The characteristics of a classified board and the effects of the board on earnings quality, accounting conservatism, and credit risk

Corporate governance studies document that strong corporate governance brings positive effects to firms; there are two different arguments about the effects of a classified board in which shareholders can change only one third of board members per year. That is, a classified board can decrease firm value by lowering the level of accountability to shareholder and investors or increase firm value by increasing board independence and focusing more on long-term planning. This study examines the characteristics of firms with a classified board and the effects of a classified board on earnings quality, accounting conservatism, and credit risk. It documents that classified board firms have both strong and weak governance characteristics. That is, firms with classified boards tend to have a larger board size, a lower percentage of insider directors on the board, a lower outside director ownership, and more operational complexity. This study finds that the market perceives classified board firms as having higher earnings quality than unitary board firms although there is no difference in accrual earnings quality, and there is no difference in accounting conservatism. However, classified board firms have higher credit ratings than unitary board firms. This study shows that there are no changes in earnings quality or credit risk when a firm changes its board structure either from unitary to classified or from classified to unitary. The study also finds that there is a decrease in accounting conservatism when a firm changes its board structure from classified to unitary, but that when a firm changes its board structure from a unitary to a classified, there is no accounting conservatism change with the accrual measure, but that the accounting conservatism increases under the market approach. These results seem to challenge the argument that a higher level of accountability to shareholders and investors results from a unitary board. Overall, the evidence is more consistent with the arguments in favor of a classified board. It also appears that the market puts more weight on the positive effects of classified boards than on the negative effects, although some active shareholders and investors argue for declassification of classified board and emphasize that a higher level of accountability should follow. Of course, a classified board can have negative effects on corporate governance, such as increased shirking, empire-building, and enjoying private benefits at shareholders. cost. However, the board can also provide positive corporate governance effects such as the avoidance of inefficient actions, and more efficient investments in long-term projects. Therefore, it appears that, as Koppes et al. (1999) mention, attention should not be focused on the existence of a classified board, but on the effectiveness of the board, and that a classified board is not necessarily inconsistent with good corporate governance. It also should not be expected that a one-size-fits-all approach to corporate governance mechanism would enhance every firm\u27s performance and firm value (Coles et al., 2008)