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...igorous CEO performance reviews take place regularly. As noted above, limiting board size has begun appearing on some agendas for reform, although only Lipton and Lorsch (1992) and Jensen (1993) identify board size as a high priority. 188 D. YermacklJoumal of Financial Economics 40 (I 996) 185 21 I Much empirical research has examined whether board structure is related to company performance, but these studies have largely overlooked board size. Instead, investigators have most frequently examined the importance of outside directors and directors’ equity ownership. Studying board composition, Hermalin and Weisbach (1991) find no relation between firm performance and the fraction of outside directors. However, this conclusion is not supported by Baysinger and Butler (1985), who find some evidence that companies perform better if boards include more outsiders. Other studies find that boards dominated by outsiders are more likely to behave in shareholders’ interest. See, for example, Weisbach (1988) (CEO turnover), Byrd and Hickman (1992) (tender offer bids), and Brickley, Coles, and Terry (1994) (poison pill adoptions and control auctions). Rosenstein and Wyatt (1990) find positive investor reactions to appoint...

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...ve and a negative effect on the value of the firm. To put it simply, at low levels of management equity ownership, an increase in their shareholdings more closely aligns managers’ and outside shareholders’ interests. As insider ownership increases beyond some point, however, further increases effectively insulate managers from outside shareholder demands. At this point, managers can allocate corporate resources in their own self-interest regardless of the effects on outside shareholders. Recent empirical contributions by Holderness and Sheehan (1988), MSV (1988), McConnell and Servaes (1990), Hermalin and Weisbach (1991), Phelps (1991), and Kole (1994) have explored the relation between corporate value and the allocation of shares among corporate insiders and other shareholders. While the results differ across the various studies, a consensus interpretation is that the allocation of equity ownership matters. Despite the apparent theoretical connection between the roles of equity ownership and debt in determining the allocation of corporate resources, the empirical studies cited above have given only peripheral attention to the relation between corporate value, debt, and equity ownership. This paper seeks to f...