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on to the fact that communication and coordination problems intensify as board
size increases. As a result, firm performance tends to be negatively associated with board size.
Jensen (1993) also points out that it is more difficult for larger boards to have a candid discussion
about managerial performance and decide on disciplinary actions against the CEO, which offers
the latter some autonomy to increase his compensation. Indeed, Core et al. (1999) document a
positive association between board size and CEO compensation in the U.S.
Supervisory boards (SBs) represent an additional control layer in the governance structure
of Chinese firms, whose purpose is to monitor managers and directors alike. Members of SBs
typically hold shares and consist of shareholders’ and workers’ representatives.5 Since they also
represent workers’ interests, SBs tend to oppose high CEO compensation. In Germany where
they have reserved seats on the board, workers’ representatives have habitually voiced their
opinion against excessive CEO compensation. Given that larger supervisory boards will give
more importance to workers’ pay grievances, it is natural to expect large SBs to be associated
with lower CEO compensation levels. However, Dahya et al. (2002) find that SBs lack
adequate information and resources to carry out their mission. In particular, their information
is often limited to working reports from the CEO. This leads Tam (2000) and Tenev and
Zhang (2002) to suggest that CEOs can easily manipulate SB expectations to extract higher
compensation.
Outside directors are supposedly more independent and concerned about shareholders’ protection
than executive directors. For that reason, Rosenstein and Wyatt (1990) and Hermalin and
Weisbach (1998) argue that outside directors provide better monitoring. Crystal (1991) expresses
some reservations: since outside directors are essentially hired by the CEO, they may be less
effective in controlling his compensation. Fama (1980) and Fama and Jensen (1983) suggest that
4 Brickley et al. (1997) quote the director of corporate affairs for London’s Institute of Directors as saying: “One of the
major functions of the board is to supervise management. If the chairman of the board is also in management, then he is
in effect marking his own exam papers.”
5 The structure is similar in German corporations. Elston and Goldberg (2003) document that for German firms with
fewer than 2000 employees, employees elect one-third of SB members. For firms with more than 2000 employees,
employees elect half of the SB members.36 D. Li et al. / Research in International Business and Finance 21 (2007) 32–49
outside directors add value to the firm by providing expert knowledge. This link between outside
directors and corporate performance is not, however, clearly established. In fact, Finkelstein and
Hambrick (1989) and Yermack (1996) find no evidence that outside directors increase firm value.
Nonetheless, a large proportion of outside directors may be a sign that the firm requires outside
expertise that cannot be found in-house. In addition, a close working relationship with outside
experts is likely to enhance the CEO’s managerial value relative to other executives. This would
hence justify a relatively higher CEO compensation. Lambert et al. (1993), Boyd (1994) and
Core et al. (1999) provide evidence of a positive relationship bet