Code) that, in the case of
board structure, recommends boards to be
composed mostly by external independent
directors, but the adoption of such provision is
left to companies’ self-regulation. However,
self-regulation has proved to be absolutely
ineffective in making companies adopt the
necessary provisions that consist in an efficient
corporate governance structure. The decision
by Spanish regulators of adopting a more
lenient normative is because the Spanish code
is closely aligned to the British Cadbury
Report. The main focus of the British code is
1–21
 The effect of environmental jolts on board governance practices and its impact on firm value
on boards’ monitoring responsibilities and it
notably highlights the importance of non-
executive directors, but fails to establish a
specific percentage of external (independent)
directors that must compound the boards and
audit committees. Besides, as emphasized by
Osma and Noguer (2007), there are some
doubts on the appropriateness of adopting a
code that closely benchmarks itself against the
UK model, since the Spanish legal tradition,
institutional environment, degree of investor
protection (La Porta et al, 1998; La Porta et al,
1999) and ownership structure are clearly
dissimilar.
Spanish boards are composed by three types
of directors: executives, dominicals and inde-
pendents. Executives are those directors who
are also officers of the company and that are
directly involved with the management of the
firm, dominical directors represent significant
shareholders, and independent directors are
classified as non-executives along with the
dominicals. Although, dominicals and indepen-
dent directors clearly have different priorities
and incentives, both are considered as external
to the firm by the Spanish code. Independent
directors are supposed to be experts in the
industry, hired to represent the interests of
minority shareholders and contribute with their
expertise to the development of the firm’s
strategy. Nonetheless, the fact that the code let
the adoption of the proposed provisions to the
discretion of the boards, which are largely
influenced by the controlling shareholders, and
that the nominating committees are composed
mostly by dominical directors and sometimes
also by executives, raises concern about the
‘independence’ of Spanish boards.
ENVIRONMENTAL JOLTS
An environmental jolt is broadly defined as a
drastic change in the level of resources available
in the environment, as defined by Meyer (1982,
p. 515) jolts are ‘transient perturbations whose
occurrences are difficult to foresee and whose
impacts on organizations are disruptive and
© 2015 Macmillan Publishers Ltd. 1741-3591
potentially inimical’. Classical examples of jolts
are economic crises, catastrophes, social and
political unrest. In organizational settings,
environmental jolts may affect firms’ organiza-
tional practices as they often cause hostile
transformations in the environment (Meyer,
1982; Dess and Beard, 1984). Moreover, during
a jolt there is a change in the level of resources
available in a given system, which often changes
the balance of forces in that system. In this new
context, the organizations that are able to
quickly respond or adapt to the new configura-
tion can create a competitive advantage over
their competitors that are not as quickly respon-
sive to the change. In the words of Charles
Darwin ‘It is not the strongest of the species that
survives, nor the most intelligent, but rather the
one most adaptable to change.’
Financial crises are an example of environ-
mental jolts that change the level and availabil-
ity of resources in the system (Dess and Beard,
1984). The capacity to respond in a timely
manner to these changes ultimately determines
the survival of any given organization operating
in the system. Moreover, jolts highlight institu-
tionalized assumptions about the environment
and reveal unexpected relationships between
institutionalized practices, organizational forms,
and outcomes that may not be apparent in times
of stability (Strang and Bradburn, 1993; Sine
and David, 2003). Therefore, organizational
structures and practices that have been working
well in times of munificence are put to the
test in times of environment jolts (Meyer,
1982; Meyer et al, 1990; Meyer et al, 2005).
Corporate governance structures, in particular
board structure and board composition, are
important institutions within organizations
capable of altering firm’s access to resources
and of making the firm better adapt to the fast
changing environment. For this reason, we
argue that the board of directors plays a major
role in making the organization adapt to this
new reality where resources are scarce and
expensive. Moreover, the strategic direction
designed by the board in times of crises is
fundamental to the survival of the organization
International Journal of Disclosure and Governance 1–21 3
 Perez-de Toledo et al
during a jolt and to firm’s success in the after-
crisis period.
From a strategic perspective, the design of
corporate governance structures is directly
related to the competitive advantages that the
firm needs to exploit. Outside directors or
independent board members represent a critical
element that strengthens external relations and
provide information about and access to valu-
able resources. Among the intangible assets that
outsiders can provide are advice and counseling,
legitimacy, a channel for the communication of
information between the firm and external
entities, and assistance in obtaining resources
and commitments from important entities out-
side the firm (Hillman et al, 2000; Lynall et al,
2003; Pfeffer and Salancik, 2003). Outside
directors can reduce the uncertainty that is
created by the environment, and can help the
firm to achieve a better competitive position
(Pfeffer, 1972; Hillman et al, 2000). Salancik
and Pfeffer (1978) argue that when a firm adds a
new member to its board, there is an expecta-
tion that the new member will support the
firm's interest in trying to solve its most pressing
problems. Board effectiveness can be enhanced
with the inclusion of more independent direc-
tors as they are not colluded with executives or
main shareholders, which can improve firm
performance (Kor, 2006; Jackling and Johl,
2009; Musteen et al, 2009). McNulty and
Pettigrew (1999) argue that boards play an
active and central role in strategy formulation
which contributes positively to firm perfor-
mance. The effective management of uncer-
tainty provides firms with more power and
therefore increases their chances of survival and
success in the marketplace (Singh, 1986).
We argue in this article that board structure is
an important governance mechanism that
makes companies adapt to the breakthrough
changes caused by a jolt through its impact on
firm performance. More specifically, board
independence, board size and board ownership
are key strategic factors in the process of firm
adaptation and performance achievement. By
comparing the effect of board structure on firm
4 © 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance
performance before and after the 2008 financial
crisis, we are able to gauge the moderating
effect of an environmental jolt in this
relationship.
THEORETICAL PREDICTIONS
AND HYPOTHESES
Board composition is used in this study as a
proxy for governance practices because of its
importance in the Spanish corporate govern-
ance system. The board of directors has a
fundamental role in a corporate governance
system, considered a major internal mechanism
along with ownership concentration; it is used
to reduce agency costs. As argued by Fama and
Jensen (1983) the board of directors is one of
the most important organizational controls. It
separates the management function from the
control aspect of the decision-making process,
and have the potential to mitigate agency
conflicts between shareholders and executives,
but also between controlling and minority
shareholders in a concentration of ownership
environment, as in the case of Spain. Board
composition is a crucial factor in this regard,
since independent directors are entitled to
watch over the separation between manage-
ment and control, assuring an effective mon-
itoring function of the board. If the board is
composed primarily by executives and other
insiders and the duality CEO-Chairman is
present, it is fair to suppose that the monitoring
function will not fully work, compromising its
role as an important governance mechanism.
Next, we provide a literature review of each
board structure component and its relationship
with firm performance in times of munificence
and during environmental jolts.
BOARD INDEPENDENCE
Independent directors are assumed to improve
the monitoring and control functions of the
board and increase firm value as their presence
potentially increases the degree of convergence
among board members, and help prevent the
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 The effect of environmental jolts on board governance practices and its impact on firm value
entrenchment effect. As independent board
members are less concerned with preserving
their positions, they have more autonomy in
judging the leadership skills and other high-
level competences of senior executives
(Renneboog, 2001). In addition to improving
the control function, independent directors
bring experience and expertise to the company
(Donaldson and Davis, 1991; Hillman and
Dalziel, 2003) and also contribute more effec-
tively to firm success as they provide intangible
resources that also protect and enhance firm
value (Huse, 2009). The active involvement of
boards in the formulation of firm’s strategy is
currently viewed as sine qua non to firm’s value
creation (Demb and Neubauer, 1992; Pugliese
et al, 2009; Machold et al, 2011). The presence
of independent directors is aimed at enhancing
the representation of diverse groups of
stakeholders, and in special, of minority share-
holders. They also contribute to the develop-
ment of the firm’s strategy by bringing an
external perspective to the discussions. Pathan
(2009) finds that the presence of independent
directors hinders banks’ risk-taking behavior, as
independent board members may try to achieve
a balance between shareholders expectations
and stakeholders’ interests. Similarly, Yeh et al
(2011) argue that in the case of financial institu-
tions independent directors can help improve
performance by reducing risk-taking behavior.
The presence of outside directors also has an
important signaling effect, as it allegedly
improves the monitoring function of the board,
thus reducing agency problems. This signaling
effect has important implications as it can
increase firms’ access to resources and reduce
the cost of acquiring such resources (that is,
external capital). Anderson and Reeb (2004)
show evidence that a larger number of outside
directors is related to lower costs of debt.
Ertugrul and Hegde (2008) extend his findings
by considering the form of compensation
offered to outside directors (that is, equity-
based compensation), and find that it also low-
ers the cost of debt, especially for lower-rated
debt firms. For this reason, most codes of best
© 2015 Macmillan Publishers Ltd. 1741-3591
practices around the world recommend that the
majority of board members ought to be inde-
pendent directors, given the potential of inde-
pendent directors to positively influence firm
performance (for example, the Australian,
Canadian, French, Spanish, the United King-
dom and the United States codes). In theory,
independent directors are in a better position
than insiders to protect the interests of all
stakeholders based on their presumed experi-
ence and respect for ethical and legal obligations
(Rodriguez-Dominguez et al, 2009). The
expected contributions of outsiders to firm
performance is manifested through the roles or
functions they perform, including the role of
monitoring and control of management, as
emphasized under the agency theory (Zahra
and Pearce, 1989; Johnson et al, 1996; Daily
et al, 2003) and the role of provider of advice
and other resources emphasized under the
resource dependency theory (Pfeffer, 1972;
Hillman et al, 2000). The role played by
independent directors is expected to have a
positive impact on firm value creation, as a
stronger monitoring function should be trans-
lated into greater control by the board over the
activities in which the organization is produc-
tively and commercially engaged, thereby help-
ing to improve firms’ internal performance. In
addition, by having a greater percentage of
independent directors, the company sends a
signal to external entities that are likely to
believe that management is being properly
supervised. This could generate a better general
appreciation of the firm by the market, autho-
rities and regulators (Huang et al, 2008). How-
ever, the effect of board independence on firm
performance is still unclear in the literature.
Hermalin and Weisbach (1991) do not find a
significant relation between board structure and
performance. Baysinger and Butler (1985b) find
weak evidence of an association between board
independence and firm performance in the long
run. Agrawal and Knoeber (1996) test the
impact and the interrelations of a set of govern-
ance mechanisms on Tobin’s q and, after using a
system of simultaneous equations, the only
International Journal of Disclosure and Governance 1–21 5
 Perez-de Toledo et al
effect that remains significant is the negative
effect of outsiders on the board on firm perfor-
mance. More recently, Franks et al (2001)
examine a sample of poorly performing firms
in the United Kingdom and find that boards
dominated by outside directors actually impede
discipline of poorly performing managers.
The role of independent directors during
financial crises is underexplored in the litera-
ture. In times of environmental jolts, indepen-
dent directors can reduce the uncertainty that is
created by the shock and can help the firm to
achieve a better competitive position (Pfeffer,
1972; Hillman et al, 2000). In particular, orga-
nizations that operate with a high degree of
uncertainty could effectively raise significant
resources through their boards of directors
(Mizruchi, 1983). Therefore, the role of inde-
pendent directors should be emphasized during
environmental jolts as they are assumed to
provide the necessary resources and knowledge
that will help the firm to survive. Research in
corporate governance has shown that the board
of directors may play a critical role in monitor-
ing executives and in confronting executives’
tendency to minimize the effects of bad
strategic decisions in the current period firm
performance (McDonald and Westphal, 2003;
Sundaramurthy and Lewis, 2003; Westphal and
Bednar, 2005). Independent directors do not
formulate or implement a firm’s strategy, for
this reason they are suitable to criticize the
executives if the current strategy is not working
(Walsh and Seward, 1990). However, indepen-
dent board members with no experience in the
industry (especially in highly specialized sectors)
have limited capacity to contribute to firm
strategy, in particular in times of crisis.
Therefore, the arguments above lead us to
propose the following hypotheses:
Hypothesis 1a: Board independence has a
positive effect on firm performance in
times of munificence.
Hypothesis 1b: The positive effect of board
independence is accentuated during an
environmental jolt.
6 © 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance
CEO DUALITY
Agency theory and stewardship theory propose
different frameworks for CEO duality as a
governance mechanism. Agency theory argues
that CEO duality may generate abuse of power
and that the separation of both roles may
enhance the monitoring function of the board
and reduce the degree of CEO entrenchment, as
a result it positively affects firm performance.
In contrast, the stewardship theory states
that CEO duality may improve performance
because of increased scope, control and effec-
tiveness. At a first glance, these theories
seem controversial; however, Finkelstein and
D’Aveni (1994) propose a contingency frame-
work that tries to integrate both theories, as they
argue they are complementary to each other.
The authors show that depending on a set of
circumstances, CEO duality may be avoided
(that is, when firms present good past perfor-
mance and when the CEO has high informal
power) but under a different set of conditions,
CEO duality may enhance firm performance.
Thus CEO duality should be contingent on a set
of firm characteristics as it is circumstantial. From
a normative perspective, however, most codes of
best practices recommend the separation
between the chair of the board and the CEO
positions. An increasing number of active share-
holders have, more recently, voiced their support
to the idea of avoiding CEO duality by promot-
ing the adoption of a dual leadership structure.
Even though most trends point out to a pre-
ference toward the separation between the two
positions, mainly in order to avoid CEO
entrenchment, the effect of CEO duality on the
performance of the firms is still inconclusive in
the literature. The majority of studies show that
firms opting for independent leadership consis-
tently outperformed those relying upon CEO
duality (Rechner and Dalton, 1991; Pi and
Timme, 1993); however, the context or the
circumstances play a very important moderator
role in this relationship (Finkelstein and D’Aveni,
1994; Rhoades et al, 2001; Elsayed, 2007). While
other studies find no association at all or show
that the costs associated with adopting an
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 The effect of environmental jolts on board governance practices and its impact on firm value
independent leadership structure are larger than
the benefits achieved (Baliga et al, 1996; Brickley
et al, 1997).
In times of environment jolt, CEO duality
may be beneficial as, according to organizations
theories, it improves unity of command and
sends a signal to stakeholders of assurance that
an unambiguous leadership is in place.
Therefore, the arguments above lead us to
propose the following hypotheses:
Hypothesis 2a: CEO duality has a negative
effect on firm performance in times of
munificence.
Hypothesis 2b: The negative effect of CEO
duality is reversed in times of environ-
mental jolts.
BOARD SIZE
Board size is an important governance mechan-
ism because of the relevance of the decisions
taken by the board to firm’s strategy and
performance (Zahra and Pearce, 1989; Palmer
and Barber, 2001). The empirical evidence on
board size shows a general negative association
between the size of the board and firm perfor-
mance (Eisenberg et al, 1998; Carline et al,
2009; de Andres et al, 2005; Mak and Kusnadi,
2005). However, the negative effect is better
explained as a quadratic relationship as the
positive impact on performance is reversed after
a certain size is achieved (Yermack, 1996).
Lipton and Lorsch (1992) are among the first
to indicate that directors rarely criticize the
policies of top managers and to recommend
limiting the membership of boards to 10 peo-
ple. In theory, larger boards can reduce the
dominance of the CEO and mitigate the
entrenchment effect. Nonetheless, in practice,
oversized boards may be informally divided into
groups with differing or even opposing points
of view or even agendas that negatively affects
the decision-making process and make boards
less effective. Boards with an excessive number
of members may neglect its monitoring role and
© 2015 Macmillan Publishers Ltd. 1741-3591
suffer from the free-rider problem (Hermalin
and Weisbach, 2003). As a result, some board
members may be able to entrench themselves as
the ‘free rider’ members fail to supervise the
executives. Some authors relate the effectiveness
of board size to other factors. Lehn et al (2004)
and Bennedsen et al (2008) argue that board size
and board structure are endogenously deter-
mined by firm size and industry complexity.
Large firms, because of the scope and scale of
their business, require specialized information
from the environment, which can be more easily
obtained with a larger number of outside direc-
tors. In this case, the relationship between board
size and firm performance may be positive albeit
quadratic, as the literature has consistently
shown, with its effect becoming ‘negative after
an optimal size is achieved. Therefore, we
propose the following hypotheses:
Hypothesis 3a: Board size has a quadratic
relationship with firm performance and
the positive effect of board size on firm
performance is reversed after an optimal
size is achieved.
Hypothesis 3b: In times of environmental
jolts, there is a shift to the left in the
quadratic effect, and the optimal board
size during environmental jolts is smaller
than in times of munificence.
BOARD OWNERSHIP
Board ownership is measured as the percentage
of total shares held by all board members
divided by the total number of shares outstand-
ing. In the case of Spain, dominical directors
represent the main shareholders; therefore,
board ownership can be used as a proxy for
active shareholders or the shareholders that
actually exert active control over the firm.
There are two possibilities for the effect of
board ownership on firm value in institu-
tional environments where concentration of
ownership is the rule, as is the case of Spain:
(i) the controlling shareholder(s) get entrenched
(the entrenchment effect), in which case a
International Journal of Disclosure and Governance 1–21 7
 Perez-de Toledo et al
negative effect of board ownership on firm
performance is expected or; (ii) the presence of
large shareholder(s) on the board increases the
monitoring and control over the managers (the
converge-of-interests hypothesis) positively
affecting firm value. The majority of studies
assumes insider/board ownership as exogenous
to the firm and find a non-monotonic relation-
ship between insider ownership and firm value
(Morck et al, 1988; Mcconnell and Servaes,
1990; Hermalin and Weisbach, 1991; Kole,
1995; Ødegaard and Bøhren, 2004). However,
some studies using simultaneous equations do
not support the hypothesis that insider owner-
ship is an exogenous variable but rather endo-
genously determined (Cho, 1998; Hermalin
and Weisbach, 1998; Himmelberg et al, 1999;
Demsetz and Villalonga, 2001). In the case of
Spain, de Miguel et al (2004) provide evidence
of the convergence-of-interest and the
entrenchment effects for Spanish firms during
the 90s. Using a robust methodology they
document a positive impact on firm value
for board ownership ranging from 0 to
35 per cent, then insiders get entrenched in the
range between 35 and 70 per cent, and again
the converge-of-interest effect seems to drive
the increase in firm value for proportions
exceeding 70 per cent. On the basis of the
findings of de Miguel et al (2004) we put
forward the following hypotheses.
Hypothesis 4a: Board ownership has a con-
cave relationship with firm value and, as
board ownership increases the negative
effect on firm value associated with
the entrenchment of manager-owners
starts to exceed the incentive benefits of
board ownership.
During environmental jolts managers have an
incentive to avoid firm value destruction, and
for this reason they get entrenched at higher
levels of ownership, which takes to following
hypothesis:
Hypothesis 4b: In times of environmental
jolts, managers get entrenched at higher
8 © 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance
levels of ownership; therefore, the turning
point is displaced to the right.
LEVERAGE
As described by Jensen (1986), the service of
debt creates a fixed cost that reduces the
amount of free cash flow mitigating the agency
problem. Leveraged companies have less free
cash flow available reducing thus the degree of
perquisite consumption by managers, as
the service of debt creates the so-called ‘disci-
pline of debt’. On the other hand, debt can
cause the underinvestment problem described
by Myers and Majluf (1984). At high levels of
financial leverage, debt holders capture most of
the net present value (NPV) of an investment
project. Thus debt can create an incentive for
controlling shareholders to give up positive
NPV projects and cause the underinvestment
problem. In this regard, financial leverage can
be seen as an alternative mechanism of govern-
ance and act as a substitute of other mechan-
isms. However, in this study we are more
interested in testing the hypothesis formulated
by Anderson et al (2004) that the presence of
independent directors enhances the validity of
accounting statements, which may be of great
importance to creditors when granting debt to
the companies. For this reason, we expect board
independence to be positively related to lever-
age in times of munificence. During environ-
mental jolts, this effect may be relaxed as
independent directors tend to be more conser-
vative and actively prevent companies to take
on excessive debt levels. Hence, our hypotheses
are formulated accordingly:
Hypothesis 5a: In times of munificence board
independence has a positive effect on the
degree of financial leverage adopted by the
firm.
Hypothesis 5b: During environmental jolts,
the presence of independent directors pre-
vents firms from increasing financial
leverage.
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 The effect of environmental jolts on board governance practices and its impact on firm value

METHODS independent directors (for example, the UK

Code).
Sample Regarding board ownership (our proxy for
Our sample consists of 101 publicly traded firms inside ownership), it can be observed from the
listed on the Mercado Continuo at the Madrid table that board members own on average
Stock Exchange at the end of calendar years 29.8 per cent of their firms’ shares. However,
2003–2010. Financial and accounting infor- there is a wide dispersion, as the distribution
mation was obtained from the Datastream ranges from 0 to 99 per cent with a median
database. Governance data was collected from ownership of 25.55 per cent. While some codes
the Corporate Governance Annual Reports recommend that part of directors’ compensa-
released by the companies. The reports were tion should be in the form of stock options to
downloaded from the webpage of the compa- align their interests to those of the shareholders,
nies or, alternatively, from the webpage of the most codes do not impose limits or make
Spanish Securities Exchange Commission. recommendations in that respect.
Table 1 reports descriptive statistics for the Finally, the firms were grouped by sector
sample. We construct a panel comprised of 101 according to the European Classification of
companies for which information is available Economic Activities. Table 2 provides a break-
for the years 2003–2010. As a result, we have a down by industry classification for the sample
balanced panel of 808 firm-year observations. firms.
Table 1 shows that the average board size of the As shown in this table, our sample is com-
companies compounding the sample is prehensive and covers all main sectors of the
11 members with a minimum of 3 members
and a maximum of 24. As a reference, the Table 2: Industry classification
Unified Code recommends a board size range
# of Percentage
of 5–15 members. firms
The proportion of independent directors
on the boards of our sample firms ranges from Petroleum and Energy 11 10.9
0–88 per cent, with an average of 28 per cent. Materials, Manufacturing and 24 23.8
The Unified Code recommends that indepen- Construction
dents should comprise at least 33 per cent of Consumer Goods 26 25.7
total board members. Most codes consider Consumer Services 17 16.8
board independence as a fundamental govern- Financial and Real Estate 20 19.8
Technology and 3 2.9
ance mechanism (for example, the US and
Telecommunications
Australian Codes), others recommend that the
Total 101 100
majority of the board should be composed by

Table 1: Descriptive statistics

Variable Mean Median Standard Deviation Minimum Maximum

Board Size 11.10 10.50 3.83 3.00 24.00

Board Independence 0.2842 0.2920 0.2058 0.0000 0.8800
CEO Duality 0.4079 — 0.4918 0 1
Board Ownership 0.2981 0.2555 0.2575 0.0000 0.9933
LN(Sales) 11.63 12.75 4.50 −1.35 17.85
Leverage 0.1664 0.1243 0.1647 0.0000 0.7228
Tobin’s q 0.8223 2.1031 6.8480 0.0007 59.7300

© 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21 9
 Perez-de Toledo et al

Table 3: Correlation matrix

ROA LSALES LEVER BSZ CEO duality BIN BOwn

ROA 1
LSALES 0.0783** 1
LEVER −0.1269*** 0.2036*** 1
BSZ 0.0269 0.3686*** 0.1631*** 1
CEO Duality 0.0174 −0.1904*** −0.0118 −0.1022** 1
BIN −0.0087 0.2215*** −0.0275 −0.0692* −0.2059 1
BOwn 0.0439 −0.2609*** 0.0127 −0.0759** 0.184*** −0.2445*** 1
Tobin’s Q −0.0145 −0.0316 −0.0642* 0.1092** 0.0521 −0.0194 −0.0079

This table reports Pearson correlation coefficients between the research variables used in the study. All variables
are for years 2003–2010. The variables are described in Table 4. Significance at the 10%, 5% and 1% levels is
indicated by *, ** and *** respectively.

Spanish economy, which is largely dominated
by construction and services activities.
Table 3 provides a correlation matrix for the
main variables used in the study. A simple
analysis of the correlations show that board size
is the only variable that is significant and
positively related to Tobin’s q. Lever presents a
negative significant correlation with q, as
expected. On the other hand, a lack of any
significant relationships between the other vari-
ables and the dependent variable of our main
specification (q) is a good sign as it prevents
multicollinearity problems in the dependence
model.
MODEL
Several studies in corporate governance have
pointed out to the endogeneity of governance
and to the possibility of reverse causality bet-
ween governance and performance (Demsetz
and Lehn, 1985; Cho, 1998; Bhagat and Jefferis,
2002; Börsch-Supan and Köke, 2002; Hermalin
and Weisbach, 2003; Ødegaard and Bøhren,
2005). The classical approach of ordinary least
squares regressions does not address the problem
of endogeneity inherent to governance studies.
For example, board size and board ownership
are among the determinants of firm perfor-
mance; however, it is also possible that these
variables are influenced by the variable they try
to explain (endogeneity). Moreover, as far as
corporate governance is concerned, endogene-
ity is always present, as the decisions taken by
the board produce results after a certain period
of time (Börsch-Supan and Köke, 2002).
Unobservable heterogeneity occurs when the
estimators are biased by the tendency of every
individual to act in a certain unobservable way
over time, and as such, it must be controlled for.
Furthermore, these individual-specific unobser-
vable effects may be correlated with other
explanatory variables (Hausman and Ruud,
1986). Dynamic panel data methodology not
only controls for endogeneity, but it is also
consistent under unobservable heterogeneity, as
shown by Arellano and Bond (1988), Arellano
and Bover (1995) and Blundell and Bond
(1999). It also gives general estimators designed
for datasets with ‘small T, large N’ panels, as is
our case. The unobservable heterogeneity is
controlled through the individual effect, ηi. dt
is the time variable, included to control for the
effect of macroeconomic factors on the perfor-
mance of the firms. Consequently, the error
term is split into three components: the time
effect, dt; the individual effect, ηi; and the
random disturbance, vit (εit = dt +ηi +vit).
As mentioned above, we use dynamic panel
data methodology and control for the problems

10 © 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21
 The effect of environmental jolts on board governance practices and its impact on firm value
of endogeneity by using instruments. Specifi-
cally, we used all explanatory variables in the
models lagged four times as valid instruments.
In order to improve efficiency, given we have a
reduced number of periods relative to the
number of individuals, we follow Arellano and
Bond (1995) and take the first differences of the
variables to eliminate the individual effect, to
then estimate the models. The general models
of panel data used for assessing the effect of
board structure on firm performance are thus
the following:
Qit ¼ α + β1 BOARD STRUCTUREit
+ ηi + dk + vik
Qit ¼α + β1 BOARD STRUCTUREit
+ β2 CRISISit + ηi + dk + vik
Qit ¼α + β1 BOARD STRUCTUREit
+ β2 CRISISit
+ β3 BOARD STRUCTUREx: CRISISit
+ ηi + dk + vik
Where:
Q Tobin’s q
BOARD_ each board characteristic
STRUCTURE (board independence,
board size, CEO Duality
and board ownership)
CRISIS the crisis effect
BOARD_ the interaction between
STRUCTURE × each board characteristic
CRISIS and the crisis included to
capture the moderation
effect of the crisis.
The specific models used to assess the effective-
ness of governance practices (proxy by board
structure) in improving firm performance in
times of munificence and in avoiding value
destruction in times of environmental jolts, are
© 2015 Macmillan Publishers Ltd. 1741-3591
described below:
Qit ¼β0 + β1 BOARD INDik + β2 CEOCHAIRMANik
+ β3 CRISISik + β4 LSALESik + ηi + dk + vik
Qit ¼β0 + α1 BOARD INDik + β2 CEOCHAIRMANik
+ β3 CRISISik + β4 LSALESik +
+ α5 BOARD IND ´ CRISIS + ηi + dk + vik :
Qit ¼β0 + β1 BOARD SIZEik + β2 BOARD SIZE 2ik
+ β3 CRISISik + β4 LSALES + ηi + dk + vik
Qit ¼β0 + β1 BOARD SIZEik + β2 BOARD SIZE 2ik
+ β3 CRISISik + β4 CRISIS ´ BOARDSIZEik +
+ β5 LSALES + ηi + dk + vik
Qit ¼β0 + β1 BOARD OWNik + β2 BOARD OWN 2ik
+ β3 CRISISik + β4 LSALES + ηi + dk + vik :
Qit ¼β0 + β1 BOARD OWNik + β2 BOARD OWN 2ik
ð1Þ
+ β3 CRISISik + β4 BOARD OWN ´ CRISIS
+ β5 LSALES + ηi + dk + vik :
Qit ¼β0 + β1 LEVERik + β2 CRISISik + β3 LSALESik
+ ηi + dk + vik
ð2Þ Qit ¼β0 + β1 LEVERik + β2 CRISISik + β3 LEVER
´ CRISIS + β4 LSALESik + ηi + dk + vik
Next we analyze the effect of board indepen-
dence on board size and on financial leverage.
BSZit ¼β0 + β1 BINik + β2 CRISISik + β3 LSALESik
+ ηi + dk + vik
ð3Þ LEVERit ¼β0 + β1 BINik + β2 CRISISik + β3 LSALESik
+ ηi + dk + vik
Table 4 provides a description of each variable
included in the study.
RESULTS
Firm performance proxy by Tobin’s q was
regressed on two blocks of independent vari-
ables. The first block contained the predictors,
instrumental and control variables, and the
second block contained the interaction
between the crisis and the predictors, so it is
possible to observe the effect of these variables
on firm performance during the period of
munificence (2003–2007) and during the per-
iod of crisis (2008–2010). Next we assess the
effect of ownership concentration on board
structure (board independence, board size) and
on the degree of financial leverage (Lever). The
regression coefficients are reported in Table 5.
International Journal of Disclosure and Governance 1–21 11
 Perez-de Toledo et al

Table 4: Summary of the research variables

Code Variable Definition

Q Tobin’s q Ratio of the market value of equity plus the book value of debt to book
value of total assets
BSZ Board Size Total number of board members
BIN Board Percentage of independent and external directors
Independence
CEO- Duality CEO/ Dummy variable: 1 if the CEO and the Chairman are not represented by the
CHAIR Chairman same person; 0 otherwise
BOwn Board Ownership Percentage of shares owned by all board members
LEVER Capital Structure Long-Term Debt / Market Value of Equity plus Long-Term Debt
ROA Return on Assets Net income / Total assets

Control Variables
CRISIS Effect of Dummy variable: 1 for years 2008–2010, and 0 for years 2003–2007
environmental
jolt
INDUSTRY Industry sector Six dummy variables
SIZE Firm Size Natural logarithm of net sales as a proxy to firm size
BETA Firm beta (β) One-year firm beta (from Datastream database)

Panel A shows the regressions of board structure
components on Tobin’s q during the period of
munificence (2003–2007) and during the envir-
onmental jolt (2008–2010). The moderating
effect of the crisis on the relationship between
board structure and firm performance is mea-
sured by the interaction variables (BOARD ×
CRISIS). Panel B reports the results of the
regressions of board structure components
(board independence and board size) on own-
ership concentration and leverage.
Our results support our first hypothesis,
which positively associates the percentage of
independent directors to firm performance.
At increasingly larger percentages of indepen-
dent directors more value is created (Model 1).
Moreover, board independence is considered in
association with duality CEO-Chairman, and
we find that the absence of duality enhances
firm value (positive coefficient of CEO-
CHAIR in models 1 and 2). When considering
the moderation effect of the crisis (model 2),
we observe that the role of the independents
in creating value is less pronounced. During
the period of crisis, for every 1 per cent
increase in the percentage of independents,
Q increases by 0.78 per cent, while in times of
munificence Q increases 0.81 per cent for
every 1 per cent increase in the percentage of
independents. This effect is shown in Figure 1
and it is consistent with the results of Baysinger
and Butler (1985a), Hermalin and Weisbach
(1988), Prevost et al (2002) and Weisbach
(1988).
Model 3 tests the effect of board size on firm
performance. The results support the hypothesis
of a quadratic relationship and show that firm
performance is positively impacted until an
optimal board size is achieved, and that after
this point performance is negatively affected.
This result is consistent with the hypothesis that
larger boards have a negative impact on firm
value and that there is an optimal range for
board size. The moderation effect of the crisis is
included in model 4 and it shows that during a
jolt, larger boards seem to be more beneficial to
performance as the breakpoint moves to the
right. Figure 2 shows this moderating effect of

12 © 2015 Macmillan Publishers Ltd. 1741-3591 International Journal of Disclosure and Governance 1–21
 © 2015 Macmillan Publishers Ltd. 1741-3591

Table 5: Results from estimations using dynamic panel data regressions

The effect of environmental jolts on board governance practices and its impact on firm value
Panel A Relationship between board structure and firm performance
Dependent variable: Tobin’s q
Independent variables (1) (2) (3) (4) (5) (6) (7) (8)

BIN 0.8409** 0.8165* — — — — 1.4838*** —

International Journal of Disclosure and Governance

CEO_CHAIR 0.1507* 0.1513*** — — — — — —

BIN x CRISIS — −0.1471* — — — — — —
CEO_CHAIR x CRISIS — — — — — — — —
BSZ — — 0.2431*** 0.1993*** — — — —
BSZ2 — — −0.0127*** −0.0066*** — — — —
BSZ x CRISIS — — — 0.0973**** — — — —
BOWN — — — — 6.4895*** 7.3369*** — —
BOWN2 — — — — −8.8632*** −9.5360*** — —
BOWN x CRISIS — — — — — 0.3188*** — —
LEVER — — — — — — −0.8450*** −0.9920***
LEVER x CRISIS — — — — — — −0.9795*** −1.1415***
CRISIS −0.4512*** −.3342*** 0.3767*** −0.5804*** 0.2996*** 0.2171*** 0.1831*** 0.3032***
LSALES 0.0030 0.0035 0.0647*** 0.1149*** 0.0000*** 0.0000*** 0.0000*** 0.0000***
Hansen: p-value 0.416 (52) 0.451 (53) 0.673 (105) 0.757 (106) 0.251 (56) 0.277 (55) 0.002 (44) 0.001 (45)
M2: p-value 0.186 0.188 0.190 0.193 0.186 0.186 0.150 0.159
Wald Test z1 3.94*** 3.80*** 6309.24*** 1499.26*** 77.09*** 63.04*** 56.62*** 109.57***
Wald Test z2 8.41*** 8.05*** 1207.05*** 1129.59*** 142.04*** 144.02*** 288.96*** 403.79***
1–21
13
 14

Perez-de Toledo et al
© 2015 Macmillan Publishers Ltd. 1741-3591

Table 5: (Continued )

Panel B Relationship between board characteristics, ownership concentration and leverage

Dependent variable:
Leverage Leverage Board size Board size
Independent variables (1) (2) (3) (4)

BIN 0.0332*** 0.0254*** 4.8295** 4.7257***

BIN x CRISIS — −0.0777*** — 0.2982
CRISIS 0.0218*** 0.0464*** 0.0817*** −0.0169
LSALES 0.0000*** 0.0000*** 0.0000*** 0.0000***
Hansen: P-value 0.261 (44) 0.403 (44) 0.339 (31) 0.558 (31)
International Journal of Disclosure and Governance

M2: p-value 0.325 0.254 0.274 0.169

Wald Test z1 6.42*** 4.83*** 9.00*** 7.44***
Wald Test z2 5.60*** 7.03*** 10.83*** 14.59***

Panel A reports the results from dynamic panel-data estimation, two-step difference GMM regressions of each board variable (board independence, board size,
CEO Duality and board ownership) along with the control variables and instruments on Tobin’s q (Q). Panel B reports the results from dynamic panel-data
estimation, two-step difference GMM regressions of board independence (BIN) on board size and leverage. The definition of each variable is provided in
Table 3. The data is relative to the period between years 2003–2010. Dummy variables that control for the crisis period (2008–2010) were included. The
interpretation for each coefficient is the change in Q associated with a one-unit change in its determinant. Hansen test of over-identifying restrictions,
asymptotically distributed as χ2 under the null hypothesis with degrees of freedom in parentheses is reported. The numbers in parentheses are probability
values for two-sided F test. ***, **, * denotes statistical significance at the 1%, 5% and 10% level respectively.
1–21
 The effect of environmental jolts on board governance practices and its impact on firm value
Tobin’s q
In times of munificence
During environmental jolts
Percentage of
independents
Figure 1: The moderating effect of
environmental jolts on board independence.
Tobin’s q
With environmental
jolts
11 members 13 members
Figure 2: The moderating effect of
environmental jolts on board size.
the crisis and how the optimal board size during
a jolt moves from 11 to 13 members.
Our results indicate that the breakpoint for
board size during times of munificence is
11 board members. However, during the crisis
there is a shift to the right and the optimal board
size increases to 13 members. We interpret this
result as evidence that during environmental
jolts, when the level and availability of resources
is compromised, companies have to adapt and
react quickly. Hence, the board assumes a
fundamental role in providing the necessary
resources, counseling, expertise, coordination
and leadership to develop a new strategy and
survive the jolt. Yet, boards get more united
and cohesive in order to tackle the problems in
a more efficient way; therefore, the optimal
board size increases, which we interpret as an
indication that larger boards are more capable of
responding to the crisis.
Regarding board ownership, our hypothesis
is that board ownership has a concave
© 2015 Macmillan Publishers Ltd. 1741-3591
relationship with firm performance which
implies that at lower levels of insider ownership
performance is positively affected because of the
converge-of-interests. However, at a certain
level of inside ownership managers become
entrenched and it then negatively influences
performance. Models 5 and 6 assess this rela-
tionship and we find evidence of a concave
effect as proposed by de Miguel et al (2004).
During the crisis the breakpoint is displaced to
the right as the sign of the interaction is positive.
Thus, in times of environmental jolts the
monitoring effect not only remains, but is
enhanced, and there is a delaying in the expro-
priation effect as illustrated by Figure 3. This
result is interpreted as evidence that, during a
jolt, managers have an incentive to avoid taking
on risky projects (as companies are at a higher
risk of bankruptcy), and for these reason they
get entrenched at higher levels of ownership.
Board
Size Models 7 and 8 assess the relationship
between leverage and Tobin’s q and the mod-
eration effect of board independence in this
relationship. The results show the negative
effect of leverage on firm performance and
how the crisis intensifies this effect as the slope
is steeper (the coefficient of leverage in the crisis
regression is higher) as illustrated in Figure 4:
Panel B reports the results regarding hypoth-
esis 5 that relates the level of financial leverage
to the presence of independent directors.
We have test this effect by finding the slope of
the moderating effect between the percentage
of independent directors and the variable crisis
(BIN × CRISIS) with leverage. As shown in
Tobin’s q
Monitoring Expropriation
With environmental jolts
Board Ownership
Figure 3: The moderating effect of
environmental jolts on board ownership.
International Journal of Disclosure and Governance 1–21 15
 Perez-de Toledo et al
Tobin’s q
With environmental
jolts
Figure 4: Interaction between leverage and
firm performance.
Leverage
With environmental jolts
Percentage of
independents
Figure 5: Interaction between board
independence and leverage.
Figure 5, the slope is flatter in times of munifi-
cence and stepper in times of an environmental
jolt. Moreover, model 1 shows that the presence
of independents enhances the level of financial
leverage of the sample firms in times of munifi-
cence. However, in times of crisis (model 2) the
presence of independent directors acts as a
deterrent to the adoption of higher levels of
leverage. Our results suggest that independent
directors exert a monitoring role over leverage,
and that during periods of environmental jolts
this role is even more pronounced.
Model 3 relates board size to board indepen-
dence and shows that larger boards have a
positive impact on firm value creation. How-
ever the positive effect of board size on firm
value is intensified by the moderating effect of
board independence. In other words, larger
boards with a majority of independent directors
create more value than large boards com-
pounded by a majority of non-independent
16 © 2015 Macmillan Publishers Ltd. 1741-3591
directors. And this effect remains unchanged in
times of crisis as shown by the lack of signifi-
cance of the coefficient of the variable CRISIS
in model 4.
CONCLUSIONS
The objective of the present study is to compare
the effectiveness of board governance practices
in creating firm value in times of munificence
Leverage and in avoiding value destruction during envir-
onmental jolts. Previous studies have focused
on the effect of board characteristics on firm
performance, but few consider the external
environment and macroeconomic context as a
factor that may affect this relationship. Firms
benchmark their practices and adopt specific
governance structures driven by institutional
factors such as the Codes of Best Practices.
Institutionalized policies and institutional fac-
tors are focused on searching for processes that
identify potential structures and practices that
have been considered legitimate and that had
previously been taken for granted. Nonetheless,
most codes were introduced in times of eco-
nomic prosperity, when achieving growth is less
challenging. Organizational structures and prac-
tices that work effectively in times of munifi-
cence are tested in times of environment jolts.
Economic crises offer a powerful setting for
testing the effectiveness of good governance
practices, as the destabilization caused by the
jolt can be viewed as an opportunity to re-
examine institutionalized management and
governance practices.
Our findings support the idea that during
environmental jolts, when resources are scarce
and firms need to adapt, the board of directors
assume an important role in steering firm’s
strategy and leading the company during the
adaptation process needed to survive the jolt.
In this context, board structure has a greater
importance in the preservation/avoidance of
firm value destruction during environmental
jolts than in times of munificence.
The relationship between board indepen-
dence, board size and board ownership with
International Journal of Disclosure and Governance 1–21
 The effect of environmental jolts on board governance practices and its impact on firm value
firm value has changed during the 2008 finan-
cial crisis. Our findings indicate that during the
crisis period (2008–2010) the optimal board size
shifted from 11 to 13 members, indicating that
larger boards may play an important role during
a jolt as they provide resources, expertise,
coordination and leadership to the company.
Similarly, boards with more independent direc-
tors have created (destructed) more (less) value
than their counterparts with less independent
board members; however, the effect of board
independence is more pronounced in times of
munificence. We also show that companies
with more independent board members present
higher financial leverage in times of economic
prosperity, evidence that the presence of inde-
pendent board members has a signaling effect
that enhances the creditworthiness of the firm.
However, in times of crisis boards with more
independent directors take on less debt than
do boards with less independent directors.
An important result that shows the monitoring
role of independent directors. Regarding board
ownership, we find evidence of a concave
relationship with firm value and, that during a
jolt, managers get entrenched at higher levels of
inside ownership, as there is a natural incentive
(the crisis) to avoid undertaking risky invest-
ment projects (or even investment projects
altogether, as growth opportunities are scant).
In general, our results show evidence that
companies that have followed and adopted best
governance practices have destroyed less value
during the 2008 financial crisis. Our conclusion
is that a functional board structure provides
firms with effective management of uncer-
tainty, which therefore increases their chances
of survival and success in the marketplace.
Finally, the article has useful implications for
practitioners. Managers and shareholders that
want to improve the quality of governance of
their companies can find our results interesting
as they show the positive impact of the adop-
tion of best board governance practices on firm
value in times of munificence and during
environmental jolts. Regulatory agencies and
policy makers may find our results useful as they
© 2015 Macmillan Publishers Ltd. 1741-3591
show evidence in support to the argument that
implementing best standards of board govern-
ance is rewarded by the market through higher
firm valuation.
LIMITATIONS AND FUTURE
RESEARCH
Our study provides a starting point for future
research on how the external environment and
the macroeconomic context may affect govern-
ance practices and board structure and its rela-
tion with firm performance and value creation.
As we offer evidence from a Western European
country, it would be fruitful to extend this
study to different institutional environments
(that is, common law countries, different bank-
ing systems, different predominant ownership
structures) and stages of development (that is,
extend the study to emerging markets).
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