Download Board independence and firm performance

Board Independence and Firm Performance:
Evidence from ASX-Listed Companies
Yi Wang
A Thesis Submitted for the Degree of
Doctor of Philosophy
Faculty of Business and Enterprise
Swinburne University of Technology
August 2009
Abstract
There is an explosion of research on corporate governance in the past two decades; two
major corporate governance models have been identified in the literature - the outsider
system in the U.K. and U.S., and the insider system in Germany and Japan.
Commentators tended to favour the insider system during the 1980s, when the
economies of Germany and Japan outperformed others, and tended to favour the
outsider system in the 1990s, when the economies of the U.S. looked better. The
Australian market is often described as forming a part of the Anglo-Saxon outsider
model; some scholars, however, raised questions about this classification, and pointed
out that the Australian market may have more in common with Germany and Japan in
terms of corporate ownership and control.
From 2003, Australian listed companies have been subject to new corporate governance
guidelines, which identify independent directors as a key component of effective
governance. It appears that these recommendations are based on the Anglo-Saxon
model, whose focus is on the agency conflict between managers and shareholders.
Matching the trend towards greater board independence, the research on the empirical
link between board characteristics and firm performance, primarily from the US and
more broadly in recent years, is growing; most of them use agency theory as their
underlying theoretical arguments. The mixed evidence, however, suggests the need for
an in-depth investigation.
This study gives an examination of various theoretical perspectives on boards of
directors, to enhance our understanding on the potential relationship between board
independence and corporate performance. It is found that agency theory, stewardship
theory and organizational portfolio theory offer different expectations. From an agency
perspective, where the board of directors is more independent of management, company
performance would be higher. Stewardship theory proposes that board of directors with
a lower level of independence would lead to better performance. The organizational
portfolio model, as a theory waiting for empirical testing, suggests that board
independence would be both proactive and reactive to performance.
To identify the effect of board independence on firm performance, and the effect of firm
performance on board independence, this study follows an archival research approach
using secondary data, which has been typically adopted by the research surrounding this
ii
topic. It may be the first Australian study which presents direct evidence on the
potential consequences of the recently altered regulatory environment with respect to
board composition and structure. It is also designed to overcome the methodological
limitations identified in prior research to provide improved evidence in this field.
The results indicate that, for Australian listed firms, there is no strong relationship
between board independence, and past or subsequent performance. The evidence casts
doubts on the hope that promoting board independence would add value to Australian
corporations. It appears that appointing independent members to the boards may merely
represent firms’ attempts to comply with institutional pressures, and therefore would not
be linked to performance. It is suggested that, despite agency theory’s policy influence,
whether certain corporate governance practices recommended by the theory would lead
to better performance need to be empirically tested. The regulatory bodies in Australia
and other economies should be mindful of the differences between the markets when
they look for the solutions to their corporate governance issues.
iii
Declaration
This thesis contains no material which has been accepted for the award to me of any
other degree or diploma, except where due reference is made in the text of the thesis. To
the best of my knowledge this thesis contains no material previously published or
written by another person except where due reference is made in the text of the thesis.
Yi Wang
Faculty of Business and Enterprise
Swinburne University of Technology
16 August 2009
iv
Acknowledgements
I would especially like to thank Dr Albie Brooks and Dr Judy Oliver for the time and
effort, and undoubted frustration from time to time, in guiding me capably and
professionally through this task. I would also like to thank my parents, Yungang Wang
and Xuezhen Hu, whose encouragement and confidence gave me the strongest
motivation to take up this challenge. A special thank you goes to my son, Yuqing
Wang, who has had to live with me through the ups and downs of completing this study.
v
Table of Contents
Page
List of Appendices
ix
List of Figures
x
List of Tables
xi
List of Abbreviations
xiii
Chapter 1.
Introduction
1
1.1
Aim of the Study
1
1.2
Context of the Study
2
1.3
Motivation
3
1.4
Contribution to Knowledge
4
1.5
Conceptual Framework
5
1.6
Research Method
7
1.7
Major Findings
8
1.8
Structure of the Thesis
9
Corporate Governance Reforms
11
2.1
Introduction
11
2.2
Corporate Governance Systems
12
2.3
Corporate Governance Standards
18
2.3.1
19
Chapter 2.
2.4
Recommendations in the U.K.
2.3.2 Listing Rules in the U.S.
24
2.3.3
29
Australian Guidelines
Summary
33
Empirical Evidence
36
3.1
Introduction
36
3.2
Australian Evidence
37
3.3
Evidence from the U.S.
40
3.3.1
Cross-Sectional Studies
41
3.3.2
Event Studies
52
Evidence from Other Regions
54
Chapter 3.
3.4
vi
3.5
Chapter 4.
Summary and Limitations
62
3.5.1
Australian Studies
63
3.5.2
Overseas Studies
65
Theoretical Development
71
4.1
Introduction
71
4.2
Theories of Board of Directors
71
4.2.1
Legalistic View
72
4.2.2
Agency Theory
74
4.2.3 Stewardship Theory
77
4.2.4
Resource and Strategy Theories
79
4.2.5 Organizational Portfolio Theory
81
4.3
Board Independence and Firm Performance
84
4.4
Testable Hypotheses
86
4.5
Summary
88
Research Method
90
5.1
Introduction
90
5.2
Research Approach
91
5.3
Sample and Data Collection
93
5.4
Research Variables
94
5.4.1
Measurement of Board Independence
94
5.4.2
Performance Measures
98
Chapter 5.
5.4.3 Control Variables
101
5.5
Data Analysis
104
5.6
Summary
110
Univariate Analysis
111
6.1
Introduction
111
6.2
Preliminary Statistics
113
6.3
Correlations: The Sample Period 2000-2003
115
6.4
Correlations: The Sample Period 2003-2006
117
6.5
Summary
119
Multivariate Analysis
121
Introduction
121
Chapter 6.
Chapter 7.
7.1
vii
7.2
Regressions: Board Independence and Past Performance
122
7.3
Regressions: Board Independence and Subsequent Performance
130
7.4
Regressions: Board Independence and Firm Risk
141
7.5
Summary
144
Discussion and Conclusions
146
8.1
Introduction
146
8.2
Discussion of Findings
146
8.2.1 Board Independence and Past Performance
146
8.2.2 Board Independence and Subsequent Performance
147
8.2.3
Board Independence and Firm Risk
149
8.2.4
Summary of Other Findings
149
8.3
Conclusions and Recommendations
151
8.4
Limitations and Future Research
157
8.5
Summary
159
Chapter 8.
References
161
Appendices
190
viii
List of Appendices
Number
Page
1.
Summary of Australian Research
190
2.
Summary of Overseas Research
193
3.
Theories and Hypotheses in Prior Research
204
4.
Pearson Correlations: 2000-2003
214
5.
Pearson Correlations: 2003-2006
220
6.
OLS and Logit Regressions: Board Independence
226
and Past Performance (ROA)
7.
OLS and Logit Regressions: Board Independence
227
and Past Performance (ROE)
8.
OLS and Logit Regressions: Board Independence
228
and Past Performance (Shareholder Return)
9.
OLS and Logit Regressions: Board Independence
229
and Past Performance (Tobin’s Q)
10.
OLS Regressions: Full Board Independence
230
and Subsequent Performance
11.
OLS Regressions: Audit Committee Independence
231
and Subsequent Performance
12.
OLS Regressions: Nomination Committee Independence
232
and Subsequent Performance
13.
OLS Regressions: Remuneration Committee Independence
233
and Subsequent Performance
14.
OLS Regressions: Chairman Independence
234
and Subsequent Performance
15.
OLS Regressions: Board Independence and Firm Risk
ix
235
List of Figures
Number
Page
4.1.
Theoretical Development: High Board Independence
86
4.2.
Theoretical Development: Low Board Independence
87
x
List of Tables
Number
Page
1.1
Relationships: Board Independence, Firm Performance and Firm Risk
7
5.1.
Measures of Firm Performance
100
5.2.
Measures of Control Variables
103
6.1.
Abbreviations of Research Variables
112
6.2.
Descriptive Statistics: Boards of Directors
113
6.3.
Descriptive Statistics: Other Research Variables
114
6.4.
Jarque-Bera Statistics
115
6.5.
Pearson Correlations: 2000-2003
116
6.6.
Pearson Correlations: 2003-2006
118
7.1.
OLS and Logit Regressions: Board Independence
123
and Past Performance (ROA)
7.2.
OLS and Logit Regressions: Board Independence
125
and Past Performance (ROE)
7.3.
OLS and Logit Regressions: Board Independence
127
and Past Performance (Shareholder Return)
7.4.
OLS and Logit Regressions: Board Independence
129
and Past Performance (TOBQ)
7.5.
OLS Regressions: Full Board Independence
132
and Subsequent Performance
7.6.
OLS Regressions: Audit Committee Independence
134
and Subsequent Performance
7.7.
OLS Regressions: Nomination Committee Independence
and Subsequent Performance
xi
136
7.8.
OLS Regressions: Remuneration Committee Independence
138
and Subsequent Performance
7.9.
OLS Regressions: Chairman Independence
140
and Subsequent Performance
7.10.
OLS Regressions: Board Independence and Firm Risk
143
8.1.
Relationship between Board Independence and Past Performance
147
8.2
Relationship between Board Independence and Subsequent Performance 148
8.3
Results: Board Independence, Firm Performance and Firm Risk
xii
152
List of Abbreviations
Abbreviation
AEOA
Australian Employee Ownership Association
AICD
Australian Institute of Company Directors
ASA
Australian Shareholders’ Association
ASX
Australian Stock Exchange
BRT
Business Roundtable
CEO
Chief Executive Officer
CFROTA
CIMA
Cash Flow Return on Total Assets
Chartered Institute of Management Accountants
EBIT
Earnings before Interest and Tax
EPS
Earnings per Share
EVA
Economic Value Added
HKSE
Hong Kong Stock Exchange
IBGC
Brazilian Institute of Corporate Governance
ICAEW
Institute of Chartered Accountants in England and Wales
IPO
Initial Public Offering
LSE
London Stock Exchange
MBT
Market-to-Book Ratio
MVA
Market Value Added
NACD
National Association of Corporate Directors
NED
Non-Executive Director
xiii
NZSE
New Zealand Stock Exchange
NYSE
New York Stock Exchange
OECD
Organization for Economic Co-operation and Development
OLS
Ordinary Least Squares
R&D
Research & Development
ROA
Return on Assets
ROE
Return on Equity
S&P
Standard & Poor’s
SEC
Securities and Exchange Commission
SET
Stock Exchange of Thailand
SG&A
Selling, General & Administrative
TSE
Toronto Stock Exchange
xiv
Chapter 1. Introduction
1.1
Aim of the Study
With the publicity surrounding recent corporate collapses, the issues of board
composition and structure generally and independent directors specifically, have
become a fertile area of interest and research. There is a global movement to enhance
board independence in public companies, initiated by the concern about agency conflict
between managers and shareholders.
The definitions of “independence” proposed by the regulatory bodies vary; it appears
that they are sourced from the statement in the Cadbury Report (1992, Code 2.2) - an
independent director “… should be independent of management and free from any
business or other relationship which could materially interfere with the exercise of their
independent judgement, apart from their fees and shareholding.”
The purpose of this study is to

test the applicability of several theories which make different predictions about
the effect of board independence on firm performance and vice versa;

address some of the limitations of prior studies, including small sample size,
short-term observation of firm performance, limited control variables and
performance measures, and simplistic dichotomy of inside and outside directors
as an empirical proxy for board independence; and

shed some light on the potential influence of a recently altered regulatory
environment with respect to corporate governance mechanisms, particularly
those relating to the requirements for a majority of independent directors on the
board and board committees, on firm performance.
However, it should be noted that the focus here is on the empirical correlation between
board independence and firm performance, rather than the performance of boards of
directors or individual directors.
This chapter offers an overview of the thesis. Section 2 and 3 provide an introduction to
the context and motivation for the research. There is a discussion in Section 4 of the
contribution that it makes to the literature. Section 5 and 6 outline the conceptual
1
framework and method used to conduct this study, followed by a summary of the major
findings in Section 7. The structure of the dissertation is described in the last section.
1.2
Context of the Study
Australia had watched closely as big corporate failures such as Enron, WorldCom and
Arthur Andersen had prompted the U.S. regulatory authorities to launch significant
corporate governance reforms. To promote and restore investor confidence, in 2003 the
Australian Stock Exchange endorsed Principles of Good Corporate Governance and
Best Practice Recommendations released by its Corporate Governance Council, which
reflect “best international practice” by highlighting the importance of board
independence.
The stock exchange requires that a majority of each listed company’s directors qualify
as independent directors. Although it is for the board to decide in particular cases
whether the definition of independence is met, there is a list of the categories of persons
who should not be considered independent.
It is also recommended that the roles of chairman and chief executive should not be
exercised by the same individual; the chairman should be an independent director.
Firms should establish an audit committee, nomination committee and remuneration
committee, and a majority of each committee’s members should be independent. In the
long-term the recommendations may result in a shift in the power of boards of directors
in favour of independent directors, and away from management.
The literature suggests that there are two major governance models around the world
(e.g., Hall and Soskice, 2001; Denis and McConnell, 2003; Murphy and Topyan, 2005;
Gillan, 2006); the first is the outsider system in the U.K. and U.S., in which the primary
corporate objective is to maximize profit, and managers must ensure the firm is run in
the interests of shareholders. From the agency perspective the main concern of
corporate governance is the conflict between strong managers and weak dispersed
shareholders. The second is the insider system in Germany and Japan, in which
corporations must fulfil wider objectives and have responsibilities to parties other than
shareholders; it is assumed that the basic conflict is between weak managers and
minority owners, and strong majority owners (Bouy, 2005).
2
Australia’s system of corporate governance has been described as forming part of the
Anglo-Saxon outsider model of ownership and control (Scott, 1997; Weimar and Paper,
1999; Campbell, 2002). Recently some academics raised questions about this
classification, and argued that the Australian system might have more in common with
the insider system (e.g., Lamba and Stapledon, 2001; Dignam and Galanis, 2004).
Dignam and Galanis (2004) demonstrated that Australia was in the process of reforming
its corporate governance based on an assumption that it is an outsider model; if that
assumption is incorrect, recent reforms may have a destabilizing effect.
1.3
Motivation
Scholars, in general, have taken two approaches to investigate the impact of board
composition and structure on firm performance (e.g., Bathala and Rao, 1995; Lawrence
and Stapledon, 1999; Bhagat and Black, 1999, 2000).
The first approach is based on relating board composition and structure to certain
corporate events, such as executive turnover and remuneration, financial reporting,
making or defending against a takeover bid, management buyout and shareholder
litigation. It is believed that “[t]he principle weakness of this approach is that it cannot
tell us how board composition affects overall firm performance. Firms with majorityindependent boards could perform better on particular tasks, such as replacing the CEO,
yet worse on other tasks, leading to no net advantage in overall performance” (Bhagat
and Black, 1999, p.3).
The second approach, which is the focus of this study, involves examining directly the
link between board characteristics and financial performance - the “bottom line” of firm
performance; as suggested by some authors (e.g., Bathala and Rao, 1995; Lawrence and
Stapledon, 1999; Bhagat and Black, 1999, 2000), it may avoid the weakness inherent in
the first group of studies.
However, after a survey of some Australian and overseas studies, it is concluded that
prior research does not establish a clear correlation between board composition and
structure, and financial performance. The recent corporate governance reforms, and the
resulting pressure on public companies for greater board independence, suggest the need
for a further investigation in the Australian context.
3
So far there is no direct empirical evidence in Australia supporting the introduction of
“best practice recommendations”. As noted by Lawrence and Stapledon (1999),
unquestioned acceptance of overseas practice may result in proposals for regulatory
reform which are not suited to the local environment; the regulatory requirements
imposed on companies may add to the compliance costs for these companies, and,
indirectly, their shareholders.
Therefore, it may be necessary to ask whether the costs of imposing governance
regulations on all listed companies would be outweighed by the benefits; in this
research the consequences of “best practice recommendations” supported by the stock
exchange are examined, which may provide some feedback to regulatory authorities,
corporations, investors and other stakeholders about the effect of such recommendations
on corporate performance.
1.4
Contribution to Knowledge
The findings of this study may contribute to current research in several ways. First, it
adds to the growing literature on this topic in Australia (e.g., Muth and Donaldson,
1998; Calleja, 1999; Lawrence and Stapledon, 1999; Cotter and Silverster, 2003; Kiel
and Nicholson, 2003), and provides updated information on board composition and
structure of public companies in this country.
Second, the majority of prior studies use agency theory as their underlying theoretical
arguments, suggesting that this theory promises a positive impact of board
independence on performance (e.g., Fosberg, 1989; Muth and Donaldson, 1998; Cotter
and Silverster, 2003; Krivogorsky, 2006; Chan and Li, 2008). Therefore they do not
address whether board characteristics are endogenously related to performance.
Although several researchers explored this concern, there is little theoretical support in
their studies; their workings are best viewed as exploratory data analysis, rather than as
testing of formal hypotheses (e.g., Hermalin and Weisbach, 1988; Denis and Sarin,
1999; Bhagat and Black, 2000). In this project an introduction to various theoretical
perspectives on boards of directors is given, which may enhance our understanding on
the potential relationship between board independence and firm performance.
Specifically, testable hypotheses are developed from agency theory, stewardship theory
4
and organizational portfolio theory, which are outlined in the next section, to answer the
following research questions:

does board independence have any influence on firm performance among
Australian listed companies? and

does firm performance have any influence on board independence among
Australian listed companies?
Third, it is found in the literature review that most Australian and overseas studies
suffer from a range of research limitations, including:

small sample size (e.g., Daily and Dalton, 1992; Lawrence and Stapledon, 1999;
Dulewicz and Herbert, 2004; Krivogorsky, 2006);

short-term observation of firm performance (e.g., Molz, 1988; Vafeas and
Theodorou, 1998; Cotter and Silverster, 2003; Chan and Li, 2008);

limited performance measures (e.g., Baysinger and Bulter, 1985; Denis and
Sarin, 1999; Kiel and Nicholson, 2003; Luan and Tang, 2007);

limited control variables (e.g., Fosberg, 1989; Barnhart and Rosenstein, 1998;
Calleja, 1999; Chang and Leng, 2004); and

simplistic dichotomy of inside and outside directors as a measure for board
independence (e.g., Kesner, 1987; Agrawal and Knoeber, 1996; Muth and
Donaldson, 1998; Randoy and Jenssen, 2004).
As shown later in Section 1.6, this study is designed to overcome the above limitations
to provide improved evidence in the field.
1.5
Conceptual Framework
Theoretical support for the belief that independent boards would enhance shareholder
returns has been provided by agency theory (e.g., Muth and Donaldson, 1998; Vafeas
and Theodorou, 1998; Cotter and Silverster, 2003). A central assumption of the theory
is that managers may pursue their own goals rather than seek to maximise shareholder
wealth, unless their discretion is kept in check by a vigilant, independent board (e.g.,
Jensen and Meckling, 1976; Stroh, Brett, Baumann and Reilly, 1996; Daily, McDougall,
Covin and Dalton, 2002). By emphasising the potential for divergence of interests
between investors and managers, most empirical research in this field assumes that,
5
where board of directors is more independent of management, company performance
would be higher.
In addition, some agency theorists assert that managers, unlike shareholders, could not
readily diversify their employment risks across a range of investments, as a result they
tend to be more risk averse than may be in the interests of shareholders (e.g., Fama,
1980; Knoeber, 1986; Prentice, 1993).
Developed as an alternative to agency theory, stewardship theory highlights a range of
non-financial motives for managerial behaviours, such as the need for achievement,
intrinsic satisfaction of successful performance, and respect for authority and work
ethics, which have been identified in the organizational literature (e.g., McClelland,
1961; Herzberg, 1966; Etzioni, 1975). Having control empowers managers to maximize
corporate profits; the detailed operational knowledge, expertise and commitment to the
firm by executive directors would make firms with a management-dominated board
more profitable (e.g., Donaldson and Davies, 1991, 1994; Fox and Hamilton, 1994;
Davis, Schoorman and Donaldson, 1997). This prediction is tested in a number of
papers (e.g., Muth and Donaldson, 1998; Kiel and Nicholson, 2003; Randoy and
Jenssen, 2004).
According to organizational portfolio theory proposed by Heslin and Donaldson (1999)
and Donaldson (2000), an increase in corporate profitability would enhance the
perceived integrity and competence of managers, thereby precipitating boards in which
managers are increasingly represented. Poor performance would lead to boards that are
more independent of management; the risk-averse governance delivered by independent
directors would prevent long-term growth and profitability, thus leading to a gradual
decline in organizational performance. This theory has received little attention from
academics, and therefore yet to be tested.
A summary of the relationships between board independence, firm performance and
risk, as expected by agency theory, stewardship theory and organizational portfolio
theory, is presented in the following table.
6
Table 1.1
Relationships: Board Independence, Firm Performance and Firm Risk
Relation
Board Independence
Past Firm Performance
Agency Theory
Unknown
Stewardship Theory
Unknown
Organizational Portfolio Theory
Negative
Subsequent Firm Performance
Agency Theory
Positive
Stewardship Theory
Negative
Organizational Portfolio Theory
Negative
Subsequent Firm Risk
Agency Theory
Positive
Stewardship Theory
Unknown
Organizational Portfolio Theory
Negative
1.6
Research Method
This study uses an archival research design which is traditionally employed by the
literature surrounding this topic.
Most Australian studies suffer from the limitation of small sample size. Muth and
Donaldson (1998) suggested that a sample size closer to 200 would have been
preferable; effects of boards on performance tend to be small which means that more
statistical power is needed to detect significant relationships. Calleja (1999) also
acknowledged that the small sample size made it difficult to reach any firm conclusions.
In this research a sample of 243 firms from the 2003 Australian top 500 is used; the
sources of data are available within the public domain.
The most popular measurement of board independence in prior research is the
proportion of non-executive directors or independent directors on the board. Based on
the “best practice recommendations” as outlined earlier, in this thesis five empirical
proxies for board independence are adopted, i.e., full board independence represented
by the proportion of independent directors on the board, monitoring committee
7
independence measured by the proportion of independent directors on the audit,
nomination or remuneration committee, and chairman independence which is a dummy
variable to assess whether or not the chairman is an independent director.
There are four measures of firm performance – market-based measures of Tobin’s q and
shareholder return, and accounting-based measures of return on assets and return on
equity; they are the most frequently used performance measures in prior studies, as well
as in the field of accounting and financial research (e.g., Hofer, 1983; Shrader, Taylor
and Dalton, 1984; Devinney, Richard, Yip and Johnson, 2005). As noted by Hofer
(1983), it is common to see several performance indices to be used because
organizations legitimately seek to accomplish a variety of objectives, ranging from
profitability to effective asset utilization and high shareholder returns.
Board characteristics of sample companies are investigated at one point in time - mid2003. Some prior research on this topic suffers from the limitation of short-term
observation of firm performance; Shrader et al (1984), in examining the literature on the
empirical relationship between strategic planning and organizational performance,
found that most studies had used 3- and 5-year periods as measures of long-range
planning and performance. Thus the performance figures employed in this project are
the three-year averages over the 2000-2003 and 2003-2006 financial years. As the basis
for endogeneity testing, firm performance are modelled as both an independent variable
(i.e., the effect of performance on board characteristics) and as a dependent variable
(i.e., the effect of board characteristics on performance).
Bathala and Rao (1995) suggested that the mixed evidence on the link between board
composition and firm performance might be attributed to the omission of other variables
that affect performance; Schellenger, Wood and Tashakori (1989) argued that the
conflicting empirical findings with respect to the existence or non-existence of a board
composition effect on financial performance could be due to failure to control risk. To
minimize the above concerns some control variables are introduced into the data
analysis, including board size, blockholder and managerial shareholdings, dividend
payout, diversification, firm age, firm size, leverage and risk.
8
1.7
Major Findings
Descriptive statistics, correlation analysis and regressions are conducted for the research
variables. The results indicate that, for Australian public companies, there does not
appear to be a strong relationship between board independence, and past or subsequent
performance; the level of board independence does not affect firm risk.
Additional findings include that companies with higher blockholder shareholdings tend
to reduce the percentages of independent directors on the board, and audit and
remuneration committees; larger firms have relatively more independent outsiders
sitting on nomination and remuneration committees.
Moreover, larger board or lower managerial shareholdings could lead to poor
performance as measured by Tobin’s q; larger firms or firms with lower leverage have
better shareholder return. It is found that smaller companies, companies with higher
gearing or shareholder return, or companies with lower dividend payout may be riskier.
1.8
Structure of the Thesis
The thesis consists of eight chapters, including this introductory chapter. An overview
of the remaining chapters is presented below.
Chapter 2 - Corporate Governance Reforms: this chapter provides an introduction to
the corporate governance models frequently addressed by researchers; within this
context the recent developments in corporate governance standards in the U.K., U.S.
and Australia are evaluated.
Chapter 3 - Empirical Evidence: a review of the literature in Australia and overseas,
which gives evidence on whether board characteristics and firm performance are
related, is undertaken; the focus is on cross-sectional studies on publicly listed
companies.
Chapter 4 - Theoretical Development: the evolving perspectives on the roles of board of
directors are discussed. The potential relationships between board independence and
firm performance, as proposed by different conceptual frameworks, are investigated; as
a result six testable hypotheses are constructed.
9
Chapter 5 - Research Method: the chapter gives a description of the research design
chosen to test the hypotheses, covering the general research approach, sample selection
and data sources, measurement of variables, and analysis procedures.
Chapter 6 - Univariate Analysis: this chapter shows descriptive statistics of the data
collected; to explore the relationships between board independence, firm performance
and risk, the correlation analysis for the research variables during the sample periods of
2000-2003 and 2003-2006 is produced.
Chapter 7 - Multivariate Analysis: the results of regression models specified for the
effect of firm performance on board independence, and the effect of board
independence on performance and risk, are reported.
Chapter 8 - Discussion and Conclusions: the findings emanating from Chapter 6 and 7
are further analysed; the analysis responds specifically to the research hypotheses and
questions, and leads to the conclusions and recommendations. Limitations in the current
study and future research opportunities are identified.
10
Chapter 2. Corporate Governance Reforms
2.1
Introduction
As observed by Gillan (2006), the definition of corporate governance differs depending
on one’s view of the world. Shleifer and Vishny (1997a, p.737) claimed that
“[c]orporate governance deals with the ways in which suppliers of finance to
corporations assure themselves of getting a return on their investment.” In Litch (2002),
corporate governance is viewed as the rules and structures for wielding power over
other people’s interests, including the use and abuse of power. Denis and McConnell
(2003, p.2) defined corporate governance “… as the set of mechanisms – both
institutional and market-based – that induce the self-interested controllers of a company
… to make decisions that maximize the value of the company to its owners …”
Becht, Bolton and Roell (2005, p.1) suggested that “[c]orporate governance is
concerned with the resolution of collective action problems among dispersed investors
and the reconciliation of conflicts of interest between various corporate claimholders”.
They identified the following reasons why corporate governance had become such a
prominent topic in recent years:

the world-wide wave of privatization of the past two decades;

the growth in pension fund and active investors;

the wave of mergers and takeovers of the 1980s an 1990s;

deregulation and integration of capital markets;

the 1998 East Asia crisis, and

a series of corporate scandals and failures in the U.S.
According to Pettigrew (1992), corporate governance lacks any form of coherence,
either empirically, methodologically or theoretically, with only piecemeal attempts to
understand and explain how the modern corporation is run. Tricker (2000) suggested
that corporate governance did not have an accepted theoretical base or commonly
accepted paradigm, and the term “corporate governance” was scarcely used until 1980.
Similarly, Murphy and Topyan (2005) found that researchers investigated corporate
governance less as a planned, systematic inquiry, and more as a response to observed
problems in corporations. As a result, corporate governance remains a collection of
11
disparate studies that lack collective coherence; there are significant disagreements in
the field of governance research.
Nevertheless, the amount of research on this topic has increased dramatically. In 2005,
Gillan (2006) carried out a search of Social Science Research Network abstracts
containing the term “corporate governance”, resulting in more than 3,500 hits. In July
2006, from the databases of Business Source Complete and Science Direct, 9,549 papers
with the key words “corporate governance” in their abstracts were found; a literature
survey of recent studies would be a daunting task.
The past fifteen years have also witnessed a proliferation of guidelines and codes of
“best practice” designed to improve corporate governance of public companies; this
heightened international awareness of corporate governance has prompted some stock
exchanges to encourage or mandate board independence among listed companies
(Gregory, 2001a, b, c).
The objective of this chapter is to present an overview of corporate governance systems
frequently addressed by researchers in the past two decades; within this context, the
recent developments in corporate governance standards in the U.K., U.S. and Australia
are introduced in order to provide some background and context information for the
current project.
In Section 2 of this chapter the major systems in corporate governance research are
introduced; the recommendations and listing rules, which have been used to promote
board independence in the U.K., U.S. and Australia, are examined in Section 3,
followed by a summary in Section 4.
2.2
Corporate Governance Systems
Denis and McConnell (2003) noted that, the publication of Jensen and Meckling (1976),
in which the authors applied agency theory to corporations and modelled the agency
costs of outside equity, had produced voluminous works in the U.S; by the early 1990s,
similar research in other countries began to appear. At first, the literature focused on
other major world economics, such as Germany, Japan and the U.K; recent years,
however, have witnessed an explosion of papers on corporate governance around the
world, for both developed and emerging markets.
12
Some researchers pointed out that, in general, two main systems or models of
governance had been identified and analysed in the literature (Aoki, 2001; Hall and
Soskice, 2001; Denis and McConnell, 2003; Gillan and Starks, 2003; Becht et al, 2005;
Aguilera, 2005; Jansson, 2005; Murphy and Topyan, 2005; Buoy, 2005).
The first is the “outsider system” (Bouy, 2005), “market-based system” (Becht et al,
2005; Murphy and Topyan, 2005) or “shareholder model” (Jansson, 2005), which has
been adopted in the U.K. and U.S. The second is the “insider system” (Bouy, 2005),
“long-term large investor system” (Becht et al, 2005; Murphy and Topyan, 2005) or
“stakeholder model” (Jansson, 2005) that has been employed by firms in continental
Europe, Japan and Korea, among others. Detailed surveys of these models are available
in Becht et al (2005), Murphy and Topyan (2005), Bouy (2005) and Jansson (2005),
whose propositions are summarized below.
The primary objective of the firm in the U.K. and U.S. is to maximize profit, and
performance is appreciated by the market value of the firm (Gay, 2002; Murphy and
Topyan, 2005; Bouy, 2005). The principal-agent relationship arising from the separation
of ownership and decision-making may cause the firm’s behaviour to diverge from the
profit-maximizing ideal; since the managers are not the owners of the firm, they can
have other objectives rather than maximizing the shareholder wealth (Jensen and
Meckling, 1976; Ross, 1987; Quinn and Jones, 1995; Shankmann, 1999). An effective
corporate governance framework is needed to minimize agency costs.
In an outsider system equities represent a large proportion of financial assets and GDP,
and there are developed investment banking and securities markets (Hall and Soskice,
2001; Denis and McConnell, 2003; Becht et al, 2005). The stock market may be
dominated by institutional investors, due to the tax incentives to collective schemes,
growth of mutual funds, and tendency for firms to issue shares directly to institutional
investors; institutional investors may have incentives to monitor management and serve
as a control mechanism (Denis and McConnell, 2003; Bouy, 2005; Aguilera, 2005).
The outsider systems in the U.K. and U.S. are also characterized by widely dispersed
share ownership and high turnover (Gay, 2002; Denis and McConnell, 2003; Becht et
al, 2005). As the power of shareholders to select directors and vote on key issues of the
company is limited by the fragmentation of ownership, regulatory bodies have to offer
adequate shareholder protection and allow investors to assume the risk-reward trade-off
13
with an equal access to information (Perotti and Von Thadden, 2003). Consequently the
main concern of corporate governance is the conflict between strong managers and
weak dispersed shareholders, and in this spirit the role of directors, stock options,
takeovers, minority shareholder protection are frequently investigated by researchers
(Becht et al, 2005; Bouy, 2005; Jansson, 2005).
As the board of directors is responsible for monitoring managerial performance and
preventing conflicts of interests, it must have some degrees of independence from
management; however, board independence often poses a problem in reality and the
board is regarded as a relatively weak governance device (Hermalin and Weisbach,
2003; Denis and McConnell, 2003; Bouy, 2005).
It is the capital markets that play a primary role in corporate governance. When
managers fail to maximize the firm’s value, they expose it to the threat of a take-over;
the market for corporate control may be a more effective disciplinary device than either
the monitoring by institutional investors or board of directors (Holmstrom and Kaplan,
2001; Becht et al, 2005; Murphy and Topyan, 2005). Thus this model is termed as the
“market-based” or “market-oriented” system in Becht et al (2005) and Murphy and
Topyan (2005); the intensity of mergers and acquisitions in the U.K and U.S. could be
justified by rent seeking behaviour, empire building and tax minimization.
In an insider system or stakeholder model such as continental Europe, Japan and Korea,
corporate ownership is typically concentrated among a stable network of strategically
orientated banks and firms, rather than fragmented among individuals and financialorientated institutional investors (Claessens, Djankov, Fan and Lang, 1998; Hansmann
and Kraakman, 2001; Hall and Soskice, 2001; Franks and Mayer, 2001; Wojcik, 2001);
the market for corporate control is largely non-existent.
Instead, banks play the central external governance role through relational financing,
commingling debt and equity, providing financial services and monitoring in times of
financial distress (McCauley and Zimmer, 1994; Fukao, 1995; Gay, 2002; Becht et al;
2005). Corporations must fulfil wider objectives and have responsibilities to parties
other than shareholders; the “best” firms are the ones with committed suppliers,
customers and employees, with corporate governance “coalitions” built among banks,
long-term investors, employees and management (Bouy, 2005; Jansson, 2005).
14
Employees could exercise voice within corporate governance, for example, through
legal rights to co-determination in Germany or extensive use of joint labourmanagement consultation in Japan; this role of employees is reflected in long
employment tenures, infrequent use of lay-offs and high investment in firm-specific
skills. Top managers tend to be internally promoted, and managerial compensation is
much closer to average employees’ schemes and lack of strong shareholder-oriented
incentives such as stock options; as a result managers are supposed to be less financeoriented and focus on long-term product strategy (Aoki, 2001; Hall and Soskice, 2001;
Jackson, 2001; Jackson and Moerke, 2005).
Bouy (2005, p.39) suggested that, for the stakeholder model, “the basic conflict is
between ‘strong voting blockholders, weak minority owners’ or ‘weak managers, weak
minority owners, strong majority owners’”; although there is little empirical evidence to
support this insight.
As found by Hansmann and Kraakman (2001), Becht et al (2005) and Murphy and
Topyan (2005), which of the two models has been favoured by scholars has varied over
time as a function of the relative success of each country’s underlying economy. The
German and Japanese stakeholder perspective had been regarded as strengths relative to
the Anglo-Saxon shareholder perspective in the 1980s, when Germany and Japan had
outperformed the U.S. From the late 1990s, following a decade of recession in Japan
and post-unification adjustments in Germany, and an economic and stock market boom
in the U.S., the American corporate governance model has been hailed as the path for all
to follow.
In the 1980s Germany and Japan had a lower cost of capital, which is assumed to be the
result of close relationships between corporations and banks and other long-term
investors (McCauley and Zimmer, 1994; Fukao, 1995), consequently Japanese firms
have higher investment rates than their U.S. counterparts (Prowse, 1990).
Another perceived strength in Japanese governance is the long-term relationships
between the multiple constituencies in the corporation, which make greater involvement
by employees and suppliers possible (Womack, Jones and Roos, 1991); the benefits of
these long-term relations are contrasted with the costs of potential “breaches of trust”
following “undesirable” takeovers in the U.S. (Shleifer and Summers, 1988).
15
Moreover, Narayanan (1985), Shleifer and Vishny (1989), Porter (1992a, b) and Stein
(1988, 1989), among others, asserted that the U.S. managers tended to be obsessed with
quarterly performance measures, had excessively “short-termist” perspective and paid
too much attention to potential takeover threats. In Porter (1992a, b) the U.S. practices
are compared to those in Germany and Japan, where the long-term involvement of
investors, especially banks, allow managers to invest for the long run and at the same
time monitor their performance.
Japanese Keiretsu, a corporate network in which a main bank serves as trade mediator,
payment guarantor and information provider to client firms, are also highlighted for
their superior ability to resolve financial distress or achieve corporate diversification
(Aoki, 1990; Hoshi, Kashyap and Scharfstein, 1990). On the other hand, the financial
regulations introduced at the beginning of the last century in the U.S. excessively limit
effective monitoring by financial institutions and other large investors (Black, 1990;
Grundfest, 1990; Roe, 1990, 1991, 1994).
After the meltdown of the Japanese stock market in 1990, the U.S. gained a lower cost
of equity, resulting from, as proposed by some commentators, superior minority
shareholder protection (e.g., La Porta, Lopez-de-Silanes and Shleifer, 1998), which is
one of the reasons why foreign firms increasingly choose to issue shares on the U.S.
exchanges (Coffee, 2002). It is also discovered that the low cost of capital in Japan in
the 1980s is a sign of excesses leading to overinvestment (Kang and Stulz, 2000). The
East Asian crisis is attributed to poor investor protection in relevant countries (Johnson,
2000; Claessens, Djankov, Fan and Lang, 2002; Shinn and Gourevitch, 2002).
The ideas that “undesirable” takeovers bring about “breaches of trust” and "shorttermist" behaviour gradually lose their popularity; instead takeovers are viewed as an
effective way to break up inefficient conglomerates (Shleifer and Vishny, 1997b). The
regulatory constraints in the U.S. that limit intervention by institutional investors offer
valuable protection to minority shareholders against expropriation or self-dealing by
large shareholders (Bebchuk, 1999, 2000; La Porta, Lopez-de-Silanes, Shleifer and
Vishny, 2000).
As shown in the review of Holmstrom and Kaplan (2001), there is a vast research on the
takeover market in the U.S; it is widely agreed that takeover is the ultimate control
mechanism of the Anglo-Saxon market-based model. Nevertheless, as pointed out by
16
Comment and Schwert (1995) and Bebchuk, Coates and Subramanian (2002), the
market for corporate control in the U.S. already disappeared, after the introduction of
anti-takeover laws and charter amendments at the end of the 1980s; most American
firms are extremely well protected against hostile takeovers (Danielson and Karpoff,
1998). The U.K may remain the only country in the Organization for Economic Cooperation and Development (OECD) with an active and open market for corporate
control (Short and Keasey, 1999; Becht et al, 2005).
Some authors addressed this contradiction. In the opinion of Hansmann and Kraakman
(2001), poison pill amendments and other anti-takeover devices are actually an
improvement because they eliminate partial bids “of a coercive character.” La Porta,
Lopez-de-Silanes and Shleifer (1999) asserted that the market for corporate control in
the U.S. was more active than elsewhere, because the U.S. anti-takeover rules were less
effective than anti-takeover measures elsewhere. In Holmstrom and Kaplan (2001), it is
concluded that hostile takeovers and leveraged buyouts are no longer needed, as the
U.S. corporate governance has reinvented itself, and the rest of the world seems to be
following the same path. Similarly, Romano (1993) and Coffee (1999) predicted a
world-wide convergence of corporate governance practices to the U.S. model.
By contrast, Easterbrook and Fischel (1991) and Easterbrook (1997) argued that no
global standards of corporate governance would be needed because international
differences in corporate governance were attributable more to differences in markets
than to differences in law; market forces would automatically create the regulatory
underpinnings national systems need.
Jackson and Moerke (2005), after an analysis of legal and regulatory reforms, banking
and financing, and employment in Germany and Japan, found no evidence to support
the arguments for international convergence; the simultaneous continuity and change in
corporate governance indicate a potential form of hybridization of national models or
renegotiation of stakeholder coalitions in these countries, and there is a growing
diversity of firm-level corporate governance practices within national systems.
The system of corporate governance in Australia is often described as forming part of
the Anglo-Saxon outsider model of ownership and control (Scott, 1997; Weimar and
Paper, 1999; Bradley, Schipani, Sundaram and Walsh, 1999; Campbell, 2002). It
appears that many large listed companies in this country have relatively dispersed
17
shareholdings, and Australia has almost all the institutions as presented in the U.K. and
U.S., such as mature securities market and regulator, takeover panel, disclosure regime
and corporate governance codes; there is also a general assumption that, as an Englishspeaking and common law country, Australia must somehow be like the U.K. and U.S.
However, questions have recently been raised about the accuracy of this classification.
Lamba and Stapledon (2001) examined a sample of 240 listed companies; the high
share concentrations at all company size suggest that, at least in terms of ownership
structure, Australian listed companies do not conform to the outsider governance model
presented in the U.K. and U.S.
In Dignam and Galanis (2004), the evidence on share ownership and shareholder voting
patterns, institutional investor activism, private rent extraction, market for corporate
control and blocks to information flow indicates that Australia does not have an outsider
system of corporate governance; rather, there is a system that has more in common with
the insider model. According to the authors, Australia is in the process of reforming its
corporate governance based on an assumption that it is an outsider model. If that
assumption is incorrect, the reforms may have a destabilizing effect; therefore
recognizing that the Australian market may have more in common with the insider
system would enable a more appropriate response to corporate governance problems
(Dignam and Galanis, 2004).
2.3
Corporate Governance Standards
Gregory (1999, p.3) noted that, “[i]n the Anglo-Saxon nations – Australia, Canada, the
U.K., and the U.S. – maximizing the value of the owners’ investment is considered the
primary corporate objective. This objective is reflected in corporate guidelines and
codes that emphasize the duty of the board to represent shareholders’ interests and
maximize shareholder value.”
Thus it appears that the current trend of recognizing that boards have responsibilities
separate from management, and describing the practices that best enable directors to
carry out these responsibilities, is a manifestation of the Anglo-Saxon shareholder
model, in which the main concern of corporate governance is the conflict between
strong managers and weak dispersed shareholders, based on agency theory introduced
by Jensen and Meckling (1976).
18
This section presents a review on the Cadbury Report (1992) and Combined Code
(1998, 2003) endorsed by the London Stock Exchange (LSE), corporate governance
listing standards issued by the New York Stock Exchange (NYSE) and Nasdaq Stock
Market (Nasdaq) in 2003, and the Guidelines (2003) published by the Australian Stock
Exchange (ASX), focusing on the rules with respect of the composition and structure of
the board of directors in these documents.
In this thesis, “the phrase ‘board composition’ means the make-up of the board in terms
of executive and non-executive directors, independent and affiliated non-executive
directors, and male and female directors. The phrase ‘board structure’ refers to the
structural features of the board, such as the presence or absence of committees (e.g.,
audit and remuneration committees), and whether the roles of chairperson and chief
executive officer (CEO) are performed by one or two persons” (Stapledon and
Lawrence, 1996, p.1).
2.3.1
Recommendations in the U.K.
The global movement to promote board independence in public companies has rapidly
gained momentum in the past fifteen years; Panasian, Prevost and Bhabra (2003)
observed that much of this trend was influenced by the publication of the Cadbury
Report (1992) in the U.K.
The Cadbury Report (1992), sometimes referred to as the Magna Carta of Corporate
Governance (Gregory, 2001a), was produced by the Committee on the Financial
Aspects of Corporate Governance chaired by Sir Adrian Cadbury. It consists of a formal
code and extensive comments and recommendations for publicly held U.K. firms,
around the separation of the role of CEO and chairman, balanced composition of the
board, selection process for non-executive directors (NEDs), transparency of financial
reporting and the need for good internal controls.
The report comments that the board must retain full and effective control over the
company and monitor the executive management. “[T]he effectiveness with which
boards discharge their responsibilities determines Britain’s competitive position. They
must be free to drive their companies forward, but exercise that freedom within a
framework of effective accountability. This is the essence of any system of good
corporate governance” (Cadbury Report, 1992, Report 1.1).
19
The report suggests that every public company should be headed by an effective board
which can both lead and control the business; this means a board made up of a
combination of executive directors, with their intimate knowledge of the business, and
of outside NEDs, who can bring a broader view to the company’s activities. Therefore
the board should include NEDs of sufficient calibre and number for their views to carry
significant weight in the board’s decisions; their appointment should be a matter for the
board as a whole, and there should be a formal selection process, which will enforce the
independence of NEDs and make it evident that they have been appointed on merit and
not through any form of patronage.
As NEDs are supposed to bring an independent judgement to bear on issues of strategy,
performance and resources, including key appointments and standards of conduct, it is
recommended that the majority of non-executives “… should be independent of
management and free from any business or other relationship which could materially
interfere with the exercise of their independent judgement, apart from their fees and
shareholding” (Cadbury Report, 1992, Code 2.2). It is for the board to decide in
particular cases whether this definition of independence is met.
Given the importance and particular nature of the chairman’s role, it should be in
principle separate from that of the CEO. If the two roles are combined in one person, it
will represent a considerable concentration of power; in such situations board members
are advised to look to a senior NED, who might be the deputy chairman, as the person
to whom they could address any concerns about the combined office of chairman/CEO
and its consequences for the effectiveness of the board.
It is also recommended that all listed companies establish an audit committee of at least
three NEDs with written terms of reference which deal clearly with its authority and
duties, and a remuneration committee consisting wholly or mainly of NEDS and chaired
by a NED, to recommend to the board the remuneration of the executive directors,
drawing on outside advice as necessary.
Following the momentum created by the Cadbury Committee, a number of
organizations and stock exchanges instituted corporate governance reviews throughout
the 1990s, for example, in Australia (Bosch report, 1995; AIMA Report, 1997),
Belgium (Cardon Report, 1998), Brazil (IBGC Code, 1999), Canada (Dey Report,
1994), France (Vienot Report I, 1995; Vienot Report II, 1999), Hong Kong (HKSE
20
Guide, 1995), India (Confederation Code, 1998), Japan (Corporate Governance
Principles, 1998), Malaysia (Report on Corporate Governance, 1999), Mexico (Code of
Corporate Governance, 1999), South Africa (King Report, 1994), South Korea (Code of
Best Practice, 1999), Thailand (SET Code, 1997), the Netherlands (Peters Code, 1997),
the U.S. (NACD Report, 1996; BRT Report, 1997), Spain (Governance of Spanish
Companies, 1998), Sweden (Swedish Academy Report, 1994) and OECD (Millstein
Report, 1998; OECD Principles, 1999). Gregory (2001a, b, c) provided detailed reviews
on these reports and codes.
In the U.K., the Cadbury Report (1992) was followed by the Greenbury Report (1995),
Hampel Report (1998) and Combined Code (1998). The Combined Code: Principles of
Good Governance and Code of Best Practices (Combined Code), issued by the LSE
Committee on Corporate Governance, has been appended to the LSE Listing Rules,
covering areas relating to composition, structure and operation of the board, director’s
remuneration, accountability and audit, relations with and responsibilities of
institutional shareholders.
Building on the Cadbury, Greenbury and Hampel reports, the Combine Code (1998)
recommends that the board include a balance of executive and NEDs such that no
individual or small group of individuals can dominate the board’s decision-making.
NEDs should comprise not less than one-third of the board, and the majority of them
“… should be independent of management and free from any business or other
relationship which could materially interfere with the exercise of their independent
judgement” (Combined Code, 1998, Provision A.3.2). NEDs considered by the board to
be independent should be identified in the annual report.
According to the Code, there are two key tasks at the top of every public company – the
running of the board and the executive responsibility for the running of the company’s
business; there should be a clear division of responsibilities which ensures a balance of
power and authority, such that no one has unfettered powers of decision. Thus a
decision to combine the posts of chairman and CEO in one person should be publicly
justified. Whether the posts are held by different people or by the same person, there
should be a strong and independent non-executive element on the board, with a
recognized senior member other than the chairman to whom concerns could be
21
conveyed. The chairman, CEO and senior independent director should be identified in
the annual report.
The Code also suggests that, unless the board is small, a nomination committee should
be established to make recommendations to the board on all new board appointment; a
majority of the members of this committee should be NEDs and the chairman may be
either the chairman of the board or a NED. The board should also establish an audit
committee of at least three directors, all non-executives and a majority of them should
be independent, with written terms of reference which deal clearly with its authority and
duties. If there is a remuneration committee on the board, the committee should consist
exclusively of independent NEDs.
The LSE requires that each listed company disclose in its annual report how it has
applied the Code principles and whether it has complied with the Code provisions, if
not, why not and for what period. Guidance for companies on how this could be
approached was needed; this led to the publication of the Turnnbull Report (1999) by
the Institute of Chartered Accountants in England and Wales (ICAEW), to define more
clearly the accountability of directors and management.
In July 2002, Derek Higgs was appointed by the Secretary of State for Trade and
Industry and the Chancellor to lead an independent review into the role and
effectiveness of NEDs, resulting in the publication of the Higgs Report (2003).
Subsequently, the Combined Code (1998) was revised based on the recommendations
made in this report.
The Combined Code (2003) continues to require the board to identify in its annual
report each NED who it considers to be independent; however, the Higgs test for
independence has been introduced. “The board should determine whether the director is
independent in character and judgment and whether there are relationships or
circumstances which are likely to affect, or could appear to affect, the director’s
judgement. The board should state its reasons if it determines that a director is
independent notwithstanding the existence of relationships or circumstances which may
appear relevant to its determination” (Combined Code, 2003, Provision A.3.1); factors
relevant to independence include if the director:

has been an employee of the company or group within the last five years;
22

has had a material business relationship with the company within the last three
years;

receives additional remuneration from the company apart from a director’s fee,
participates in the company’s share option or a performance-related pay scheme,
or is a member of the company’s pension scheme;

has close family ties with any of the company’s advisers, directors or senior
employees;

holds cross-directorships or has significant links with other directors through
involvement in other companies or bodies;

represents a significant shareholder; and

has served on the board for more than nine years from the date of first election.
NEDs may serve beyond six years, i.e., two terms, but longer periods of service should
be subject to rigorous review. This is a dilution of the Higgs recommendation that
NEDs generally be limited to serving for six years and the reasons for any longer period
of service explained to shareholders.
The revised Code takes the original position concerning board composition a step
further by suggesting that at least half of the members of the board, excluding the
chairman, should be independent NEDs. The chairman must meet the test of
independence on appointment but thereafter is not regarded as independent. According
to Higgs (2003), the chairman will be in constant and close contact with the executive
directors in carrying out his or her duties; as a result the test for independence is
considered to be “neither appropriate nor necessary” once a chairman has been
appointed.
It should be noted that, in this recommendation, a non-independent NED is regarded in
the same category as an executive director, rather than neutral, like the chairman. Higgs
(2003) argued that his recommendation that at least half the board comprise independent
NEDs should not be interpreted as meaning that non-independent NEDs had no place on
company boards. However, for many companies, the presence of non-independent
NEDs could make compliance with this recommendation significantly more difficult.
The Code states that a chief executive should not go on to become chairman of the same
company except in exceptional cases where major shareholders are consulted in
23
advance and the reasons for that appointment set out in the annual report; this is a
relaxation of the Higgs recommendation that a chief executive should not be permitted
to become chairman of the company.
The revised Code provides that every company should establish an audit committee
consisting of at least three, or in the case of smaller companies two, independent NEDs,
and at least one member should have recent and relevant financial experience. The
remuneration committee must consist of at least three, or in the case of smaller
companies two, independent NEDs.
Some of the more controversial Higgs recommendations were dropped in the Combined
Code (2003). For example, Higgs (2003) suggested that the senior independent NED,
rather than the chairman, should be responsible for communicating shareholder views to
the board. The Code confirms that the chairman should communicate shareholder views
to the board and discuss governance and strategy with major shareholders. The senior
independent NED is expected to attend sufficient meetings with major shareholders to
develop an understanding of their concerns; he or she must also be available to meet
with shareholders if they have concerns which have not been resolved by, or are
inappropriate to discuss with, the chairman, chief executive or financial director.
2.3.2 Listing Rules in the U.S.
In the U.S., in direct response to corporate collapses resulting from accounting
irregularities and failures of ethics and controls, i.e., Enron, WorldCom and Arthur
Andersen, the Sarbanes-Oxley Act was passed into law by the Congress in July, 2002.
The Act sought to enhance corporate governance and disclosure requirements by
enforcing a higher level of responsibility, accountability and financial reporting
transparency on company executives, directors and auditors.
Subsequently, the NYSE and Nasdaq initiated corporate governance reforms and
proposed changes to their listing requirements. According to the NYSE (NYSE Press
Release, August 16, 2002), the reforms “…focus on giving boards greater independence
and investors greater say in the governance of their companies. The tighter corporategovernance standards aim to help win back the trust and confidence of investors”.
In November 2003, the Securities and Exchange Commission (SEC) approved the
corporate governance listing standards of the NYSE. The rules, which are codified in
24
Section 303A of the NYSE Listed Company Manual, are the culmination of a series of
proposals and amendments from the NYSE that had occurred over more than one year.
The NYSE rules require that a majority of each listed company’s directors qualify as
independent directors. “No director qualifies as ‘independent’ unless the board of
directors affirmatively determines that the director has no material relationship with the
listed company (either directly or as a partner, shareholder or officer of an organization
that has a relationship with the company). Companies must identify which directors are
independent and disclose the basis for that determination” (NYSE Manual, 2003,
Section 303A.02). In addition to the absence of a material relationship, the NYSE
prohibits a finding that a director is independent in the following situation:

a director who is an employee, or whose immediate family member is an
executive officer, of the company is not independent until three years after the
end of such employment relationship;

a director who receives, or whose immediate family member receives, more than
$100,000 per year in direct compensation from the listed company, other than
director and committee fees and pension or other forms of deferred
compensation for prior service (provided such compensation is not contingent in
any way on continued service), is not independent until three years after ceasing
to receive more than $100,000 per year in such compensation;

a director who is affiliated with or employed by, or whose immediate family
member is affiliated with or employed in a professional capacity by, a present or
former internal or external auditor of the company is not independent until three
years after the end of the affiliation or the employment or auditing relationship;

a director who is employed, or whose immediate family member is employed, as
an executive officer of another company where any of the listed company’s
present executives serve on that company’s compensation committee is not
independent until three years after the end of such services or the employment
relationship; or

a director who is an executive officer or an employee, or whose immediate
family member is an executive officer, of a company that makes payments to, or
receives payments from, the listed company for property or services in an
amount which, in any single financial year, exceeds the greater of $1 million, or
25
2% of such other company’s consolidated gross revenues, is not independent
until three years after falling below such threshold.
“Immediate family member” is defined to include a person’s spouse, parents, children,
siblings, mothers and fathers-in-law, sons and daughters-in-law, brothers and sisters-inlaw, and anyone, other than domestic employees, who shares such person’s home. The
NYSE stated in commentary to the rules that the board should consider the issue not
merely from the standpoint of the director, but also from the standpoint of persons or
organizations with whom the director had an affiliation. Because the concern is
independent from management, the rules do not view ownership of even a significant
amount of shares, by itself, as a bar to an independence finding.
To facilitate the determination of whether a director has a material relationship with the
company, the board may adopt categorical standards, which must be disclosed, and may
make a general disclosure if a director meets these standards. Any determination of
independence for a director who does not meet the standards must be specifically
explained; in the event that a director with a relationship that does not fit within the
standards is determined to be independent, a board must disclose the basis for its
determination.
Under the NYSE rules, the NEDs of a listed company must convene regularly
scheduled sessions without members of management in attendance; if the NEDS include
persons who are not independent directors as defined under the rules, at least one
separate session of independent directors should be convened annually. If a director is
chosen to preside at these meetings, that director’s name must be disclosed and, in order
that interested parties may be able to make their concerns known to the NEDs, the
company must disclose a method for such parties to communicate directly with the
presiding director or with the NEDs as a group.
Every listed company is required to have a nominating/corporate governance committee
and a compensation committee, each of which is comprised entirely of independent
directors and has a charter outlining certain minimum duties and responsibilities. Each
company must have an internal audit function and an audit committee with a charter
addressing the committee’s purpose and certain minimum duties and responsibilities;
the audit committee must have a minimum of three members, each of whom qualifies as
26
an independent director under the rules, as well as the independence criteria for audit
committee members set forth in the Securities Exchange Act Rule 10A-3(b)(1).
According to Rule 10A-3(b)(1), in order to be considered to be independent, a member
of an audit committee may not be an affiliated person of the company or any subsidiary
of the company, and may not accept any consulting, advisory or other compensatory fee
from the company or any subsidiaries thereof, other than in his or her capacity as a
member of the board or any board committee. Compensatory fee does not include the
receipt of fixed amounts of compensation under a retirement plan for prior service with
the company, provided that such compensation is not contingent in any way on
continued service.
The NYSE asked each company to develop and disclose its corporate governance
guidelines and a code of business conduct and ethics for its directors, officers and
employee. The CEO must certify on an annual basis that he or she is not aware of any
violation by the company of the NYSE corporate governance listing standards, and must
promptly notify the NYSE after becoming aware of any material non-compliance with
the governance requirements.
The NYSE may issue a public reprimand letter to a company that violates a listing
standard. The NYSE commented that suspending trading or delisting a company could
be harmful to the very shareholders the standards sought to protect; therefore these
measures would be used sparingly and judiciously. For companies that repeatedly or
flagrantly violate the rules, suspension and delisting remain the ultimate penalties.
In November 2003, the SEC also issued an order approving the corporate governance
rules of Nasdaq. Perhaps the most important provision of the rules, which are codified
as Nasdaq Marketplace Rules 4200 and 4350, is the requirement that a majority of the
board of directors of a listed company be independent directors.
As defined by Nasdaq Marketplace Rule 4200(a)(15), “[i]ndependent directors means a
person other than an officer or employee of the company or its subsidiaries or any other
individual having a relationship which, in the opinion of the company’s board of
directors, would interfere with the exercise of independent judgement in carrying out
the responsibilities of a director. The following persons shall not be considered
independent”:
27

a director who is, or at any time during the past three years was, employed by
the company or by any parent or subsidiary of the company;

a director who accepted or who has a family member who accepted any
payments from the company or any parent or subsidiary of the company in
excess of $60,000 during any period of twelve consecutive months within the
past three years, other than some exceptions listed in the rule;

a director who is a family member of an individual who is, or during the past
three years was, employed by the company or by any parent or subsidiary of the
company as an executive officer;

a director who is, or has a family member who is, a parent in, or a controlling
shareholder or an executive officer of, any organization to which the company
made, or from which the company received, payments, other than those arising
solely from investments in the company’s securities or payments under nondiscretionary charitable contribution matching programs, for property or services
in the current or any of the past three financial years that exceed 5% of the
recipient’s consolidated gross revenues for that year, or $200,000, whichever is
more;

a director who is, or has a family member who is, employed as an executive
officer of another entity where at any time during the past three years any of the
executive officers of the listed company serve on the compensation committee
of such other entity; or

a director who is, or has a family member who is, a current partner of the
company’s outside auditor, or was a partner or employee of the company’s
outside auditor who worked on the company’s audit at any time during any of
the past three years.
Nasdaq specified that share ownership alone would not preclude a director from being
deemed independent. The term “family member” as used in the test of independence
includes a person’s spouse, parents, children and siblings whether by blood, marriage or
adoption, or anyone residing in such person’s home.
Independent directors must have regularly scheduled meetings, at which only
independent directors are present. These sessions, which Nasdaq contemplated would
28
occur at least twice a year in conjunction with regularly scheduled board meetings, are
designed to encourage and enhance communication among independent directors.
The rules require that the compensation of the CEO and other executive officers of the
company must be determined, or recommended to the board for determination, either by
a majority of the independent directors, or a compensation committee comprised solely
of independent directors. Director nominees must either be selected, or recommended
for the board’s selection, either by a majority of the independent directors, or a
nominating committee comprised solely of independent directors. Thus Nasdaq, unlike
the NYSE, does not mandate a listed company to have a compensation committee and a
nominating committee.
Each company must establish an audit committee of at least three members, who qualify
as independent directors under the rules, and satisfy the independence criteria for audit
committee members set forth in the Securities Exchange Act Rule 10A-3(b)(1). In
addition, they should not have participated in the preparation of financial statements of
the company or any current subsidiary of the company during the past three years, and
should be able to read and understand financial statements at the time of appointment to
the committee. At least one member must have past employment experience in finance
or accounting, requisite professional certification in accounting or any other comparable
experience or background which results in the individual’s financial sophistication. It is
required that all related party transactions be approved by the audit committee or
another independent body of the board of directors.
Companies are also required to adopt a code of conduct for their directors, officers and
employees, which should be publicly available. Each company must provide Nasdaq
with prompt notification after an executive officer becomes aware of any material noncompliance by the company with any of the Nasdaq’s listing requirements.
2.3.3
Australian Guidelines
Australia had watched closely as big corporate failures had prompted the U.S.
regulatory authorities to launch significant corporate governance reforms, including the
Sarbanes-Oxley Act of 2002 and the then proposed amendments to the NYSE and
Nasdaq listing standards. In order to promote and restore investor confidence, the ASX
convened the ASX Corporate Governance Council in August 2002; its purpose, as
29
announced by the ASX, was to develop recommendations which reflect international
best practice.
In March 2003, the Council released Principles of Good Corporate Governance and
Best Practice Recommendations (Guidelines), which, as indicated by the Council,
follows the “if not, why not” approach of the U.K. Combined Code (1998, 2003). It is
concluded that, “[t]he best practice recommendations are not prescriptions. They are
guidelines, designed to produce an efficient, quality or integrity outcome. This
document does not require a ‘one size fits all’ approach to corporate governance.
Instead, it states aspirations of best practice for optimising corporate performance and
accountability in the interests of shareholders and the broader economy. If a company
considers that a recommendation is inappropriate to its particular circumstances, it has
the flexibility not to adopt it – a flexibility tempered by the requirement to explain why”
(Guidelines, 2003, p.5).
In the Guidelines (2003), companies are recommended to formalise and disclose the
function reserved to the boards and those delegated to management. All directors should
bring an independent judgement to bear in decision-making, and a majority of the board
should be independent directors.
According to the Council (Guidelines, 2003, p.19), “[a]n independent director is
independent of management and free of any business or other relationship that could
materially interfere with – or could reasonably be perceived to materially interfere with
– the exercise of their unfettered and independent judgement.” It is further defined in
Box 2.1 of the Guidelines (2003) that an independent director is a NED and

is not a substantial shareholder of the company or an officer of, or otherwise
associated directly with, a substantial shareholder of the company;

within the last three years has not been employed in an executive capacity by the
company or another group member, or been a director after ceasing to hold any
such employment;

within the last three years has not been a principal of a material professional
adviser or a material consultant to the company or another group member, or an
employee materially associated with the service provided;
30

is not a material supplier or customer of the company or other group member, or
an officer of otherwise associated directly or indirectly with a material supplier
or customer;

has no material contractual relationship with the company or another group
member other than as a director of the company;

has not served on the board for a period which could, or could reasonably be
perceived to, materially interfere with the director’s ability to act in the best
interests of the company; and

is free from any interest and any business or other relationship which could, or
could reasonably be perceived to, materially interfere with the director’s ability
to act in the best interests of the company.
The board should state its reasons if it considers a director to be independent
notwithstanding the existence of relationships listed above. In this context, it is
important for the board to consider materiality thresholds from the perspective of both
the company and its directors, and to disclose these.
Directors considered by the board to be independent should be identified as such in the
annual report. The tenure of each director, which is important to an assessment of
independence, should also be disclosed. The board should regularly assess the
independence of each director in light of interests disclosed by them; where the
independence status of a director is lost, this should be immediately disclosed to the
market.
The Guidelines (2003) advise that the role of chairman and CEO should not be
exercised by the same individual, and the chairman should be an independent director.
Where the chairman is not an independent director, it may be beneficial to consider the
appointment of a lead independent director.
The board is encouraged to establish a nomination committee, a remuneration
committee and an audit committee; all the members of the audit committee should be
NEDs. Each committee should consist of at least three members, the majority being
independent directors, with a formal charter setting out the committee’s role and
responsibilities, composition, structure, and membership requirements. The nomination
committee should be chaired by the chairman of the board or an independent director;
31
the remuneration committee and the audit committee should be chaired by an
independent director.
The board or appropriate committee should establish and disclose policies on risk
oversight and management, and trading in company securities by directors, officers and
employees. The process for performance evaluation of the board, its committees,
directors and key executives, should be disclosed; companies may provide disclosure in
relation to their remuneration policies to enable investors to understand the costs and
benefits of those policies, and the link between remuneration paid to directors and key
executives and corporate performance. Companies are also suggested to clearly
distinguish the structure of NEDs remuneration from that of executives, and to ensure
that payments of equity–based executive remuneration are made in accordance with
thresholds set in plans approved by shareholders.
Company are advised to adopt a code of conduct to guide their directors, CEOs, chief
financial officers and any other key executives as to the practices necessary to maintain
confidence in the companies’ integrity, and the responsibility and accountability of
individuals for reporting and investigating unethical practices. A code of conduct to
guide compliance with legal and other obligations to legitimate stakeholders should also
be developed and disclosed.
The Guidelines (2003) recommend that written policies and procedures be developed to
ensure compliance with the ASX disclosure requirements and to ensure accountability
at a senior management level for that compliance. The strategy to promote effective
communication with shareholders and encourage effective participation at general
meetings should be designed and disclosed; the company should request the external
auditor to attend the annual general meeting and answer shareholder questions about the
conduct of the audit and the preparation and content of the auditor’s report.
Under ASX Listing Rule 4.10.3, from 2004 each company is required to provide a
statement in its annual report disclosing the extent to which it has followed the best
practice recommendations in the reporting period; where the company has not followed
all the recommendations, it must identify the recommendations that have not been
followed and give reasons for not following them.
32
In August 2007, the Corporate Governance Council released the second edition of the
Guidelines (2007), which contains no significant changes to the recommendations to
“[s]tructure the board to add value” as introduced above (Guidelines, 2003, p.19;
Guidelines, 2007, p.16), except that the last two points in Box 2.1 have been removed
from the definition of independence. “Best practice” has also been removed from the
title and text of the document to eliminate any perception that the principles are
prescriptive and so not to discourage companies from adopting alternative practices and
“if not, why not” reporting where appropriate.
2.4
Summary
Recent years have witnessed an explosion of research on corporate governance around
the world, and there are, in general, two major governance systems that have been
identified in the past two decades. The first is the outsider system adopted in the U.K.
and U.S., and the second is the insider system in Germany and Japan. It is noted that
researchers tended to favour the insider system during the 1980s, when the economies
of Germany and Japan outperformed others, and tended to favour the outsider system in
the 1990s, when the economies of the U.S. looked better.
Australia’s system of corporate governance has been described as forming part of the
Anglo-Saxon outsider model of ownership and control. However, some researchers
raised questions about this classification, and argued that the Australian system might
have more in common with the insider system.
The calls for greater board independence become increasingly popular after the
publication of the Cadbury Report (1992); it appears that this movement is based on the
Anglo-Saxon shareholder model, which assumes that the basic conflict is between
managers and shareholders. From 2003, listed companies in the U.K., U.S. and
Australia have been subject to new governance code, rules or guidelines, which sought
to improve board independence in public companies.
There are some differences in the general approaches of governance endorsed by the
stock exchanges. In the U.S., the NYSE and Nasdaq take a mandatory approach in
which every company must comply with every standard, in order to be listed on the
stock exchanges. On the other hand, the ASX and LSE follow a voluntary approach in
which “[i]f a company considers that a recommendation is inappropriate to its particular
33
circumstances, it has the flexibility not to adopt it – a flexibility tempered by the
requirement to explain why” (Guidelines, 2003, p.5).
It is agreed that a majority of each listed company’s directors, or in the case of the LSE
at least half of the members, should qualify as independent directors. Although the
definitions of “independence” vary, it appears that all of them are based on the
statement in the Cadbury Report (1992, Code 2.2) - an independent director “… should
be independent of management and free from any business or other relationship which
could materially interfere with the exercise of their independent judgement, apart from
their fees and shareholding”.
Although it is for the board to decide in particular cases whether the definition of
independence is met, there are lists of the persons who should not be considered
independent. For a company listed on the ASX and LSE, the board may state its reasons
if it determines that a director is independent notwithstanding the existence of
relationships or circumstances included in the lists. In contrast, the lists presented by
the NYSE and Nasdaq are coercive, and more prescriptive.
According to the ASX and LSE, the roles of chairman and CEO should not be exercised
by the same individual, and the chairman should be an independent director or meet the
independence test on appointment; if the two roles are combined in one person or the
chairman is not independent, companies are suggested to appoint a lead or senior
independent director. The NYSE and Nasdaq do not have any opinion on the concern
over CEO duality.
All the stock exchanges support listed companies to establish an audit committee. For
firms listed on the ASX and LSE, the committee should be comprised entirely of NEDs,
the majority being independent directors; in addition, the ASX recommends that the
committee be chaired by an independent director. The NYSE and Nasdaq require that
all the members of the committee qualify as independent directors under their rules, as
well as the independence criteria for audit committee members set forth in the Securities
Exchange Act.
The ASX, LSE and NYSE believe it would be necessary for each company to have a
nomination committee and a remuneration committee. The ASX recommends that a
majority of each committee’s members be independent directors; the nomination
34
committee should be chaired by the chairman of the board or an independent director,
and the remuneration committee should be chaired by an independent director. The LSE
suggests that a majority of the members of the nomination committee should be NEDs,
and the committee should be chaired by the chairman of the board or a NED; the
remuneration committee should consist exclusively of independent directors. The
NYSE and Nasdaq require that both committees be comprised entirely of independent
directors.
From the above review, it could be concluded that, in the long-run, these
recommendations and listing rules are likely to result in a shift in the overall power of
boards of directors in favour of independent directors, and away from executive
management, among public companies in the U.K., U.S. and Australia.
35
Chapter 3. Empirical Evidence
3.1
Introduction
The empirical research on board of directors, matching the trend towards greater board
independence, is growing. In general, researchers have taken two approaches to study
the impact of independent or outside directors on firm performance (Bathala and Rao,
1995; Lawrence and Stapledon, 1999; Bhagat and Black, 1999, 2000; Panasian et al,
2003).
The first approach is based on relating board composition and structure to certain
corporate events, such as executive turnover (e.g., Weisbach, 1988; Borokhovich,
Parrino and Trapani, 1996; Mikkelson and Partch, 1997; Suchard, Singh and Barr,
2001) and remuneration (e.g., Newman and Wright, 1995; Sridharan, 1996; Brick,
Palmon and Wald, 2006), financial reporting (e.g., Wright, 1996; Beasley, 1996;
Dechow, Sloan and Sweeney, 1996; Peasnell, Pope and Young, 1998; Beasley and
Petroni, 1998), making, or defending against, a takeover bid (e.g., Byrd and Hickman,
1992; Brickley, Coles and Terry, 1994), management buyout (e.g., Chun, Rosenstein,
Rangan and Davidson, 1992) and shareholder litigation (e.g., Romano, 1991; Ferris,
Lawless and Makhija, 2001; Ferris, Jagannathan and Pritchard, 2003; Helland and
Sykuta, 2005).
Some scholars, for example Lawrence and Stapledon (1999) and Bhagat and Black
(1999) have reviewed this research; although these studies offer some insights into how
different boards behave on particular jobs, “[t]he principle weakness of this approach is
that it cannot tell us how board composition affects overall firm performance. Firms
with majority-independent boards could perform better on particular tasks, such as
replacing the CEO, yet worse on other tasks, leading to no net advantage in overall
performance” (Bhagat and Black, 1999, p.3).
The second approach involves investigating directly the correlation between board
characteristics and financial performance, i.e., the “bottom line” of firm performance.
As indicated by Bathala and Rao (1995), Lawrence and Stapledon (1999), Bhagat and
Black (1999, 2000), and Panasian et al (2003), it may avoid the weakness inherent in
the first group of studies.
36
In this chapter an up-to-date review of this stream of literature in Australia and
overseas, which gives evidence on whether board characteristics and firm performance
are related, is produced; its focus is on cross-sectional studies on publicly listed
companies.
The remainder of this chapter is organized as follows. Section 2 provides a survey of
Australian research in this field. In Section 3 some U.S. studies on the board
demographics-firm performance link, and three event studies on the stock-market
reactions to changes in board composition, are examined. Section 4 provides an
introduction to empirical evidence from other regions. A summary of the findings and
identified limitations in these studies is then presented in Section 5.
3.2
Australian Evidence
Kiel and Nicholson (2003) conducted a brief survey of Australian studies on board of
directors, and noted that there were only three papers addressing the relationship
between board composition and firm performance. They concluded that “[t]he
Australian literature on corporate governance has been primarily descriptive, with an
emphasis on describing the size and composition of boards and the extent to which
board interlocks occur” (Kiel and Nicholson, 2003, p.191).
In Muth and Donaldson (1998), the authors investigated the validity of agency theory
and stewardship theory, which make different predictions about the impact of board
independence on firm performance. By examining a sample of 145 large ASX-listed
companies, it was found that a higher board independence factor, which is composed of
CEO duality, board size, proportion of NEDs, interest alignment with owners and
average age across all directors, leads to both lower subsequent shareholder wealth
(dividends and share price appreciation) and sales growth; the level of board
independence, however, appears to have no significant effect on profit performance
factor made up of return on assets (ROA), return on equity (ROE) and profit margin.
Muth and Donaldson (1998) concluded that agency theory predictions relating to board
independence and firm performance were not upheld while those of stewardship theory
were supported.
Calleja (1999) investigated 83 of the top 100 Australian companies ranked by market
capitalization, listed on the ASX at 31 December 1997; her performance measure is the
37
one year adjusted shareholder return for each company at 31 December 1997.
Regressions are carried out for the number of board committees, board size and the
proportion of NEDs, on shareholder return; no statistically significant relationship is
found.
Similarly, Lawrence and Stapledon (1999) attempted to determine whether there was an
association between board composition and corporate performance in the top 100
companies listed on the ASX at the end of 1995. They discovered that the proportion of
independent directors and the proportion of executive directors were insignificant
explanatory variables for share price performance, i.e., the mean percentage change in
share price, during the 1985-1995 and 1990-1995 periods.
For accounting performance measure, during the 1987-1991 and 1991-1995 sample
periods, the proportion of independent directors is significantly negatively related to the
ratio of revenue to assets. However, there is no relation between board composition and
other accounting measures such as net profit, earnings before interest and tax (EBIT),
ratio of revenue to assets, and net profit to revenue. Lawrence and Stapledon (1999)
suggested that, as far as Australian largest listed companies were concerned,
independent directors did not appear to have added value over the 1985 to 1995 period.
In Cotter and Silverster (2003), the authors focused on the independence of board of
directors and its audit and compensation committees; they assumed that “[f]or firms
whose boards use a committee structure, much of the monitoring responsibility of the
board is expected to rest with the independent committee members” (Cotter and
Silverster, 2003, p.211).
Moreover, they argued that the more direct indicator of effective monitoring of
management was firm value rather than performance; “[w]hile performance and value
are linked, firm value more directly captures predictions emanating from agency theory”
(Cotter and Silverster, 2003, p.216). Market value of equity is used as the measure for
firm value. It appears that the year of interest in their study is 1997.
Their analysis of 109 large Australian companies show a negative relationship between
leverage and audit committee independence, regardless of whether this is measured as
the proportion of independent directors or the absence of the CEO from this committee,
indicating that when debt-holders have lower incentives to monitor the financial
38
reporting and audit functions, the independence of committee level monitoring becomes
more important.
For the full board, managerial ownership and substantial shareholders are negatively
associated with independence; that is, a more independent board is used for monitoring
when there is low managerial ownership and an absence of substantial shareholders.
However, neither board nor committee independence is significantly associated with
firm value.
Kiel and Nicholson (2003) is the first large-scale investigation of the Australian
experience concerning board characteristics and corporate performance; their sample
includes 348 companies out of the top 500 companies trading on the ASX in 1996. It is
reported that larger companies have larger, more interlocked boards, a greater
proportion of outside directors and more likely to separate the roles of chairman and
CEO.
Turning to correlation of board demographics and firm performance, different results
occur depending on whether the market-based measure (Tobin’s q) or the accounting–
based measure (ROA) of firm performance is used. It appears that the market rewards
large boards and also boards with a relatively lower proportion of outside directors,
although no such relationship is found with respect to the accounting-based
performance measure.
In Bonn, Yoshikawa and Phan (2004), the authors addressed the concern over the
influence of national differences in corporate governance on firm performance. Their
Australian sample consists of 104 manufacturing firms from the top 500 companies
listed on the ASX, and the Japanese sample consists of 160 manufacturing firms from
the Nikkei 300 Index. With the Australian firms, they found a positive association
between outside director ratio and ROA, and between the ratio of female directors and
market-to-book ratio (MBT). For Japanese firms, board size and the average age of
directors are both negatively associated with MBT.
Bonn et al (2004) asserted that their findings confirmed the importance of national
context on corporate governance practices. It is recommended that when applying
existing theory in different countries, or developing new theory, researchers need to take
the national context into consideration; there may be different agency relationships in
39
different countries, and it is necessary to be cautious when interpreting and generalizing
the results across national boundaries.
Balatbat, Taylor and Walter (2004) examined ownership structure and board attributes
of 313 Australian initial public offerings (IPOs) between 1976 and 1993, and their
relations with up to 5 years of post-listing operating performance.
From their sample of 1,316 firm-year observations, the authors identified a positive
association between managerial ownership and firm performance in terms of operating
return (EBIT deflated by total assets) in the fourth and fifth years after the IPO; there is
some evidence of a positive relationship between institutional ownership and
performance, although this is not consistent across post-listing years. There is no
evidence that board composition is associated with variation in performance, although
firms with dual leadership are found to perform better than those with a unitary
leadership structure.
Balatbat et al (2004, p.327) commented that “[t]he circumstances faced by IPO firms
may frequently render more traditional corporate governance practices irrelevant,
especially as they relate to monitoring managers who provide highly firm-specific
human capital as a key component of the firm’s value.”
Hutchinson and Gul (2004) explored whether some corporate governance variables,
including the ratio of non-executive to executive directors on the board, would moderate
the relationship between investment opportunities and firm performance. The sample
they used includes 310 companies listed on the ASX in 1998-1999. Their regression
indicates that NEDs present a positive effect on ROE; this effect, however, disappears
in the sensitivity test.
3.3
Evidence from the U.S.
Bhagat and Black (2000) searched the literature on whether board demographics affect
firm performance or vice versa. Based on their review of twelve U.S. studies, they
concluded that “[p]rior research does not establish a clear correlation between board
independence and firm performance” (Bhagat and Black, 2000, p.5).
The literature to date confirms that the empirical research around this topic has been
most developed in the U.S; of the thirty-seven overseas papers for which complete texts
40
were obtained in 2008, twenty-four are from this country, including three event studies.
In this section an overview of these U.S. papers is provided.
3.3.1
Cross-Sectional Studies
In an early study, Pfeffer (1972) proposed that the percentage of inside or outside
directors on the board might be an important indicator of the extent to which the
organization was externally or internally orientated. If, either directors matter, or the
extent of the organization’s inside-outside orientation matters, then some consequences
should be evident for those organizations that do or do not match well with
environmental requirements. Specifically, it was hypothesized that “organizations that
deviate relatively more from a preferred inside-outside director orientation should be
relatively less successful when compared to industry standards than those that deviate
less from a preferred board composition” (Pfeffer, 1972, p.225).
This hypothesis was tested using a random sample of 80 large U.S. corporations with
relevant data in 1969. The author developed an equation to represent the pooled
experience of the sample companies with respect of inside-outside director orientation
proxied by the percentage of inside directors. According to Pfeffer (1972), the equation
gives an optimal insider-outsider relationship for each company. The findings indicate
that firms that deviated more from the optimal equation are likely to perform more
poorly compared to industry standards, in terms of net income to sales ratio and net
income to stockholders’ investment ratio.
Baysinger and Bulter (1985, p.115), in order to “… examine performance differences
across corporations as a function of differences in board independence and changes in
independence occurring between 1970 and 1980”, constructed a sample of 266 major
U.S. firms. They classified the directors of sample companies into three components.
The executive component includes corporate officers and retirees, and other insiders;
the instrumental component includes financiers, consultants, legal counsel and
interdependent decision-makers. The monitoring component is made up of public
director, professional directors, private investors and independent decision-makers; it is
asserted that only these directors in the monitoring group “… meet the popular
standards of independence” (Baysinger and Bulter, 1985, p.113).
41
The measure of financial performance selected in this paper, relative financial
performance, is calculated by dividing the firm’s ROE by the average ROE for all the
firms in its primary industry, including those not in the sample. Baysinger and Bulter
(1985) reported that firms that had invited relatively more independent directors onto
their boards in 1970 enjoyed relatively better records of financial performance in 1980;
however, changes in the proportion of independent directors did not produce significant
changes in performance over time.
To offer some insights into the relationship between financial involvement of directors
and firm performance, Kesner (1987) randomly chose 250 of the 1983 Fortune 500
companies. They found that insiders owned a far greater amount of stock than their
outside counterparts, and the proportion of insiders was positively related to current
firm performance (1983), in terms of profit margin and ROA, and future performance
(1984-1985) measured by total return to investors. According to the writer, “[t]hese
findings suggest that higher inside representation is associated with greater profitability
and higher asset utilization” (Kesner, 1987, p.504).
In addition, it appears that in low growth industries director ownership does not affect
current or future performance, but the reverse is true for companies in high growth
industries on most performance measures. Kesner (1987, p.505) concluded that “[a]
firm in a rapid growth industry tends to perform better when directors have a high
personal financial stake in the company”.
Hermalin and Weisbach (1988), to investigate whether firm performance, CEO tenure
and changes in market structure would lead to changes in board composition, assembled
a database on the directors of 142 NYSE-traded companies between 1971 and 1983,
obtaining 1,521 firm-year observations in their sample. Full-time employees of the firm
are designated as insiders. Directors who are closely associated with the firm, but are
not full-time employees, are designated as “greys”; “grey” directors are either related to
an officer of the company or have extensive business dealings with the company, which
make their independence from management questionable. The remaining board
members are identified as outsiders.
Their results suggest that, poor performance, measured by stock return, leads to the
resignations of insiders, although there is not an analogous effect for earnings change.
Outsiders are added after poor performance measured by both stock return and earnings
42
change. Decreases in the number of industries in which firms operate increase the
departures of insiders, and firms tend to replace departing insiders with outsiders. In
addition, insiders are more likely to be added to the board when a CEO nears retirement;
a new CEO, who tends to add outside directors to the board, leads to the departures of
insiders.
According to Molz (1988), two extreme forms of corporate board organization can be
characterized as managerial dominated and pluralistic. “A managerial dominated board
is one made up primarily of inside directors (officers of the firm). A pluralist board is
one made up of more diverse directors, and the managers of the corporation are not the
dominant group. Other types of boards identified here and elsewhere generally fall
somewhere between these two extremes. A better empirical understanding of these
extremes will facilitate further study of variations within them” (Molz, 1988, p.236).
Molz (1988) aggregated multiple measures of managerial or pluralistic control,
including joint chairman/CEO, outside-dominated social responsibility committee,
inside versus outside directors, frequency of board meetings, salary ratio of the highest
paid to the second highest-paid executive, stockholdings of inside and outside directors,
representation of woman and identifiable minority groups, and tenure of the
chairman/CEO, into one single scale, using a sample of 50 firms selected at random
from the 1983 Fortune 500 Industrial list. Molz (1988) reported that there was no
significant relationship between the degree of managerial control on the board and
financial performance as measured by ROA, ROE and total return to shareholders.
In Fosberg (1989, p.32), it is noted that “[a]gency theory assigns to outside directors the
role of monitoring the firm’s management to make certain that it performs its duties in a
manner consistent with the best interests of shareholders”; thus increasing the
percentage of outside directors on the board may enhance management performance.
To test this managerial monitoring hypothesis, a paired sample methodology is used
where firms in the same industry of comparable size and capital structure and with a
significantly different proportion of outside directors on the board are paired, producing
127 pairs of firms over the five years of 1979 – 1983. Outside directors are defined to
be those directors who are not current or former members of the firm’s management or
their relatives.
43
Fosberg (1989) found that agency theory could not be confirmed by his analysis.
Specifically, no relationship is found between the proportion of outside directors and the
various variables used to gauge managerial performance, including ROE, sales,
expenses, number of employees, sales to total assets, expenses to total assets, and
number of employees to total assets ratio.
Fosberg (1989, p.32) argued that “[t]here are at least two feasible explanations for this
finding. First, management may succeed in getting outside directors elected to the board
who are either incapable or unwilling to properly discipline management. In this
eventuality, outside directors would not be providing the monitoring services contracted
for by the shareholders. A second explanation is that the other mechanisms for
controlling the agency costs associated with the separation of ownership and control,
such as the market for corporate control, effectively motivate and discipline
management, thereby leaving little for the board to do in this regard.”
Schellenger, Wood and Tashakori (1989) believed that the conflicting empirical
evidence with respect to the existence or non-existence of a board composition effect on
financial performance might be due to failure to control risk. “Differences in
performance may reflect nothing more than differences in risk. Conversely, observed
equal performance may ignore differences in risk. Difference in financial performance
must be evaluated relative to the risk associated with that performance. Consequently,
financial performance is best measured by risk-adjusted shareholder wealth”
(Schellenger et al, 1989, p.458).
After testing a sample of 526 U.S. firms with complete data for the year 1986, they
located a positive association between the percentage of outside directors and
performance as measured by ROA and risk-adjusted shareholder return. Consequently
Schellenger et al (1989, p.465) suggested that “[t]his study provides support for
advocates of outsider representation on the boards of corporations.”
In addition, it is reported that the percentage of outsiders and standard deviation of
returns, a proxy for total risk, are negatively correlated, and the proportion of outside
directors and beta, a measure of systematic risk, are positively correlated. According to
the researchers, “[w]hat this suggests is that firms with a greater percentage of outsiders
on the board have greater systematic risk, but less total risk. The difference implies that
44
unsystematic risk is less for firms with a greater percentage of outsiders on the board”
(Schellenger et al, 1989, p.463).
Using the same sample and database in Hermalin and Weisbach (1988), Hermalin and
Weisbach (1991, p.102) attempted “… to measure differences in firm performance
caused by board composition and ownership structure. These two variables are intended
to measure the direct incentives and monitoring faced by top management.” Like their
previous study, the directors of sample companies are classified as insiders, “greys” and
outsiders.
According to their results, at low levels of management shareholdings (less than one
percent), performance, measured by both q and EBIT, improves with increases in
ownership; beyond one percent, performance declines with ownership. There does not
appear to be a relation between board composition and corporate performance, although
firms with longer median tenures of outside directors tend to have higher performance
measured as q.
As observed by Pearce II and Zahra (1992, p.414), “[d]espite the wide recognition of
the consequences of board composition for company survival and performance, very
few empirical studies have been undertaken to explain its determinants.” To reduce this
gap in the literature, they collected data through a mailed questionnaire directed to the
CEO (or president) of the Fortune 500 corporations; 119 responses were received.
Four measures of corporate performance are employed in Pearce II and Zahra (1992) –
ROA, ROE, earnings per share (EPS) and net profit margin. Each is operationalized as
the 1983-1985 average for the three years preceding, and the same criteria are measured
for the three years following 1987-1989. Outside directors are classified into two groups
- affiliated and non-affiliated directors. The scholars acknowledged that their study
focused on composition variables at a given point in time; however, it is unclear what
the given point is.
They reported that effective past performance, in terms of ROA, ROE and EPS, was
associated with larger boards and lower representation of outsiders; large boards and
high representation of outsiders are positively associated with future performance
measured by the three performance criteria. It appears that the distinction between
45
affiliated and non-affiliated outsiders is not as important to performance as one would
expect based on the normative literature.
Pearce II and Zahra (1992, p.432) asserted that “the study highlights the dual role of
corporate performance in the context of research on board composition” and “the results
provide compelling evidence of an important relationship between board composition
and firm performance” (Pearce II and Zahra, 1992, p.434).
Daily and Dalton (1992) argued that empirical works in the area of corporate
governance had concentrated on the largest of firms, and the equivocal results might be
attributable to the reliance upon the large scale firms. Their study, then, focuses on
successful, but modestly sized firms, because “[i]t is in these organizations that the
impact of individual actions may be more salient” (Daily and Dalton, 1992, p.376).
Their sample is composed of the 100 fastest-growing small publicly held companies in
the U.S. in 1990. Although no significant performance differences were found when
CEOs elected the dual versus the independent structure, Daily and Dalton (1992)
located a positive relation between total numbers and proportion of outside directors
and performance indicated by price/earnings ratio.
One year later, they produced another paper in which a sample of 186 small
corporations with relevant data in 1990 is tested. Adopting the same board and
performance variables as in Daily and Dalton (1992), Daily and Dalton (1993) reported
similar findings to those in Daily and Dalton (1992). It is confirmed that there are no
significant performance differences when CEOs elected the dual versus the independent
structure, and there is a positive relationship between total numbers and proportion of
outside directors and financial performance. Thus “[i]t seems that firms adhering to
suggested board reforms realize performance advantages” (Daily and Dalton, 1993,
p.75).
In Yermack (1996, p.189), the author decided to test the hypothesis that “…firm value
depends on the quality of monitoring and decision-making by the board of directors,
and that the board’s size represents an important determinant of its performance”, using
a sample of 3,438 annual observations for 452 companies between 1984 and 1991.
He identified an inverse association between firm value measured as Tobin’s q and
board size; all the three financial ratios used in his work, i.e., ROA, sales over assets
46
and return on sales, have negative associations with the board-size log. Yermack (1996,
p.194) concluded that the findings were “… consistent with an interpretation that
coordination, communication, and decision-making problems increasingly hinder board
performance when the number of directors increases.”
However, the influence of board composition on firm value is ambiguous. In the OLS
model there is a negative association between the percentage of outside directors and q,
where in the fixed-effect model a positive association is found. It is also found that firm
value is positively related to firm size and insider ownership, and firms are valued more
highly when the CEO and chairman positions are separated.
To investigate the relationships among the mechanisms to control agency problems
between managers and shareholders and with firm performance measured by Tobin’s q,
Agrawal and Knoeber (1996) collected data on the Forbes 800 firms in 1988; a sample
of 383 firms with complete record in 1987 was obtained.
The only consistent findings presented in their paper are that fewer outside directors
may lead to improved firm performance or, better performance may lead to fewer
outsiders on the board. Agrawal and Knoeber (1996, p.393) commented: “[t]he
persistent effect of board composition on firm performance presents a puzzle. The
fraction of outsiders on the board of directors is an internal decision, and so we expect it
to be made to maximize firm value. Our results indicate otherwise. The negative effect
of outsiders on the board on firm performance suggests that firms tend to have too many
outside directors. We do not have a ready explanation for this finding.”
The objective in Barnhart and Rosenstein (1998) is to test the sensitivity of
simultaneous equations techniques used in corporate governance literature. They noted
that “[a] number of recent empirical papers have used simultaneous equations methods,
such as two- and three-stage least squares to model the relations between corporate
governance variables and firm valuation … However, current theory provides little
guidance in the specification of corporate governance models, and the econometric
literature points out that misspecification of any of the equations in a system may result
in serious bias in all of the equations. In fact, ordinary least squares (OLS) tends to be
less sensitive to misspecification error …” (Barnhart and Rosenstein, 1998, p.2).
47
Their sample contains 321 U.S. firms from the 1990 Standard & Poor’s (S&P) 500. As
the authors did not disclose the time frame of their research, it is unclear for which
year(s) the data is analysed. Based on the mixed results of several OLS and 3SLS
models, the authors suggested that their paper provided support for a curvilinear
relationship between the proportion of independent directors or managerial ownership
and Tobin’s q; there is stronger support to the presumption that board composition,
managerial ownership and firm performance are jointly determined, in that governance
changes over time to allow for value maximization.
According to Barnhart and Rosenstein (1998, p.14-15), “[t]he empirical results are
strongly dependent on the specification of the overall model and of the first-stage
regressions. Relatively minor changes in either have profound effects on overall results
… This leads to the conclusion that results using simultaneous equations methods must
be interpreted cautiously, that ordinary least squares estimates should not be casually
dismissed, and that sensitivity analysis is essential when estimating an empirical model
whose structure is uncertain.”
Dalton, Daily, Ellstrand and Johnson (1998), in order to conduct meta-analyses for both
board composition and board leadership structure and their relationships to financial
performance, examined empirical research surrounding this topic. It is not necessary
that these relationships be the focus of an article to be included for the meta-analyses; it
is only necessary that a Pearson correlation between these variables be available in the
piece, or derivable from it. Therefore whether a given variable is a dependent,
independent, or a control variable is not an issue.
They identified 54 studies with 159 usable samples for the board composition/financial
performance analysis, and located 31 studies with 69 usable samples addressing board
leadership/financial performance relationships. The results for all samples suggest that
particular operationalizations of board composition, including the percentages of inside,
outside, affiliate and independent/interdependent directors, have virtually no effect on
accounting and market performance indicators; there is no evidence of a systematic
relationship between board leadership structure, i.e., joint CEO/chairman or CEO
duality, and firm performance indices.
Dalton et al (1998, p.284) recommended that future research should pay attention to
board committees, as “… many of the critical processes and decisions of boards of
48
directors do not derive from the board-at-large, but rather in subcommittees.” It is also
suggested that “[c]onsideration of multiple theories in evaluating the performance
advantages of suggested corporate governance reforms may lead to a more complete
understanding of the subtleties which characterize the relationships between board
composition, board leadership structure and firm performance” (Dalton et al, 1998, p.
285).
Denis and Sarin (1999) carried out a time-series analysis of equity ownership structure
and board composition in a random sample of 583 U.S. firms with 4,563 firm-years
over the 10-year period 1983-1992. The researchers labelled directors as insiders if they
were employees of the firm, as affiliated outsiders if they had substantial business
relations with the firm, were related to insiders, or were former employees, and as
independent outsiders if they were neither insiders nor affiliated outsiders.
Their results indicate that ownership and board characteristics are interrelated;
specifically, insider ownership is negatively related to the fraction of independent
outsiders, and board size is positively related to the fraction of independent outsiders.
Large changes, both increase and decrease, in insider ownership, outside representation
and board size are strongly associated with CEO replacements and corporate control
threats. Changes in insider ownership are negatively related to prior stock price
performance, and market-adjusted stock return appears to be higher among those firms
that subsequently increase the fraction of independent outsiders, and those firms that
subsequently increase board size.
The authors therefore concluded that “… the predominant factors associated with
ownership and control changes appear to be top executive changes, prior stock price
performance, and corporate control threats” (Denis and Sarin, 1999, p.210).
Bhagat and Black (2000) is the largest sample study of large U.S. corporations. The
researchers constructed a “1991 sample” of 934 firms and a sub-sample of 205 firms,
with board composition data in early 1991 and 1988, respectively.
For the 1991 sample, during the “retrospective” period (1988-1990), board
independence, proxied by the proportion of independent directors minus proportion of
inside directors, correlates negatively with all the performance measures employed,
including Tobin’s q, ROA, market-adjusted stock price return, and ratio of sales to
49
assets. During the “prospective” period (1991–1993), the correlation remains negative
for q. There is a negative relationship between future industry sale growth and board
independence; it is acknowledged that there is no good explanation for this correlation.
For the 1988 sample, prior performance (1985-1987) correlates negatively with board
independence in early 1988 for q and ROA, and there is a negative relationship between
current performance (1988-1991) and changes in board independence over the same
period for q and ROA. Thus Bhagat and Black (2000) concluded that there was a
reasonably strong correlation between poor performance and subsequent increase in
board independence; however, there is no evidence that greater board independence
leads to improved firm performance.
Coles, McWilliams and Sen (2001, p.23) argued that “… previous work has generally
focused on examining subsets of governance mechanisms, typically studying one or two
governance variables in any one study. Our view is that the most critical issue still to
examine, is the ability of firms to choose among a number of different governance
mechanisms in order to create the appropriate structure for that firm, given the
environment in which it operates.”
Coles et al (2001) then located a sample of 144 firms and searched for the impact of
board composition, leadership structure, CEO compensation and tenure, and ownership
structure on market value added (MVA), a market measure of performance, and
economic value added (EVA), an accounting measure of performance, over a five-year
time frame from 1984 to 1988. Contrary to their expectations supported by agency
theory, the researchers found negative influences of independent director representation
and CEO salary sensitivity on MVA; they also identified a positive contribution of CEO
duality to EVA. Coles et al (2001) suggested that future research could investigate the
roles of firm risk and diversification on performance, which might provide some
insights into their findings.
Singh and Davidson III (2003), in their analysis of the relations between managerial
ownership, blockholder ownership, and agency costs measured in terms of asset
turnover and selling, general and administrative (SG&A) expenses scaled by sales,
controlled for the effects of the size and composition of board of directors on the level
of agency costs. The authors classified board members as insiders, affiliated outsiders
50
and independent outsiders; their sample includes 236 observations of 118 large U.S.
corporations for the years 1992 and 1994.
Singh and Davidson III (2003) reported that managerial shareholdings were positively
related to asset utilization, but did not serve as a significant deterrent to excessive
discretionary expenses. Board size is negatively related to asset turnover, but unrelated
to discretionary expenditures; board composition, however, does not seem to
significantly influence agency costs.
Anderson and Reeb (2004), rather than concentrating on the board’s role in alleviating
agency problems between managers and shareholders, explored the board’s possible
role in mitigating conflicts between opposing shareholder groups. The researchers used
the 1992 S&P 500 firms for the period from 1992 to 1999 to develop their sample,
obtaining 2,686 firm-year observations of 403 firms. Each firm is classified as either a
family or non-family firm, using the fractional equity ownership of the founding family
and the presence of family members on the board as benchmarks.
They found that, in general, there was no significant relationship between board
independence measured by the fraction of independent directors and firm performance
measured as Tobin’s q; only when delineating the sample based on the presence of
founding families did they identify a positive association between the fraction of
independent directors and q.
It is documented that family firms, on average, perform better than non-family firms.
This finding, however, appears to be primarily driven by family firms with greater
degrees of board independence relative to family firms with few independent directors.
In firms with family ownership, when family control of the board exceeds independent
director control, the firm’s performance is poorer; when family control is less than
independent directors’, performance is better.
Additional tests indicate a negative association between family member presence on the
nominating committee and independent director representation on the full board; there
is a positive association between the presence of institutional holdings and independent
director representation on the board. The results are interpreted to imply that families
often seek to minimize the presence of independent directors, while outside
shareholders call for independent directors to minimize founding-family opportunism.
51
Anderson and Reeb (2004, p.209) suggested that “[t]hese findings highlight the
importance of independent directors in mitigating conflicts between shareholder groups
and imply that the interests of minority investors are best protected when, through
independent directors, they have power relative to family shareholders.”
Chan and Li (2008) noted that, with the demise of Enron and debatable accounting
practices of Global Crossing, many in the U.S. had been furious with the monitoring
provided by directors, especially those in the audit committee. Although the
independence of audit committee is widely accepted as a must for good governance and
internal control for assessing risks, little is know about the “quality” of these
independent directors sitting on the committee.
Thus, using a sample of Fortune 200 companies in the year 2000 and defining top
executives of other publicly traded firms among independent outsiders as expertindependent directors, Chan and Li (2008) tested the influence of audit committee
independence, which is measured by the percentage of independent directors on the
committee, on Tobin’s q, with two thresholds of independence for boards, 50% and
35% or more expert-independent director membership, respectively.
Their findings indicate that the independence of audit committee results in higher firm
value when a majority of expert-independent directors serve on the board. It is also
reported that directors with finance-trained backgrounds serving on the audit committee
enhance firm value, when expert-independent directors are a majority in the committee;
however, the presence of chief executives who are also chairman of the board is related
to negative q.
3.3.2
Event Studies
The studies as introduced above, using different variables, measures and models,
evaluate whether board composition and structure correlates directly with performance.
Some scholars, such as Rosenstein and Wyatt (1990, 1997) and Klein (1998), have
suggested that an alternative way to address the concerns of whether board composition
is important and whether outside or inside directors increase firm value is to examine
the stock-market reactions to changes in board composition.
In Rosenstein and Wyatt (1990), the writers obtained a sample of 1,251 announcements
of the appointment of only one outside director and no inside directors, over the 198152
1985 period; an outside director is defined as a director who is not a present or former
employee of the firm and whose only formal connection with the firm is his or her
duties as a director. They categorized announcements by the director’s primary
occupation as either a financial outsider (officer of any potential supplier of capital),
corporate outsider (officer or employee of other corporation), and neutral outsider
(outside director with any other affiliations).
In the study, it is reported that the appointments of an outside director are accompanied
by positive excess returns, even though most boards are numerically dominated by
outsiders before the appointments. There is no clear evidence that outside directors of
any particular occupation are perceived more or less valuable than others by the stockmarket. Rosenstein and Wyatt (1990, p.190) concluded that “… the addition of an
outside director increases firm value. The empirical results are consistent with the
hypothesis that outside directors are selected, on average, in the interests of
shareholders.”
Later on, the same authors argued that “[t]hough Rosenstein and Wyatt (1990) found a
positive stock-market reaction to the appointment of an outside director, their evidence
does not imply that the appointment of an insider is harmful to shareholders. If
corporations adjust board composition to respond, in the interests of shareholders, to
new challenges, then inside director appointments may also increase shareholder
wealth” (Rosenstein and Wyatt, 1997, p.230).
Thus, by sampling director announcements over the same period as in Rosenstein and
Wyatt (1990), Rosenstein and Wyatt (1997) investigated the stock-market reactions to
appointments of inside managers to corporate boards. Rosenstein and Wyatt (1997)
categorized low (less than 5%), moderate (5%-25%), and high (greater than 25%) levels
of insider ownership; they expected that the stock-price effects of insider appointments
might vary across levels of insider ownership.
Their analysis shows that, for the full sample of 170 insider appointments, the average
stock-market reaction is close to zero; however, the market reaction is negative when
inside directors own less than 5% of the firm’s stock, positive when their ownership
level is between 5% and 25%, and insignificantly different from zero when ownership
exceeds 25%. According to Rosenstein and Wyatt (1997, p.229), “[t]hese results
suggest that the expected benefits of an inside director’s expert knowledge clearly
53
outweigh the expected costs of managerial entrenchment only when managerial and
outside shareholder interests are closely aligned.”
In Klein (1998), the author investigated market reactions to changes in board committee
composition between 1992 and 1993 around the 1993 proxy mailing date, for a sample
of 461 firms listed on the S&P 500 for both years. Directors are classified as insiders,
outsiders and affiliates. Insiders are presently employed by the firm. Outsiders have no
affiliation with the firm beyond being a number of the firm’s board. Affiliates are
former employees, relatives of the CEO, or those who have significant transactions
and/or business relationships with the firm.
Klein (1998) reported that firms that significantly increased inside director
representation on finance and investment committees experienced significantly higher
abnormal returns on the proxy mailing date than firms decreasing the percentage of
inside directors on these two committees. To complement the results, Klein (1998)
conducted regressions of firm performance measures, including ROA, Jensen
Productivity and market returns, on board and committee composition, using a sample
of 485 firms listed on the 1992 S&P 500.
No significant relationship is found between performance measures and the percentage
of inside directors on the board as a whole; however, there are significantly positive
linkages between the percentages of inside directors on finance and investment
committees and performance measures. Klein (1998, p.275) thereby claimed that
“[t]hese findings are consistent with Fama and Jensen’s assertion that inside directors
provide valuable information to boards about the firms’ long-term investment
decisions.”
3.4
Evidence from Other Regions
In this section, some studies which attempt to uncover the board characteristics-firm
performance relations in Belgium (Dehaene, Vuyst and Ooghe, 2001), Canada
(Panasian et al, 2003), China (Peng, 2004), continental Europe (Krivogorsky, 2006),
Hong Kong (Chen, Cheung, Stouraitis and Wong, 2005), Malaysia (Chang and Leng,
2004), New Zealand (Hossain, Prevost and Rao, 2001; Chin, Vos and Casey, 2004),
South Korea (Choi, Park and Yoo, 2007), Sweden (Randoy and Jenssen, 2004), Taiwan
54
(Luan and Tang, 2007), and U.K. (Vafeas and Theodorou, 1998; Dulewicz and Herbert,
2004), are introduced.
Vafeas and Theodorou (1998) noted that most empirical research studying the
relationships between board characteristics and performance used U.S data; “[w]hile the
assumption of a utility-maximizing agent is universal, each country’s regulatory and
economic environment, the strength of capital markets, and current governance
practices are different. As a result, the importance and value of various governance
structures should be separately examined in each country” (Vafeas and Theodorou,
1998, p.384).
Their sample includes 250 public U. K. firms with complete data for the 1994 financial
year; four performance measures, i.e., MBT (equity capitalisation plus total liabilities
divided by total assets), market to book value of equity, stock return and ROA, are used.
The explanatory variables for performance are the percentages of independent and
“grey” directors on the board, percentages of equity ownership by independent, “grey”
and executive directors, percentages of non-executive directors serving in the audit,
remuneration and nomination committees, and chairman independence.
Their tests do not discern a significant link between board characteristics, director
ownership and firm performance. Vafeas and Theodorou (1998, p.383) asserted that
“[t]hese results are consistent with governance needs varying across firms, and contrast
the notion that uniform board structures should be mandated.”
Similarly, Dehaene et al (2001) found that most of the empirical studies on corporate
governance were made in an Anglo-Saxon context; the legal framework and structural
context in continental Europe differ strongly from those in the Anglo-Saxon business
world, “[t]herefore, the corporate governance discussion in continental Europe countries
ought to be based on country-specific research” (Dehaene et al, 2001, p.394).
They analysed board characteristics in a sample of 122 large Belgian companies, with
complete accounting and board information in 1995, to assess the impact of board
composition and structure on firm performance, as measured by industry-adjusted ROA
and ROE.
Dehaene et al (2001) identified a positive relationship between the number of external
directors and ROE; however, where the functions of CEO and chairman are combined,
55
ROA appears significantly higher. They suggested that “[d]istinct corporate governance
models for companies exist because they operate in different business context.
Comparing these models in isolation can lead to futile conclusions” (Dehaene et al,
2001, p.394).
In Hossain et al (2001), the authors assessed the efficacy of monitoring by directors in
New Zealand; specifically, they investigated whether the impact of board composition
and structure on firm performance was influenced by the Companies Act of 1993 and
related legislation. “The passage of the 1993 Companies Act and accompanying
legislation provides a unique environment for studying the monitoring ability by the
board of directors because its direct purpose is to increase and enhance monitoring and
firm performance. The study has implications for whether corporate governance can be
legislated. The findings should be of interest in light of attempts by some quarters to get
the government through its regulatory bodies involved in setting guidelines for
corporate governance” (Hossain et al, 2001, p.120-121).
Data for a sample of firms listed on the New Zealand Stock Exchange (NZSE) was
collected for the years 1991 through 1997, resulting in 633 firm-years of observations.
Directors are placed into one of three categories: inside directors, affiliated directors or
independent directors; independent directors are defined as individuals who are not an
active or retired employee of the firm, do not have close business ties with the firm, and
are not a representative of or appointed by a majority shareholder of the firm.
Their findings suggest that while the proportion of independent directors has a positive
influence on firm performance measured as Tobin’s q, the Companies Act of 1993 with
its obvious implications for the corporate governance role of the board has not resulted
in an increased sensitivity of firm performance to the proportion of independent
outsiders on the board.
Three years later, another New Zealand study, Chin et al (2004) reports contrasting
results. The initial dataset in Chin et al (2004) includes all firms listed on the NZSE
from 1996 to 2001; the final sample comprises a total of 426 annual observations over
the five-year period.
The value of firm is also measured by Tobin’s q, which is supposed to be explained by
director ownership, board size and percentage of outside directors; outside directors are
56
defined as those who are not current or former employees of the firm. According to their
analysis, there does not seem to be a rise-fall relationship in performance relating to
ownership structure, nor to the percentage of outside directors, nor to board size. The
authors believed that this might be due to endogenous factors or due to the small size of
the New Zealand pool of corporate directors.
In 1993, the Toronto Stock Exchange (TSE) nominated a committee under the
leadership of Peter Dey to assess the corporate governance practices of publicly held
Canadian corporations. The Dey Committee ultimately proposed a set of guidelines for
improved board performance, highlighting the importance of independent directors.
Two years later, the TSE adopted the recommendations as a listing requirement
whereby companies had to specify their governance practices with respect to each of the
guidelines and, where company practices differed from the guidelines, an explanation
for the difference.
To investigate the consequences of the TSE’s adoption of the Dey Committee
guidelines on firm performance as measured by Tobin’s q, Panasian et al (2003)
developed a sample of 274 firms with a complete record of board and ownership
characteristics for the five years 1993-1997, from the companies comprising the 1995
TSE 300 index. Directors are classified as either related or unrelated as per the Dey
Committee’s definition of an unrelated director - “… a director who is independent of
management and is free from any interest and any business or any other relationship
which could, or could reasonably be perceived to materially interfere with the director’s
ability to act with a view to the best interests of the corporation, other than interests and
relationship arising from shareholdings” ( Dey Report, 1994, Guideline 2).
Panasian et al (2003) found that the adoption of the recommendation that boards
comprise a majority of unrelated directors improved performance among companies
which became compliant during the period following the Dey Report, and companies
which were always compliant and increased their proportion of outsiders thereafter;
however, this improvement appears to be limited to firms that had average levels of q
less than one for the two years prior to introduction of the guidelines.
For the entire sample, the relationship between q and the percentage of unrelated
directors is insignificant, although the TSE’s adoption of the Dey guidelines might
enhance performance for all the companies. For the subset of firms with pre-Dey
57
average q less than one, there is a positive relationship between the proportion of
outsiders and performance. As Tobin’s q has been used by some scholars to estimate the
extent of agency problems with the firm, Panasian et al (2003, p.30) concluded that “…
increasing outsiders is most beneficial for firms that are most likely to have agency
problems.”
Peng (2004, p.453) noted that “[a]lthough the debate on the link between board
composition and firm performance is hardly resolved in developed economies,
appointing outsiders to corporate boards has become an increasingly widespread
practice in emerging economies going through institutional transitions such as China,
which provides an interesting ‘research laboratory’.”
Based on a database covering 405 Chinese listed firms and 1211 company-years of
observations during 1992-1996, the analysis of Peng (2004) indicates that outside
directors do made a difference in firm performance, if such performance is measured by
sales growth; outside directors, however, have little impact on financial performance
measured as ROE.
CEO duality displays a positive effect on ROE and sales growth; a possible explanation
is that “… CEO duality may be more important for firms in turbulent environments, as
China’s transitions may be argued to be” (Peng, 2004, p.463). Peng (2004) also
documented a bandwagon effect behind the diffusion of the practice of appointing
outsiders to corporate boards.
In Dulewicz and Herbert (2004), board characteristics and evaluations about how boards
actually worked in 1997 are assessed in relation to firm performance over the ensuring
three years. The authors sent questionnaires to the chairmen of U.K. listed companies in
1997; 134 responses were received. In the questionnaire, there are 117 indicators of
current board practice relating to 16 key tasks of the board and ratings of “potential for
improvement” on the same indicators. Performance data on these companies were
sought, resulting in a sample of 86 companies.
They reported that the number of executive directors is positively associated with cash
flow return on total assets (CFROTA). The number and proportion of NEDs are
negatively related to sales, which in turn is positively associated with the percentage of
equity held by directors. In addition, a significant correlation is found between
58
CFROTA and the chairman independence factor, i.e., companies with a chairman who
is not the CEO or is a NED may perform better.
The evidence provided by the correlations between current practice and potential ratings
on the 16 board tasks and firm performance is confusing. Dulewicz and Herbert (2004)
acknowledged that board practice examined in their study was generally not linked to
performance.
Randoy and Jenssen (2004) explored how the attractiveness of board independence was
contingent on the level of competition in the product market; they obtained 294 firmyear observations from 98 randomly selected companies listed and headquartered in
Sweden, over the 1996-1998 period. Board independence is measured by the percentage
of outside directors; an outside director is defined as someone who is not, and has not
been employed by the firm. Product market competition is proxied by a two-year
moving average profit margin for the 19 industry groups assigned by the Stockholm
Stock Exchange. The sample set is then split into three subsets based on the industry’s
level of product market competition; it is acknowledged that the partition points are not
theoretically motivated.
Randoy and Jenssen (2004) reported a negative effect on firm performance by board
independence among firms that faced high levels of product market competition; this is
the case for both Tobin’s q and ROE. They also identified a positive effect on
performance measured as q by board independence among firms that faced low levels of
product market competition. They concluded that “… board independence is less
relevant or even redundant in highly competitive industries, where the firm is already
‘monitored’ by a competitive product market … on the other hand, board independence
enhances firm performance among companies facing less competitive product market”
(Randoy and Jenssen, 2004, p.281).
Chang and Leng (2004) observed that poor governance standards in both private and
government-owned firms were blamed in part for the Asian financial crisis of 19971998, demonstrating the importance of effective corporate governance in developing
countries. To establish corporate governance factors that significantly influence the
financial performance of Malaysian firms, they developed a sample of 77 randomly
selected public companies in Malaysia, over the period 1996-1999, with each firm-year
representing a separate observation.
59
The independent variables used in their regressions are factors that may affect firm
performance as measured by ROE and dividend payout ratio, including firm size
measure by sales, leverage measured by total debt to total capital, ownership
concentration measured by the proportion of shares owned by the largest shareholder,
proportion of shares owned by institutional investors, proportion of NEDs, and dummy
variables for CEO duality and NED chairman on the audit committee.
There are three variables which are found to be significant in influencing ROE, i.e., firm
size, leverage and institutional ownership. However, several corporate governance
variables, i.e., ownership concentration, proportion of NEDs, CEO duality, and NED
chairman on the audit committee, do not have any impact on corporate performance.
In Chen et al (2005), the researchers attempted to address three research questions.

Does concentrated family ownership affect firm operating performance and
value?

Does it affect dividend policy?

What is the impact of corporate governance (CEO duality, board composition
and audit committee) on performance, value and dividend payouts in family
controlled firms?
According to Chen et al (2005), Hong Kong is an appropriate market for conducting
their project because it is characterized by widespread family control of publicly listed
companies, while at the same time having a common law legal system and corporate
governance influenced by recent developments in the U.K. Their initial dataset consists
of all companies listed on the Hong Kong Stock Exchange (HKSE) in 1995, which they
followed through 1998; the final sample contains a balanced panel of 1,648 firm-years
for 412 firms.
Their empirical analysis does not establish a relation between family ownership and
proxies for firm performance - ROA, ROE and MBT. Only for small market
capitalisation firms there is a negative association between dividend payout ratio and
family ownership up to 10% of the company’s stock and a positive association for
family ownership between 10 and 35%; these firms also exhibit low sensitivity of
dividend payouts to performance. Board characteristics, i.e., the proportion of
independent NEDs, outsider-dominated board and presence of audit committee, have
60
little impact on firm performance and dividend policy, although there is a negative
relation between CEO duality and MBT.
Chen et al (2005, p.448) recommended that “… corporate governance in Hong Kong
needs to be strengthened. In addition, more effort is needed in order to ensure the true
independence of non-executive directors and that they are able to perform an adequate
monitoring function … Our findings have relevance for other East Asian countries too,
which are characterized by even lower standards of corporate governance and investor
protection compared to Hong Kong.”
Using the same measures for firm performance as in Chen et al (2005), Krivogorsky
(2006, p.177) investigated “… the empirical validity of the claims that the composition
of the board and ownership structure affects a firm’s profitability after considering the
mechanisms by which a European company is directed and controlled (as described in
European Corporate Governance Codes).”
The 87 firms used in his analysis are continental European companies listed on the
NYSE as foreign registrants during 2000 and 2001. Board characteristics tested include
the percentages of inside directors, independent directors, and scholars on the board,
and CEO duality. It is disclosed that “independence” involves an absence of close
family ties or business relationships with management and controlling shareholder(s);
however, little is known about the standards of scholars endorsed in this paper.
It is documented that the percentage of independent directors has a positive correlation
with ROA and ROE. The authors also identified a positive relation between the level of
institutional ownership and ROA, ROE and MBT. Consequently Krivogorsky (2006,
p.191) confirmed that “… the theoretical predictions of agency theory on a positive
relationship between outside (independent) director and firm performance … are also
applicable in the European environment as well.”
Luan and Tang (2007) pointed out that, theoretically and empirically, the linkage
between outside directors and firm performance was not conclusive in previous studies;
they suspected that the mixed results were due to the failure to meet the requirements of
the independence of outside directors. As it is argued that in Taiwan there is a rigorous
definition of outside director independence, a dataset from the island is employed to
examine the impact of independent director assignment on a firm’s performance. There
61
are 259 firms having been tested in their model, in which ROE in 2002 is the dependent
variable; independent director assignment, a dummy variable to assess whether
independent directors were present in 2002, is used as an independent variable.
Their findings suggest that, after controlling for past performance, independent director
appointments have a positive effect on ROE. Luan and Tang (2007, p.640) believed that
“[t]his may be the first paper to show that independent outside directors may be
beneficial to the firm.”
Choi et al (2007) introduced that, despite the inconclusive empirical results in the U.S.
and elsewhere, the idea of a monitoring board was vigorously imported and
implemented by South Korean authorities in the aftermath of the Asian financial crisis.
As weak corporate governance was viewed as one of the factors that had contributed to
the crisis, the government instituted a series of regulatory changes in 1998 and for listed
firms required at least 25% of the board composed of non-executive directors.
Since outside directors were uncommon in this country prior to 1997, according to Choi
et al (2007), post-crisis Korea presents a natural laboratory for testing the effect of
board independence enforced by the authorities. Using a sample of 1,834 firm-year
observations from 1999 to 2002, the authors found that the proportion of outside
directors had a positive effect on firm performance as measured by Tobin’s q; the effect
is stronger for independent directors than for “grey” directors who may have
professional ties with the firm.
Choi et al (2007, p.942) concluded that “… the presence of independent outsiders is
critical in an emerging market that is subject to external shocks and that may lack
sufficient liquidity as well as indigenous institutional infrastructure.” However, they
also argued that, given the still significant influence of insiders in Korean firms, their
results should not be interpreted as evidence supporting American-style superindependent boards; rather, it may support the notion that an injection of independent
directors into insider-dominated boards could enhance performance.
3.5
Summary and Limitations
As introduced in Section 2, there are several papers which provide evidence on the
relationship between board characteristics and the “bottom line” performance of
Australian public companies; Appendix 1 exhibits a summary of their samples, research
62
variables and method, and major findings. In Section 3 and 4 some papers from the U.S.
and other regions are reviewed; a summary of these studies could be found in Appendix
2.
3.5.1
Australian Studies
Seven studies, i.e., Muth and Donaldson (1998), Calleja (1999), Lawrence and
Stapledon (1999), Cotter and Silverster (2003), Kiel and Nicholson (2003), Balatbat et
al (2004) and Hutchinson and Gul (2004), with mixed evidence, conclude that board
independence may not add value to Australian corporations. Only one study, Bonn et al
(2004), indicates that greater board independence may enhance performance.
According to Muth and Donaldson (1998), the level of board independence, constructed
by CEO duality, board size, proportion of NEDs, interest alignment with owners and
average age across all directors, is negatively associated with shareholder wealth and
sales growth. Lawrence and Stapledon (1999) asserted that the proportion of
independent directors was negatively related to the ratio of revenue to assets. Kiel and
Nicholson (2003) discovered a negative correlation between the proportion of outside
directors and the market-based performance measure of Tobin’s q.
Calleja (1999) and Hutchinson and Gul (2004) could not find a relation between
shareholder return or ROE, and the proportion of NEDs. Cotter and Silverster (2003)
reported that neither board nor committee independence was significantly associated
with firm value. Balatbat et al (2004) concluded that, for IPO firms, board composition
was not related to variation in operating performance, although firms with dual
leadership tended to perform better. At last, Bonn et al (2004) documented a positive
association between outside director ratio and ROA, for their Australian sample firms.
As illustrated in Appendix 1, all these studies apart from Kiel and Nicholson (2003),
Balatbat et al (2004) and Hutchinson and Gul (2004) suffer from the limitation of small
sample size. Muth and Donaldson (1998) suggested that a sample size closer to 200
would have been preferable; effects of boards on performance tend to be small which
means that more statistical power is needed to detect significant relationships. Calleja
(1999) also acknowledged that the small sample size in her study made it difficult to
reach any firm conclusions.
63
It appears that all Australian studies concentrate on the concern whether board
characteristics and subsequent performance are related. As suggested by Bhagat and
Black (2000), board composition and structure may affect firm performance, and firm
performance may also affect board demographics; thus the projects could have been
designed to address both of the two research questions, i.e., does board independence
have any influence on firm performance, and does firm performance have any influence
on the firm’s board independence?
In Muth and Donaldson (1998), Calleja (1999), Kiel and Nicholson (2003), Bonn et al
(2004) and Hutchinson and Gul (2004), the researchers used the simplistic executive
(inside), non-executive (outside) director dichotomy as an indicator of board
independence. Kiel and Nicholson (2003) acknowledged that this did not allow them to
calculate the presence of “grey” directors as identified by Baysinger and Bulter (1985).
In a review of the directors of 100 Australian companies, randomly selected from the
top 500 companies listed on the ASX, Clifford and Evans (1997) found that 35% of
NEDs in their sample were involved in transactions with their companies which
potentially threatened their independence. They noted that the combination of insider
and “grey” directors would constitute a majority of the board, and this could lead to
companies appearing to comply with the recommendations for board independence
through possessing a non-executive majority on the board, whilst in fact being
controlled by internal management. Thus, in examining the relationships between board
independence and firm performance, it would be appropriate to classify the NEDs as
independent or affiliated.
Calleja (1999) and Kiel and Nicholson (2003) also suffer from the limitation that they
are essentially cross sectional without controls. Lawrence and Stapledon (1999)
controlled for firm size and board size; Cotter and Silverster (2003) used firm size, and
Bonn et al (2004) used firm age, as the only control variable in their works. There are
many factors which could contribute to a company’s performance; it would be
appropriate to add more controls to cover some important contributing factors.
The performance measures employed by Calleja (1999), Kiel and Nicholson (2003),
Bonn et al (2004), Balatbat et al (2004) and Hutchinson and Gul (2004) are quite
limited; on the other hand, the measures used in Lawrence and Stapledon (1999) may be
“noisy”, that is, too many variables without sufficient explanation about their choice.
64
For example, it is unclear why Lawrence and Stapledon (1999) used the numbers of
employees as an accounting performance measure. In addition, it appears that most
Australian researchers did not examine the consistency between their performance
measures, to verify the results of their tests using these measures.
The one year performance in Calleja (1999), Cotter and Silverster (2003), Bonn et al
(2004) and Hutchinson and Gul (2004) may be too short for the purpose of their
research. Bonn et al (2004) recognized that generalizability of their findings would have
been enhanced if they had used data from a longer period, and the one-year lag might
not be sufficient to examine the influence of board composition on firm performance.
In Balatbat et al (2004), due to the combination of cross-sectional and time-series data
(firm-year observations), the OLS and 2SLS regressions conducted may be unsuitable
for the purposes of their project (Leamer, 1978). As recommended by Chang and Leng
(2004), the appropriate method of analysis would involve panel data regression
technique. There are two frequently used estimation techniques for panel data
regression, i.e., the fixed-effect model and random-effect model (Gujarati, 2003); the
Hausman test, a model of specification test, can be used to decide between the two
models (Hausman, 1978).
Taking into consideration of the limitations in prior research as discussed above, and the
increased pressure on public companies for greater board independence as introduced in
Chapter 2, there is perhaps a need for an in-depth investigation of the relationships
between board independence and corporate performance in Australia.
3.5.2
Overseas Studies
Some studies give evidence that greater board independence may improve performance
or firm value. Baysinger and Butler (1985) reported that firms that had invited relatively
more independent directors onto their boards in 1970 enjoyed relatively better records
of industry-adjusted ROE in 1980, although changes in the proportion of independent
directors did not produce significant changes in performance over time. Schellenger et
al (1989) identified a positive correlation between ROA, risk-adjusted shareholder
return and the proportion of outside directors; moreover, firm risk is lower for firms
with a greater percentage of outsiders.
65
Pearce II and Zahra (1992) found that high representation of outsiders was associated
positively with future performance criteria such as ROA, ROE and EPS; it appears that
the distinction between affiliated and non-affiliated outsiders is not as important to
performance as one would expect based on the normative literature. Daily and Dalton
(1992, 1993) reported a positive relationship between total numbers and proportion of
outside directors and firm performance measured by price/earnings ratio, although no
significant performance differences were found when CEOs elected the dual versus the
independent structure.
Dehaene et al (2001) documented a positive relationship between the number of
external directors and industry-adjusted ROE; industry-adjusted; ROA appears higher
where the functions of CEO and chairman are combined. Hossain et al (2001) and Choi
et al (2007) found that the proportion of independent directors had a positive influence
on Tobin’s q, and Krivogorsky (2006) discerned a positive correlation between ROA,
ROE and the fraction of independent directors on the board. The evidence in Luan and
Tang (2007) suggests that firms that choose to appoint independent directors tend to
have a higher ROE. It is concluded in Chan and Li (2008) that the independence of
audit committee enhances firm value when a majority of expert-independent directors
serve on the board; the presence of CEO duality leads to negative q.
In an event study Rosenstein and Wyatt (1990) discovered that the appointment of an
outside director was accompanied by positive abnormal return, even though most
boards had been dominated by outsiders before the appointments. Stock price neither
increases nor decreases on average when an insider is added to the board; the stockprice effects of insider appointments vary significantly across levels of insider
ownership (Rosenstein and Wyatt, 1997).
In contrast, a number of papers provide results indicating that firms with a greater
percentage of outside or independent directors may perform worse, or firms with a
greater percentage of inside directors may perform better. Kesner (1987) noted that the
proportion of insiders was positively related to current firm performance, in terms of
profit margin and ROA, and future performance measured by total return to investors.
Agrawal and Knoeber (1996) identified a negative correlation between the proportion of
outside directors and Tobin's q.
66
According to Klein (1998), firms increasing inside director representation on finance
and investment committees experience higher abnormal returns than firms decreasing
the percentage of inside directors on these committees, and there are positive linkages
between the percentages of inside directors on finance and investment committees, and
ROA and market return. Coles et al (2001) identified a negative influence of
independent directors on market performance, and a positive contribution of CEO
duality to accounting performance. In Dulewicz and Herbert (2004), the number of
executive directors is positively associated with CFROTA, and the number and
proportion of NEDs are negatively related to sales turnover, although companies with a
chairman who is not the CEO or is a NED may perform better.
Several researchers addressed the concern whether board composition is endogenously
related to firm performance, resulting in inconsistent findings. According to Hermalin
and Weisbach (1988), independent outsiders are added following poor stock return and
earnings change, and poor stock return leads to the resignations of insiders. Pearce II
and Zahra (1992) found that effective past performance in terms of ROA, ROE and EPS
was associated with lower representation of outsiders. However, in Denis and Sarin
(1999), market-adjusted stock return appears to be higher among those firms that
subsequently increase their fraction of independent outsiders.
In the largest sample study of large American firms, Bhagat and Black (2000)
concluded that there was a reasonably strong correlation between poor performance
measured as ROA, q, market-adjusted stock price return and ratio of sales to assets, and
subsequent increase in board independence, proxied by the proportion of independent
directors minus proportion of inside directors. There is no evidence that greater board
independence leads to improved firm performance.
There are also some papers which fail to identify a clear correlation between board
characteristics and performance, or produce ambiguous evidence. In Molz (1988),
Fosberg (1989), Hermalin and Weisbach (1991), Dalton et al (1998), Vafeas and
Theodorou (1998), Singh and Davidson III (2003), Chin et al (2004), Chang and Leng
(2004) and Chen et al (2005), no significant link is found between board characteristics
and corporate performance, except a negative relationship between CEO duality and
MBT as documented in Chen et al (2005).
67
Yermack (1996) discerned a negative association between the percentage of outside
directors and q in the OLS model, and a positive association in the fixed-effects model;
firms are valued more highly when the CEO and chairman positions are separated. Peng
(2004) demonstrated that, although outside directors made a difference in sales growth,
they had little impact on ROE; consistent with Dehaene et al (2001) and Coles et al
(2001) but in contrast to Yermack (1996), Dulewicz and Herbert (2004) and Chen et al
(2005), CEO duality gives a positive contribution to performance.
A number of studies attempt to offer different insights into the board compositionperformance link. As noted by Pfeffer (1972), firms that deviate more from an optimal
inside-outside director orientation are less successful when compared to industry
standards than those that deviate less from an optimal board composition. Barnhart and
Rosenstein (1998) presented some support for a curvilinear relationship between the
proportion of independent directors and q-value; their findings indicate that board
composition, managerial ownership and firm performance may be jointly determined.
Panasian et al (2003) found that, for the entire sample in their study, the relationship
between Tobin’s q and the percentage of unrelated directors was insignificant; however,
for the subset of firms with average levels of q less than one in the past two years, there
was a positive relationship between the proportion of independent directors and
performance. It is therefore proposed that independent directors are more beneficial for
firms that are more likely to have agency problems.
Similarly, Anderson and Reeb (2004) observed that, in general, there was no significant
relationship between board independence and firm performance. However, in firms with
founding-family ownership, there is a positive association between the fraction of
independent directors and Tobin’s q, suggesting that there are performance premiums
for family firms with greater degrees of board independence relative to non-family firms
or family firms with insider-dominated boards.
Randoy and Jenssen (2004) identified a negative effect on performance by outside
directors among firms that faced high levels of product market competition for q-value
and ROE, and a positive effect on performance measured as q by outside directors
among firms that faced low levels of product market competition. They concluded that
board independence was less relevant or even redundant in highly competitive
industries where the firm was already “monitored” by a competitive product market,
68
while board independence might enhance performance among companies facing less
competitive product market.
From Appendix 2, it appears that most overseas papers suffer from the same limitations
as identified in Australian research:

small sample size (Pfeffer, 1972; Molz, 1988; Pearce II and Zahra, 1992; Daily
and Dalton, 1992; Coles et al, 2001; Dehaene et al, 2001; Dulewicz and Herbert,
2004; Krivogorsky, 2006);

short-term observation of firm performance (Pfeffer, 1972; Molz, 1988;
Schellenger et al, 1989; Daily and Dalton, 1992, 1993; Agrawal and Knoeber,
1996; Klein, 1998; Vafeas and Theodorou, 1998; Dehaene et al, 2001; Luan and
Tang, 2007; Chan and Li, 2008);

limited performance measures (Baysinger and Bulter, 1985; Agrawal and
Knoeber, 1996; Barnhart and Rosenstein, 1998; Denis and Sarin, 1999; Hossain
et al, 2001; Peng, 2004; Chin et al, 2004; Chang and Leng, 2004; Luan and
Tang, 2007; Choi et al, 2007; Chan and Li, 2008);

limited control variables (Pfeffer, 1972; Baysinger and Bulter, 1985; Kesner,
1987; Molz, 1988; Fosberg, 1989; Schellenger et al, 1989; Pearce II and Zahra,
1992; Daily and Dalton, 1992; Dalton et al, 1998; Dehaene et al, 2001; Dulewicz
and Herbert, 2004; Chin et al, 2004; Chang and Leng, 2004);

simplistic dichotomy of inside and outside directors as a measure for board
independence (Pfeffer, 1972; Kesner, 1987; Molz, 1988; Fosberg, 1989;
Schellenger et al, 1989; Daily and Dalton, 1992, 1993; Agrawal and Knoeber,
1996; Dehaene et al, 2001; Dulewicz and Herbert, 2004; Randoy and Jenssen,
2004; Chin et al, 2004; Chang and Leng, 2004); and

failure to examine whether board characteristics are endogenously related to
performance (Pfeffer, 1972; Baysinger and Bulter, 1985; Kenser, 1987; Molz,
1988; Fosberg, 1989; Schellenger et al, 1989; Hermalin and Weisbach, 1991;
Daily and Dalton, 1992, 1993; Yermack, 1996; Klein, 1998; Vafeas and
Theodorou, 1998; Coles et al, 2001; Dehaene et al, 2001; Hossain et al, 2001;
Singh and Davidson III, 2003; Anderson and Reeb, 2004; Dulewicz and Herbert,
2004; Randoy and Jenssen, 2004; Chin et al, 2004; Chang and Leng, 2004; Chen
69
et al, 2005; Krivogorsky, 2006; Luan and Tang, 2007; Choi et al, 2007; Chan
and Li, 2008).
Moreover, the positive relationship between the percentage of independent directors on
the board in 1970 and relative firm profitability in 1980, identified in Baysinger and
Butler (1985), may not be taken as strong support for board independence; the authors
did not offer explanation of why it took such a long time (10 years) for the benefits of
independent director monitoring to manifest themselves in firm profitability.
Similar to the Australian study of Balatbat et al (2004), in Hermalin and Weisbach
(1991), Denis and Sarin (1999), Hossain et al (2001), Randoy and Jenssen (2004), Chin
et al (2004) and Krivogorsky (2006), due to the use of firm-year observations, the OLS
regressions performed by these researchers may not be suitable for the purposes of their
analyses. In the circumstances, they could have employed panel data regression
technique, such as the fixed-effect models in Yermack (1996), Anderson and Reeb
(2004), Chang and Leng (2004) and Chen et al (2005), or the random-effect models in
Choi et al (2007).
This chapter presents a review of the literature testing board composition and financial
performance relationships; from the review it appears that such empirical studies have
become a popular topic, although their results have been inconsistent. Zahra and Pearce
II (1989) identified some sources of these conflicting findings, including differences in
time-frames, samples, performance measures, and the operational definitions employed
with regard to the outsiders’ variable. Beyond these methodological concerns, however,
like most scholars in this field Zahra and Pearce II (1989) expected a positive
association between board outsiders’ proportion and company performance, based on
the theory of firms developed by Jensen and Meckling in their 1976 publication.
In addition to the quantitative research as introduced above, there are some works which
use the qualitative methods to investigate the links between directors and firm
performance. For example, by employing a pattern matching analysis of five cases, Kiel
and Nicholson (2007) tested the hypothesized impact of board demography on
performance as predicted by agency theory, stewardship theory and resource
dependence theory. They concluded that while each theory could explain a particular
case, no single model could explain the general pattern of results.
70
Chapter 4. Theoretical Development
4.1
Introduction
As noted by Dalton et al (1998), Cotter and Silverster (2003) and Krivogorsky (2006),
most researchers in this field have used agency theory, which promises a positive
influence of board independence on corporate performance, as their underlying
theoretical arguments.
However, as shown in Chapter 3, “[p]rior research does not establish a clear correlation
between board independence and firm performance” (Bhagat and Black, 2000, p.5).
Consequently, some authors, for example, Dalton et al (1998, p.285), suggest that
“consideration of multiple theories (beyond agency theory) … may lead to a more
complete understanding.”
There are five sections in this chapter. Section 2 presents an examination of the
evolving perspectives on the contribution of board of directors. The potential
relationships between board independence and firm performance, as proposed by these
theories, are then summarized in Section 3, to provide a theoretical framework for this
study. As a result, five research hypotheses are developed and stated in Section 4.
4.2
Theories of Board of Directors
Juran and Louden (1966) remarked that it was an astonishing fact that the job of board
of directors was, in proportion to its intrinsic importance, one of the least studied in the
entire spectrum of industrial activities. Thirty years later, Johnson, Daily and Ellstrand
(1996) observed that there was no convergence in the understanding of the role of the
boards of directors.
According to Stiles and Taylor (2001, p.4), “[t]he description of what a board of
directors is for varies depending on which particular theoretical approach scholars take
…” The roles of boards of directors, as suggested by legalistic theory, agency theory,
stewardship theory, resource and strategy theories, and organizational portfolio theory,
are introduced as fellows.
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4.2.1
Legalistic View
Regarded as the earliest theory on corporate governance, the legalistic approach is
grounded in the Companies’ Act and common law (Ong and Lee, 2000). Chaganti,
Mahajan and Sharma (1985) pointed out that almost every country’s law decreed that
the business affairs of a corporation be managed under the jurisdiction of its board, and
boards could contribute to the performance of their firms by carrying out their legally
mandated responsibilities.
While the board may not necessarily need to have technical expertise related to the
firm’s services or products, it has legal power to ensure that the company reaches or
maintains a certain level of acceptable performance. Therefore a board may see its
primary function as controlling performance (Chaganti et al, 1985), and directors are
required to undertake the duty in “good faith” and “due care” for the benefit of the
company and shareholders (Pennington, 1986).
Since a firm is a legal entity separated from its owners to “furnish immortality”, the
directors have an obligation to ensure its survival (Koontz, 1967; Henn, 1974; Kosnik,
1987); the ultimate responsibility for corporate performance rests with the board
(Tricker, 1994).
According to Juran and Louden (1966), for directors to achieve “control before results”,
they should set the course of the business so that the general directions are determined
in advance and they should preview up-coming plans developed by the management.
The board may achieve some of these activities through a thorough study of available
leading indicators, a broad-based judgment of what lies ahead, a periodic re-evaluation
of the company’s plans, and developing alternative plans to circumvent unexpected
events (Juran and Louden, 1966).
For the control role of directors to be effective, a board which is independent from
management would be preferred, as the board would be more likely to get peer status
with the CEO and serve as the decision-makers in the organization (Vance, 1978, 1983).
However, the legalistic view does not propose a positive relationship between board
independence and corporate performance, although it is suggested that an independent
board, with effective control over the company, may ensure that the company reaches or
72
maintains an acceptable or satisfactory level of performance (Chaganti et al, 1985;
Pennington, 1986; Patton and Baker, 1987).
There is no precise definition of acceptable or satisfactory performance. The
performance considered being acceptable or satisfactory by directors might be different
from that of the managers, or shareholders. According to Parkinson (1993), the duty of
care says that directors must act in accordance with the standard of the “ordinary
prudent man”, which provides a low standard and one that has been accused of being
devoid of content. The fiduciary duty is framed in terms of subjective intentions, and
“any plausible assertion that a course of action is designed to increase the company’s
financial well-being will be enough to protect it from attack” (Parkinson, 1993, p.96).
Daily and Dalton (1994) provided evidence that non-executive directors would tend to
prevent performance from dropping to the level that causes bankruptcy.
There is a large literature around the topic that directors do not always perform their
legal functions (e.g., Juran and Louden, 1966; Koontz, 1967; Mace, 1971; Bacon, 1973;
Louden, 1982; Epstein, 1986; Patton and Baker, 1987; Lorsch and MacIver, 1989;
Zahra, 1990; Pearce II and Zahra, 1991). In theory directors hire executives to run the
corporation, in practice the reverse occurs; executives typically nominate directors
(Epstein, 1986). Directors frequently fail to perform their legal mandate because they
are “creatures of the CEO” (Patton and Baker, 1987) or simply “rubber stampers”
(Zahra, 1990).
Patton and Baker (1987) interviewed a number of lawyers, bankers, accountants, and
recently-retired chief executives about the practice of CEO duality; many felt that the
joint authority would reduce the check and balance allowed by the board. As the
chairman is also the CEO, he or she is the chief protector of shareholders as well as
chief manager; conflict of interests may occur. When CEOs dominate boards, power is
vested in these executives; they could select, reward or replace directors (Zahra, 1990).
Since directors are principally selected and retained by the CEO, the board may pay
little attention to its control function; board power is thus limited to the ceremonial
approval of managerial decisions, which falsely gives a form of legitimacy to the
managers’ decisions (Pearce II and Zahra, 1991). When companies do not perform well,
boards are blamed for not controlling the managers’ performance (Loevinger, 1986;
Fleischer, Hazard and Klipper, 1988).
73
Rosenstein (1987) indicated that directors might not be equipped to handle changing
organizational complexity. As the CEOs are the most important persons in companies,
they may not want a capable board that could challenge their power and authority;
therefore directors tend to be obtrusive and they may delegate the control authority to
the CEO (Rosenstein, 1987). Vance (1978, 1983) reported that delegation of power was
most visible among the small, new, low-technology, and closely-held firms where the
founders were still working in the firm.
As noted by Stiles and Taylor (2001), consideration of the legal duties of directors takes
us only a small way towards understanding the work of directors and boards, for at least
two main reasons. First, though boards may have de jure control of the organization, the
de facto control may rest with management. Secondly, the legal notion of boards has
also been attacked because it pays insufficient attention to the interests of stakeholders
other than shareholders.
4.2.2 Agency Theory
Denis and McConnell (2003) found that the publication of Jensen and Meckling (1976),
in which the authors applied agency theory to corporations and modelled the agency
costs of outside equity, spawned a voluminous body of research on corporate
governance in general, and boards of directors in particular, around the world.
According to Jensen and Meckling (1976), an agency relationship is a contract under
which one party (the principal) engages another party (the agent) to perform some
services on the principal’s behalf. Under the contract, the principal delegates some
decision-making authority to the agent; in the situation, where both the principal and the
agent are utility maximisers; there is no a priori reason to believe that the agent will
always act in the principal’s best interests.
The agency problem that arises is the problem of inducing an agent to behave as if he or
she were maximising the principal’s welfare; the agency problem is also characterized
by asymmetric information, as the principal has more restricted information set than the
agent. This problem, in turn, gives rise to agency costs. At the most general level,
agency costs could be measured as the dollar equivalent of the reduction in welfare
experienced by the principal due to the divergence of the principal’s and the agent’s
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interests. Jensen and Meckling (1976) further divided agency costs into monitoring
costs, bonding costs and residual loss.
In investor-owned firms, shareholders act as the principals with interests in deriving
maximum utility from the action of managers, serving as the agents. Under debt
contracts, the principals are debtholders, or lenders; the agents are managers acting on
behalf of shareholders (Godfrey, Hodgson and Holmes, 2003).
An early study by Berle and Means (1932) shows a divergence of interests between
investors and managers. Investors have three interests; the first is that the company
should be able to earn the maximum profits under an acceptable risk; the second is that
they want as large a proportion of profits to be distributed to them as possible, and third,
the company’s stock should remain marketable at a fair price. Managers have only one
major aim - to run the company for their “personal profits”. Williamson (1975) termed
the phenomenon as “opportunism” whereby people act with self-interest and guile in
pursuing their own goals. To reduce agency costs, firms should align the interests of
managers with those of shareholders; suggested measures include:

the separation of CEO and chairman because the CEO cannot both represent the
shareholders and management due to conflict of interests (Rechner and Dalton,
1991);

equity ownership by firm‘s management to tie the management’s compensation
to firm performance (Jensen and Meckling, 1976);

strengthening the governance structure of organizations whereby boards of
directors keep potentially self-serving managers in check by performing audits
and performance evaluations (Fama and Jensen, 1983);

managerial labour market in which a poor performing manager limits his or her
career opportunities (Fama, 1980);

market for corporate control in which a poor performing firm risks being
acquired by another and the consequence may be the replacement of
management of the acquired firm (Grossman and Hart, 1980); and

inclusion of at least some outside directors to monitor the performance of the
CEO and other managers (Baysinger and Hoskisson, 1990).
75
Agency theory perceives the board’s effectiveness in monitoring management to be
crucial (Stroh, Brett, Baumann and Reilly, 1996). Corporations could benefit from the
external oversight a board can offer by shielding the invested stakes of equity holders as
well as debtholders, from potential managerial self-interest, as well as from the risk that
the CEO may mix personal and business goals (Castaldi and Wortmann, 1984; Daily,
Johnson and Dalton, 2002).
Bacon and Brown (1975) suggested that the monitoring efforts would help to reduce
agency costs and ensure compliance of managers to focus on established procedures and
goals. Board of directors can function as an important information system for external
stakeholders to monitor firm performance and reduce asymmetric information (Bacon
and Brown, 1975). If monitoring fails, the more expensive external measures, such as
acquisitions, divestitures and ownership amendments, would arise. As external controls
could be detrimental to the principals, monitoring is generally preferred (Walsh and
Steward, 1990).
Thus from an agency perspective, directors are valued for their ability to be independent
when overseeing operating matters, protecting the assets of the firm, and holding
managers accountable to the firm’s stakeholders to ensure the success of the enterprise.
It is asserted that monitoring practices that align shareholders’ and managers’ interests
and prevent managers from pursuing self-serving objectives would be positively
associated with firm performance; the results would be the maximization of company’s
profitability and shareholders’ wealth (Fama, 1980; Scott, 1983). Consequently,
proponents of agency theory expect that where board of directors is more independent
of management, company performance would be higher.
Regarding the difference between agency theory and the legalistic approach, it is
indicated that legalistic theory views directors’ power coming from state law where
agency theory indicates that directors’ power arise from shareholders; while control is
the dominant function of directors under legalistic theory, monitoring is its counterpart
under agency theory (Ong and Lee, 2000).
Although agency theory has received widespread acceptance among researchers, it is
argued in some papers that the fundamental assumption of the theory that all action is
driven by a desire to maximise wealth is too simplistic and rather negative, which does
not allow other motivations for managerial behaviours to be examined (e.g., Tinker,
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Merino and Niemark, 1982; Christenson, 1983; Williams, 1989; Sterling, 1990;
Chambers, 1993; Gray, Owen and Adams, 1996; Howieson, 1996).
Jensen and Meckling (1994) criticized the theory as being a simplification for
mathematical modelling and an unrealistic description of human behaviour.
Doucouliagos (1994) commented that labelling all motivation as self-serving could not
explain the complexity of human action. Frank (1994) suggested that this model of man
would not suit the demand of a social existence; man takes care of both his personal and
social needs at the same time, and self-interest can be sacrificed for the sake of
organization. In reality it is possible that as managers contribute their human capital to
the organization, they could be equally, if not more, concerned with the success of the
company as shareholders (Frank, 1994).
4.2.3 Stewardship Theory
The stewardship model has been developed as an alternative to agency theory
(Donaldson and Davis, 1991, 1994; Donaldson, 1990; Fox and Hamilton, 1994; Davis,
Schoorman and Donaldson, 1997). Agency model, rooted in the field of economics and
finance, examines the structures of capitalism, finds only self-interested behaviour and
assumes “this is human nature … and neglects the enormous amount of neutral and
other-regarding behavior that exist … and the structures that might increase it” (Perrow,
1986, P.234).
According to Donaldson (1990), the assumptions of agency theory are extreme, which
fail to recognize a range of non-financial motives for managerial behaviours, including
the need for achievement and recognition, the intrinsic satisfaction of successful
performance, respect for authority and work ethic. These concepts are well supported in
the organizational literature (McClelland, 1961; Argyris, 1964; Herzberg, 1966; Etzioni,
1975).
Donaldson and Davis (1991) found that managers could be viewed as interested in
achieving high performance and capable of using a high level of discretion to act for the
benefit of shareholders; they are good stewards of corporate assets, loyal to the
company, when confronted with a course of action seen as personally unrewarding, may
comply based on a sense of duty and identification with the organization. There is also
77
evidence that close supervision often causes people to shift their focus from performing
their roles to actively resisting attempts to control them (Argyris, 1964).
Similarly, it is reported that managers whose behaviours are pro-organizational and
collectivistic have higher utility than individualistic, self-serving behaviours (Donaldson
and Davis, 1991, 1994; Fox and Hamilton, 1994; Davis, Schoorman and Donaldson,
1997). Where the interests of managers and principals are not aligned, managers may
place higher value on co-operation than defection. Since managers perceive greater
utility in co-operative behaviours and behave accordingly, their behaviours could be
considered rational (Fox and Hamilton, 1994).
The belief that managers have a wide range of motives beyond self-interest is the
rationale for arguing that goal conflict may not be inherent in the separation of
ownership from control. Davis et al (1997) claimed that the reallocation of corporate
control from owners to professional managers might be a positive development toward
managing the complexity of modern corporations.
Consequently, insider dominated boards are favoured by stewardship theorists for their
depth of knowledge, access to current operating information, technical expertise and
commitment to the firm (Muth and Donaldson, 1998; Kiel and Nicholson, 2003;
Anderson and Reeb, 2004; Dulewicz and Herbert, 2004; Randoy and Jenssen, 2004).
Boards should play a greater role in facilitating and empowering managers instead of
monitoring and control; managers would protect and maximize shareholders’ wealth
through firm performance because, by doing so, their utility functions would be
maximized (Donaldson and Davis, 1991, 1994; Fox and Hamilton, 1994). Boards
should play an indirect function, and empower the managers who would directly be
responsible for the performance of their companies.
For CEOs who are stewards, their pro-organizational actions may be best facilitated
when the corporate governance structures give them high authority and discretion
(Donaldson and Davis, 1991); structurally, this situation is attained more readily if the
CEO is also chair of the board of director. The CEO-chair who is unambiguously
responsible for the fate of the corporation would have the power to determine strategy
without fear of countermand by an outside chair of the board.
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4.2.4
Resource and Strategy Theories
From the 1980s, three theories founded on the organizational literature have been
increasingly used by academics in investigating corporate governance issues, i.e.,
resource based theory, resource dependence theory and strategic choice theory.
The resource based approach generally argues that a firm's internal environment, in
terms of its resources and capabilities, is critical for creating sustainable competitive
advantage (Prahalad and Hamel, 1990; Teece, Pisano and Shuen, 1997). Being aware
of, improving, and protecting the unique resources of the firm would then reinforce firm
strengths and rearrange firm weaknesses, and thereby improve a firm’s competitive
position.
However, firms are generally characterized by a lack of internal resources, and in-house
knowledge may in many cases be scarce or non-existing (Storey, 1994). It has in this
respect been considered important to have a board with outside members in order to
overcome this internal lack of resources and complement the management with
experience, knowledge and skills (Castaldi and Wortmann, 1984).
The board of directors, and especially outside directors, may be considered as a bundle
of strategic resources to be used by and within the firm as they can provide advice and
counsel to the CEO and the management in areas where in-firm knowledge is limited or
lacking. The resource-based view consequently recognizes that outside directors can be
a valuable source of competitive advantage through their professional and personal
qualifications.
From a different point of view, resource dependence theory notes that the long-term
survival and success of a firm is dependent on its abilities to link the firm with its
external environment (Pfeffer, 1972; Pfeffer and Salancik, 1978). A basic argument in
this theory is that firms must constantly interact with its external environments either to
purchase resources, or to distribute its finished products. Firms should seek to gain
control over its environment to create more stable flows of resources and lessen the
effects of environmental uncertainty. Directors, as boundary spanners, could form links
with the external environment, which may be useful for the managers in the
achievement of the various goals of the organization (Pfeffer and Salancik, 1978; Zahra
and Pearce, 1989; Pearce and Zahra, 1992; Borch and Huse, 1993).
79
Specifically, outside directors may help firms initiate and maintain control over critical
relationships, assets and contacts in the external environment. The firm may also co-opt
representatives from important organizations as board members in order to achieve
organizational goals and manage environmental contingencies. Directors who are
prestigious in their professions and communities can be a source of timely information
for executives. They become involved in supporting the organization by influencing
their other constituencies on behalf of the focal organization (Pfeffer, 1972; Pfeffer and
Salancik, 1978). Pfeffer and Salancik (1978, p.163) found that “[w]hen an organization
appoints an individual to a board, it expects the individual will come to support the
organization, will concern himself with its problems, will favorably present it to others,
and will try to aid it”.
According to the strategic choice theory, strategy is the primary link between
organization and its environment, and boards should actively participate in the process
of strategy formulation and implementation, because:

directors, as boundary spanners, may have the necessary resources to collect
information about competitiveness and industry changes, which could be
important for strategic actions;

directors who are managers in other companies would be in a advantageous
position to provide information in strategic decision-making process;

increasing shareholders’ expectations has led to directors paying more attention
to strategic activities;

the strategy formulation process is generally complicated, directors are urged to
join in to provide inputs; and

as the results of the complex competitive environment, boards should offer CEO
guidance in strategic actions (Zahra, 1990).
Proponents of this model recognize that strategic management is under the direct
responsibility of top management, as they are ultimately responsible for integrating the
functional and divisional areas of the firm, and balancing the short, medium and longterm planning and control cycles for the firm. It is suggested that CEOs and boards must
understand the possible areas of conflict between them, and allow for mutual
collaboration. These conflicts should be clearly stated and agreed upon (Kreiken, 1985;
80
Zahra, 1990). Directors could add value to the process of strategy formulation and
implementation by:

making strategy a regular topic on the agenda;

knowing the origins of the plans;

taking a broad analysis of environmental factors;

considering strategic alternatives and three theories founded on the
organizational literature; and

checking on progress and adaptation of strategic plans and actions (Kreiken,
1985).
Companies with better strategies would achieve higher levels of performance
(Hambrick and Mason, 1984). With board involvement, CEOs and managers could be
more effective in strategic management (Andrews, 1986).
From the above introduction, it appears that all the three theories agree that support is
the most important function of boards of directors. The resource based approach notes
that the board of directors could support the management in areas where in-firm
knowledge is limited or lacking. The resource dependence model suggests that the
board of directors could be used as a mechanism to form links with the external
environment in order to support the management in the achievement of organizational
goals. The strategic choice perspective recommends that the board of directors should
support the management by actively participating in the process of strategic formulation
and implementation.
However, the scholars in these schools do not provide any opinion on board
independence and its relationship with firm performance, although outside directors are
valued in their models with different rationales. Outside directors comprise independent
directors and affiliated directors, or “grey directors” as termed by Baysinger and Bulter
(1985). The above models are more interested in affiliated directors and their
experience, knowledge and linkages with other organizations (Pfeffer and Salancik,
1978; Castaldi and Wortmann, 1984; Zahra, 1990).
4.2.5
Organizational Portfolio Theory
Heslin and Donaldson (1999) and Donaldson (2000) proposed another theory of
organizational change and success, namely, organizational portfolio theory; however,
81
unlike resource and strategy theories, it views the central function of boards of directors
as a mechanism to adjust firm performance variance, i.e., firm risk.
Since firms typically need to experience a crisis of poor performance before they make
required structural changes (Chandler, 1962; Williamson, 1971; Child, 1972;
Donaldson, 1987; Hamilton and Shergill, 1992), it is postulated that a combination of
portfolio factors which causes poor performance is the usual trigger of organizational
adaptations (Heslin and Donaldson, 1999; Donaldson, 2000).
According to Heslin and Donaldson (1999, p.81), “[o]ne purpose of this theory is to
provide a fresh perspective on the determinants and consequences of board
composition”. The authors suggested that instances of poor firm performance led to
executive directors on the board being replaced by more independent non-executive
directors. Such changes decrease the amount of trust and discretion granted to
executives, based on the assumption that the decline in profitability is a result of their
poor management of the firm.
In turn, an increase in organizational profitability enhances the perceived integrity and
competence of managers, thereby precipitating boards in which managers are
increasingly represented. In Heslin and Donaldson (1999), three factors are identified
that are likely to prevent instances of poor performance and so forestall calls for a
tougher and more independent board.
Diversification generally lowers corporate risk as unrelated product-lines tend to be on
different business cycles and thus exhibit negative correlated performance; the high
performances of some product-lines often occur simultaneously with the poor
performances of other product-lines. The overall effect would be moderate risk so that
firm performance remains above the level at which board change may occur.
Divisionalization follows diversification and further reduces risk; divisional
performances are decoupled by the discretion of divisional managers to make
autonomous decisions and divisional managers’ incentives to smooth the fluctuations in
performance they report, thereby diminishing firm-level risk. Finally, divestments are
often undertaken during periods of low performance and result in an injection of cash
flow which forestalls the immediate likelihood of poor performance.
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There are also three factors that could contribute to poor performance and lead to the
appointment of more non-executives as board members or chair (Heslin and Donaldson,
1999). Depressed business cycles have a detrimental influence on company profitability.
Competition also has an adverse impact on profitability, particularly if competitors are
well organized. Debt raises the level of profitability that is regarded as satisfactory as it
requires large, regular interest payments, thus increases the chance of sufficiently poor
performance occurring to diminish confidence in management
Based on the evidence provided by Baysinger, Kosnik and Turk (1991) and Hill and
Snell (1998), Heslin and Donaldson (1999) assumed that, in general, executive directors
would raise risk and non-executives would reduce risk. Executives are more likely to
approve risky proposals such as increasing expenditures on R & D (Baysinger et al,
1991). This probably reflects their intimate knowledge of the business and resulting
confidence that anticipated benefits will flow from their proposed investments (Lorsch
and MacIver, 1989).
In contrast, independent directors may have less first-hand familiarity with the business;
as they are often appointed in order to curb the ostensibly radical excesses of
management, they would tend to be risk-averse (Heslin and Donaldson, 1999). The
pressure of strong public criticism and the threat of legal action for failure in their
fiduciary responsibility for poor corporate performance may reinforce the risk-aversion
of independent directors and chairpersons (Davis and Thompson, 1994).
Therefore, according to Heslin and Donaldson (1999), during periods when executives
constitute a large proportion of the board, risk tends to increase. When peaks from the
high risk strategy co-occur with favourable combinations of the other portfolio factors,
outstanding performance is likely to result. This would reinforce confidence in the
integrity and competence of the largely non-independent corporate governance
structure, thus bolstering the position of executives on the board.
When the troughs in the high risk strategy occur simultaneously with other
performance-depressing portfolio factors, the particularly low firm performance may
trigger the installation of an independent chair and a higher proportion of independent
directors on the board; the resulting risk-averse governance would tend to reduce firm
performance variance (Heslin and Donaldson, 1999).
83
It is considered that reducing firm risk may be a means of increasing short-term
economic value (Brealey and Myers, 1996). However, Heslin and Donaldson (1999)
and Donaldson (2000) indicated that low risk could prevent the performance crises
needed to trigger required structural adaptation; high economic value achieved by
lowering risk is thereby prone to inhibiting long-term growth and profitability. By
reducing risk, independent directors would not only prevent long-term success, but
indeed foster a gradual decline in organizational performance.
Thus shareholders interested in the medium to long-term profitability of a firm should
resist joining demands for board independence. “Prematurely instituting independent
directors to closely monitor and discipline executive management may unnecessarily
forfeit the advantages of non-independent boards. Paramount among these is a
willingness to take the risks necessary to precipitate both instances of outstanding shortterm performance and the structural changes needed for long-term organizational
growth and prosperity” (Heslin and Donaldson, 1999, p.86).
Although organizational portfolio theory is built on the empirically supported premise
that low performance is required to trigger adaptive organizational changes, it is
acknowledged that “… the theory is at present an extended conjecture following from
that premise … It is a series of propositions waiting for empirical testing. Only after it
has received such empirical confirmation would the policy implications sketched here
become valid prescriptions” (Donaldson, 2000, p.395).
4.3
Board Independence and Firm Performance
As discussed in the last section, although outside directors are valued in legalistic
theory, resource theories and strategy choice theory with different rationales, these
models do not make any explicit predictions regarding the relationship between board
independence and firm performance. Three theories, namely, agency theory,
stewardship theory and organizational portfolio theory, provide some guidelines on the
potential correlation between board independence and corporate performance.
As noted by some authors, theoretical support for the conventional wisdom that
independent boards would enhance shareholder returns has been provided by agency
theory (e.g., Muth and Donaldson, 1998; Dalton et al, 1998; Vafeas and Theodorou,
1998; Cotter and Silverster, 2003). A central assumption of the theory is that managers
84
may pursue their own goals rather than seek to maximise shareholder wealth, unless
their discretion is kept in check by a vigilant, independent board (Castaldi and
Wortmann, 1984; Daily et al, 2002). By emphasising the potential for divergence of
interests between investors and managers, agency theory predicts that where board of
directors is more independent of management, company performance would be higher
(Fama, 1980; Scott, 1983).
In contrast, stewardship theory highlights a range of non-financial motives for
managerial behaviours, such as the need for achievement, the intrinsic satisfaction of
successful performance, and respect for authority and the work ethics (Donaldson and
Davis, 1991, 1994; Donaldson, 1990; Fox and Hamilton, 1994; Davis et al, 1997).
Having control empowers managers to maximize corporate profits; the detailed
operation knowledge, expertise and commitment to the firm by executive directors,
would make firms with a management-dominated board more profitable (Donaldson
and Davis, 1991, 1994; Fox and Hamilton, 1994; Davis et al, 1997).
Organizational portfolio theory asserts that firm performance determined by a
combination of portfolio factors drives organizational changes (Heslin and Donaldson,
1999; Donaldson, 2000). An increase in corporate profitability would enhance the
perceived integrity and competence of managers, thereby precipitating boards in which
managers are increasingly represented; poor performance would lead to boards that are
more independent of management.
During periods when executives constitute a large proportion of the board, risk tends to
increase; when peaks from the high risk strategy co-occur with favourable combinations
of the other portfolio factors, outstanding performance is likely to result. On the other
hand, the risk-averse governance delivered by independent directors would inhibit longterm growth and profitability (Heslin and Donaldson, 1999).
In Chapter 3, some papers which provide empirical evidence on the relations between
board characteristics and the “bottom line” performance of public listed companies, in
Australia and overseas, are examined. Appendix 3 exhibits a summary of their
conceptual frameworks, hypotheses and conclusions, which shows that the agency
model is the most frequently used theoretical framework in the literature (Baysinger and
Butler, 1985; Schellenger et al, 1989; Hermalin and Weisbach, 1991; Agrawal and
Knoeber, 1996; Rosenstein and Wyatt, 1997; Muth and Donaldson, 1998; Vafeas and
85
Theodorou, 1998; Lawrence and Stapledon, 1999; Coles et al, 2001; Dehaene et al,
2001; Hossain et al, 2001; Cotter and Silverster, 2003; Kiel and Nicholson, 2003; Singh
and Davidson III, 2003; Panasian et al, 2003; Bonn et al, 2004; Balatbat et al, 2004;
Anderson and Reeb, 2004; Peng, 2004; Dulewicz and Herbert, 2004; Randoy and
Jenssen, 2004; Chin et al, 2004; Chang and Leng, 2004; Chen et al, 2005; Krivogorsky,
2006; Luan and Tang, 2007; Choi et al, 2007; Chan and Li, 2008).
The prediction proposed by stewardship theory, with respect to the relationship between
board independence and firm performance, is also tested in a number of papers (Muth
and Donaldson, 1998; Dalton et al, 1998; Coles et al, 2001; Kiel and Nicholson, 2003;
Anderson and Reeb, 2004; Dulewicz and Herbert, 2004; Randoy and Jenssen, 2004;
Luan and Tang, 2007). Several researchers explored the concern whether board
characteristics are endogenously related to performance; however, there is little
theoretical support in their studies (Hermalin and Weisbach, 1988; Pearce II and Zahra,
1992; Denis and Sarin, 1999; Bhagat and Black, 2000).
4.4
Testable Hypotheses
Based on the preceding discussion, the potential relations between board independence
and firm performance as suggested by agency theory, stewardship theory and
organizational portfolio theory could be illustrated as follows:
Figure 4.1
Theoretical Development: High Board Independence
Agency Theory
Low Firm
Performance
High Board
Independence
High Firm
Performance
Stewardship Theory &
Organizational
Portfolio Theory
Low Firm
Performance
Organizational
Portfolio Theory
86
Agency theory suggests that where board of directors is more independent of
management, company performance would be higher. As an alternative to agency
theory, stewardship model predicts that high board independence may lead to low
performance.
Organizational portfolio theory proposes that poor performance may trigger the
installation of an independent chair and a higher proportion of independent directors on
the board; however, the resulting risk-averse governance would foster a gradual decline
in performance.
Figure 4.2
Theoretical Development: Low Board Independence
High Firm
Performance
Stewardship Theory &
Organizational
Portfolio Theory
High Firm
Performance
Low Board
Independence
Agency Theory
Low Firm
Performance
Organizational
Portfolio Theory
Agency theory indicates that low board independence would lead to low performance.
Stewardship theory expects that, as shareholders would maximize their returns if the
organization structure facilitates effective control by management, board of directors
with a lower level of independence may lead to higher company performance.
According to organizational portfolio theory, an increase in organizational profitability
would enhance the perceived integrity and competence of managers, thereby
precipitating boards in which managers are increasingly represented. During periods
when executives constitute a large proportion of the board, risk tends to increase; when
the high risk strategy co-occur with favourable combinations of the other portfolio
factors, outstanding performance is likely to result.
Therefore, with respect of the relation between board independence and firm
performance, the following research hypotheses are developed:
87
H1:
There is a negative relationship between board independence and past firm
performance (organizational portfolio theory);
H2 :
There is a negative relationship between board independence and subsequent
firm performance (stewardship theory, organizational portfolio theory); and
H3:
There is positive relationship between board independence and subsequent
firm performance (agency theory).
Stewardship theory and organizational portfolio theory make the same prediction about
the relation between board independence and subsequent firm performance. To
differentiate between these two theories, a further hypothesis which could be tested is:
H4 :
There is a negative relationship between board independence and subsequent
firm risk (organizational portfolio theory).
As introduced earlier, supported by some empirical evidence (Lorsch and MacIver,
1989; Baysinger et al, 1991; Davis and Thompson, 1994; Hill and Snell, 1998), Heslin
and Donaldson (1999) argued that, in general, executive directors would raise risk and
non-executives would reduce risk. Thus, according to organizational portfolio theory,
there may be a negative relationship between board independence and firm risk.
However, some agency theorists claim that managers, unlike shareholders, could not
readily diversify their employment risks across a range of investments, as a result they
tend to be more risk averse than may be in the interests of shareholders (e.g., Fama,
1980; Knoeber, 1986; Prentice, 1993; Vafeas and Theodorou, 1998; Coles et al, 2001;
Godfrey et al, 2003). From the point of view of agency theory:
H5:
There is a positive relationship between board independence and subsequent
firm risk (agency theory).
4.5
Summary
The description of what a board of directors is for varies depending on which theoretical
approach scholars take. According to the legalistic view, boards are legally required to
act in the best interests of shareholders and control is the dominant function of directors.
Agency theory perceives the board’s effectiveness in monitoring management to be
crucial; firms could benefit from the external oversight an independent board can offer
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by shielding the invested stakes of equity holders as well as debtholders, from potential
managerial self-interest. Stewardship model shows that managers have a wide range of
motives beyond self-interest, and boards should play a greater role in facilitating and
empowering managers instead of monitoring and control.
There are three organizational models indicating that support is the most important
function of directors. The resource based approach notes that board of directors could
support the management in areas where in-firm knowledge is limited or lacking. The
resource dependency model suggests that board of directors could be used as a
mechanism to form links with the external environment in order to support the
management in the achievement of organizational goals. According to the strategic
choice perspective, board of directors should support the management by actively
participating in the process of strategic formulation and implementation.
Organizational portfolio theory, which is built on the premise that low performance is
required to trigger adaptive organizational changes, views the central function of boards
of directors as a mechanism to adjust firm risk. It is proposed that poor firm
performance would lead to executive directors on the board being replaced by
independent directors; however, by reducing risk, independent directors may indeed
foster a gradual decline in organizational performance.
Regarding the correlation between board independence and corporate performance,
agency theory, stewardship theory and organizational portfolio theory offer different
expectations. From an agency theory perspective, where the board of directors is more
independent of management, company performance would be higher. According to
stewardship theory, shareholders would maximize their returns if the corporate structure
facilitates effective control by management, thus board of directors with a lower level of
independence may lead to higher company performance. As a new theory waiting for
empirical testing, organizational portfolio model suggests that board independence may
be negatively associated with past and subsequent performance.
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Chapter 5. Research Method
5.1
Introduction
As shown in earlier chapters, the issues of board composition and structure generally
and independent directors specifically, have become a fertile area of interest and
research. This study intends to:

test the applicability of several theories which make different predictions about
the effect of board independence on firm performance and vice versa;

address some of the limitations of prior studies, including small sample size,
short-term observation of firm performance, limited control variables and
performance measures, and simplistic dichotomy of inside and outside directors
as an empirical proxy for board independence; and

shed some light on the potential influence of a recently altered regulatory
environment with respect to corporate governance mechanisms, particularly
those relating to the requirements for a majority of independent directors on the
board and board committees, on firm performance.
The focus, as indicated in Chapter 3, is on the empirical correlation between board
independence and the “bottom line” of firm performance, rather than the relationship
between board characteristics and certain corporate events, or the relationship between
the performance of boards of directors or individual directors and firm performance.
There are two broad research questions to be investigated in this project.

Does board independence have any influence on firm performance among
Australian listed companies?

Does firm performance have any influence on board independence among
Australian listed companies?
According to Gill and Johnson (2002), the use of a particular methodology for a
research project depends on the scope, purpose and target population of the study as
well as the resources available to the researcher. For researchers to achieve their
objectives, they need to adopt the right methodology and select the right data collection
techniques through which they could obtain appropriate data within their available
resources.
90
This chapter provides a discussion of the methods used in this research. In Section 2, an
introduction of the general research approaches and justification of the approach chosen
in this study are provided, which is followed by a description of the sample and data
sources in Section 3. Section 4 defines the research variables tested in the project,
including measures of board independence and financial performance, and controls. The
analysis tools selected are then discussed in Section 5. The last section presents a
summary of this chapter.
5.2
Research Approach
There are two general research approaches widely recognized in social science, i.e., the
quantitative and qualitative approaches. The goal of the quantitative approach is to
determine whether the predictive generalizations of a theory hold true (Ryan, Scapens
and Theobald, 2002; Veal, 2005; Frankfort-Nachmias and Leon-Guerrero, 2006). As
noted by Frankfort-Nachmias and Leon-Guerrero (2006), the quantitative approach is
deductive, researchers in this school deal directly with the operationalisation,
manipulation, prediction, and testing of empirical variables; therefore they place great
emphasis on methodology, procedures and statistical measures of validity.
It is suggested that quantitative research should be organised to show a clear
progression from theory to operationalisation of concepts, from choice of methodology
and procedures to data collection, and from statistical tests to findings and ultimately
conclusions (Ryan et al, 2002; Veal, 2005; Frankfort-Nachmias and Leon-Guerrero,
2006). Smith (2003) and Veal (2005) identified four types of quantitative methods.

Experimental method: this method is characterized by random assignment of
subjects to experimental conditions and use of experimental controls;

Quasi-experimental method: this method shares almost all the features of
experimental design except that it involves non-randomized assignment of
subjects to experimental conditions;

Survey method: this method uses questionnaires or interviews for data collection
with the intent of estimating the characteristics of a large population of interest
based on a smaller sample from that population; and

Archival method: archival research is based on historical (secondary) data and
uses cross-sectional and/or time-serial data to investigate a problem.
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According to Hussey and Hussey (1997), in a quantitative study, data are collected in
numerical form; one of the advantages of this approach is the relative ease and speed
with which the research can be conducted.
In contrast, the qualitative approach is inductive in nature. Qualitative researchers use
field research methods, primary case studies and participant observation within natural
settings; their reports present much more descriptive materials and show how the
observations prompt the researchers to analyse and isolate variables (induction) and
how, in turn, these variables may be developed into a theoretical framework (FrankfortNachmias and Leon-Guerrero, 2006).
Mason (1996) found that there were three types of qualitative studies, namely, case
study, ethnographic study and phenomenological study.

Case study: the researchers explore a single entity or phenomenon bounded by
time and activity and collect detailed information through a variety of data
collection procedures over a sustained period of time;

Ethnographic study: the researchers investigate an intact cultural group in a
natural setting over a specific period of time; and

Phenomenological study: the researchers examine human experiences through a
detailed description of the people being studied.
Thus it appears that, in most cases, qualitative data are concerned with qualities and
non-numerical characteristics. Hussey and Hussey (1997) commented that qualitative
research might present problems relating to rigour and subjectivity.
This study uses an archival research design which is traditionally employed by the
literature surrounding this topic. It follows such a design because one of its purposes is
to test the predictive generalizations of several theories with respect to the relationship
between board independence and firm performance.
Moreover, the nature of the data required to conduct this research on ASX-listed
companies indicates that such data would be publicly available; it is a time and cost
efficient decision to use secondary data. Consequently, this project is organized to show
a clear progression from theories to hypotheses, from choice of methodology and
procedures to data collection, and from statistical tests to findings and conclusions. As
noted by Novak and Gowin (1984), such a consistency would ensure that the knowledge
92
claims made as a result of the research program are logically linked to the philosophical
base of the theories and concepts used.
5.3
Sample and Data Collection
For any empirical study, it is essential to clearly define the population of interest, and to
ensure that the sample selected provides an accurate representation of that population
(Thomas, 1996; Weisberg, Krosnick and Bowen, 1996; Ryan et al, 2002; Smith, 2003;
Veal, 2005).
In Chapter 3, it is revealed that most Australian studies and some overseas papers in this
field suffer from the limitation of small sample size. Muth and Donaldson (1998), for
example, suggested that a sample size closer to 200 would have been preferable; effects
of boards on performance tend to be small which means that more statistical power is
needed to detect significant relationships. Calleja (1999) also acknowledged that the
small sample size in her study made it difficult to reach any firm conclusions.
This project uses the top 500 companies listed on the ASX in 2003, ranked by market
capitalisation, as the initial dataset. Each year the ASX collects information on these
companies to calculate its All Ordinaries Index, which is the primary indicator of the
Australian equity market. At December 31, 2003, the top 500 companies represent 95%
of the total market capitalisation of the ASX-listed companies (S&P, 2004). Thus, this
dataset offers a reasonable coverage for the population of interest, i.e., Australian
publicly listed corporations.
The top 500 companies change over time; it is necessary to select a specific year to
determine the list of the firms which presents the initial sample for this research. 2003,
which is the midpoint of the period for which the data is collected and tested (20002006), is chosen to reduce the chance of missing data due to delisting or suspension of
sample firms. The data used in this study was collected in October 2006.
Due to lack of comparable performance data in the financial institutions section, Muth
and Donaldson (1998) had to reduce their sample of top Australian firms. Kiel and
Nicholson (2003) also removed banks from their analysis because the recorded assets of
financial institutions consist of loans which represent the use of depositors’ funds.
Calleja (1999) and Cotter and Silverster (2003, p.217) noted that “[t]rusts have unique
characteristics which impact on their corporate governance practices. The trust manager
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and the trustee are jointly responsible for governance matters but have a fundamental
separation of responsibilities and powers between them”; consequently trusts were
excluded from their samples of large ASX-listed companies.
There are 503 firms in the 2003 list of top 500 companies provided by Huntleys’
Shareholder (2003). Following the local studies as shown above, financial institutions
including property trusts and investment funds are removed from this list; as a result, an
initial sample of 384 companies listed on the ASX is obtained.
The sources of data required to construct the research variables, which are described in
the next section, are available within the public domain. Data on firm performance and
risk, dividend payout, firm size and financial leverage is collected from Fin Analysis
database. The data on board independence and size, and blockholder and managerial
ownership is developed from the corporate reports provided by Connect 4 database. The
information on diversification and firm age is obtained from Huntleys’ Shareholder
(2003). The sample is further reduced to 243 firms after the following are excluded:

62 companies which had been delisted or suspended from the ASX during the
three years between 2003 and 2006;

32 companies without complete market performance data on Fin Analysis for the
periods of 2000-2003; most of them have been listed on the ASX after 2000;

12 companies whose annual reports could not be obtained from Connect 4, or
the company’s website if there is one; and

35 companies without sufficient information on board composition and
structure, and/or managerial ownership in their 2003 reports.
5.4
Research Variables
In order to examine the relationship between board independence and firm performance,
the level of board independence, firm performance and some control variables used in
the research have to be measured.
5.4.1
Measurement of Board Independence
As shown in Appendix 1 and 2 listed at the end of this thesis, the most popular measure
of board independence in prior research is the proportion of outside or independent
directors on the board (e.g., Baysinger and Butler, 1985; Fosberg, 1989; Schellenger et
94
al, 1989; Hermalin and Weisbach, 1991; Pearce II and Zahra, 1992; Yermack, 1996;
Agrawal and Knoeber, 1996; Barnhart and Rosenstein, 1998; Calleja, 1999; Lawrence
and Stapledon, 1999; Denis and Sarin, 1999; Coles et al, 2001; Singh and Davidson III,
2003; Bonn et al, 2004; Anderson and Reeb, 2004; Peng, 2004; Randoy and Jenssen,
2004; Chin et al, 2004; Krivogorsky, 2006; Choi et al, 2007). The definitions of an
outside or independent director embodied in these studies may be slightly different.
Some authors, for example, Baysinger and Bulter (1985), Lawrence and Stapledon
(1999), Kiel and Nicholson (2003), Peng (2004) and Luan and Tang (2007) argued that
a limitation of some previous studies was that NEDs in the samples were not classified
as independent or affiliated. The combination of insider and “grey” directors may
constitute a majority of the board, and this could lead to companies appearing to comply
with the recommendations for board independence through comprising a non-executive
majority on the board, whilst in fact being controlled by internal management (Clifford
and Evans, 1997).
From the recommendations and listing rules as outlined in Chapter 2, it appears that, in
the U.K., U.S. and Australia, the stock exchanges encourage or mandate a shift in the
overall power of boards of directors in favour of independent directors, and away from
executive management. For companies listed on the ASX, it is recommended in the
Guidelines (2003) that:

a majority of each company’s directors should qualify as independent directors;

each company should establish audit, nomination and remuneration committees
dominated by independent directors; and

the roles of chairman and CEO should not be exercised by the same individual,
and the chairman should be an independent director.
Thus, in this study five empirical proxies for board independence are adopted, i.e., full
board independence represented by the proportion of independent directors on the
board, monitoring committee independence measured by the percentages of independent
directors on the audit, nomination and remuneration committees, and chairman
independence which is a binary variable to assess whether or not the chairman is an
independent director.
95
If the sources of information only divide directors into executive directors and NEDs, it
would be necessary to divide NEDs into independent directors and affiliated directors,
using the definition of independence proposed by the ASX Corporate Governance
Council as a benchmark. According to the Guidelines (2003, p.19), “[a]n independent
director is independent of management and free of any business or other relationship
that could materially interfere with – or could reasonably be perceived to materially
interfere with – the exercise of their unfettered and independent judgement”. It is further
defined in Box 2.1 of the Guidelines (2003) that an independent director is a NED and

is not a substantial shareholder of the company or an officer of, or otherwise
associated directly with, a substantial shareholder of the company;

within the last three years has not been employed in an executive capacity by the
company or another group member, or been a director after ceasing to hold any
such employment;

within the last three years has not been a principal of a material professional
adviser or a material consultant to the company or another group member, or an
employee materially associated with the service provided;

is not a material supplier or customer of the company or other group member, or
an officer of otherwise associated directly or indirectly with a material supplier
or customer;

has no material contractual relationship with the company or another group
member other than as a director of the company;

has not served on the board for a period which could, or could reasonably be
perceived to, materially interfere with the director’s ability to act in the best
interests of the company; and

is free from any interest and any business or other relationship which could, or
could reasonably be perceived to, materially interfere with the director’s ability
to act in the best interests of the company.
The Guidelines (2003) suggests that family ties and cross-directorships may be relevant
in considering interests and relationships which may compromise independence;
however, it is unclear how long an independent director could serve on the same board.
This research follows the U.K. Higgs Report (2003) which nominates ten years in
relation to director tenure consideration.
96
Following the approach supported by prior studies (e.g., Pfeffer, 1972; Kesner, 1987;
Molz, 1988; Schellenger et al, 1989; Pearce II and Zahra, 1992; Daily and Dalton, 1992,
1993; Agrawal and Knoeber, 1996; Muth and Donaldson, 1998; Vafeas and Theodorou,
1998; Calleja, 1999; Lawrence and Stapledon, 1999; Dehaene et al, 2001; Cotter and
Silverster, 2003; Kiel and Nicholson, 2003; Bonn et al, 2004; Dulewicz and Herbert,
2004; Chan and Li, 2008), the levels of board independence among sample companies
are assessed at one point in time, i.e., mid-2003, using the above criteria.
Director independence is evaluated from disclosures in the company’s 2003 report.
Specifically, the director’s report or board of directors section of the annual report,
which gives an introduction to each board member, is used to ascertain whether the
director is a substantial shareholder or is an officer of a substantial shareholder
(substantial shareholders of the company are disclosed in shareholder information
section of the annual report), whether he/she has been employed in an executive
capacity by the company or another group member (group members of the company,
including associated entities and controlled entities, are disclosed in the notes to the
financial statements), and whether he/she has served on the board for more than ten
years.
Moreover, from the corporate governance section and related party notes to the financial
statements it is assessed whether the board member has been a principal or employee of
a material adviser or consultant to the company, whether he/she is a material supplier or
customer of the company, or an officer of a supplier or customer, and whether he/she
has any material contractual relationship with the company other than as a director of
the company. AASB 1031 provides guidance in relation to a quantitative assessment of
materiality. An item is presumed to be material if it is equal to or greater than 10% of
the appropriate base amount; according to the ASX (ASX, 2006), this would seem a
reasonable position for consideration by the board in determining materiality. Thus in
this study the materiality threshold is set at 10% of net assets or operating result before
tax, for balance sheet or profit and loss items respectively. If a close analysis of the
information could not provide an objective basis for determining director independence,
the company is excluded from the analysis.
It is introduced in Chapter 2 that the ASX asks each company to include a statement in
its annual report from 2004 onwards disclosing the extent to which it has followed the
97
best practice recommendations; the company should identify the recommendations that
have not been followed and give reasons for not following them. Therefore, from mid2003 Australian listed companies have been subject to the corporate governance
principles of the Guidelines (2003); the results of this study may indicate the potential
consequences of these recommendations on the performance of Australian firms.
However, it should be noted that, as the Guidelines (2003) became effective in the
financial year ending 30 June 2004, it would be unlikely that the board members would
have changed radically from 2003 to 2004. Weisbach (1988) and Lawrence and
Stapledon (1999) believed that board composition, in terms of executive, affiliated and
independent directors, would only change slowly over time. This belief is supported by
the ASX analysis of corporate governance disclosures (ASX, 2005, 2008), which shows
that the compliance statistics for the best practice recommendations had been improved
slowly but surely over 2003-2007. Although there may be an extraneous effect of
anticipated regulatory change for the Guidelines (2003) to become effective in 2004, the
effect, as noted by some authors (e.g., Larcker, Richardson and Tuna, 2007), could not
create significant biases in the results, as it would affect all listed firms.
5.4.2
Performance Measures
In Chapter 3, it is suggested that the performance measures in some papers are quite
limited, for example, Baysinger and Bulter (1985), Agrawal and Knoeber (1996),
Barnhart and Rosenstein (1998), Calleja (1999), Denis and Sarin (1999), Hossain et al
(2001), Kiel and Nicholson (2003), Bonn et al (2004), Balatbat et al (2004), Peng
(2004), Chin et al (2004), Chang and Leng (2004), Luan and Tang (2007), Choi et al
(2007) and Chan and Li (2008).
Currently, there appears to be no consensus concerning the selection of an appropriate
set of measures which account for corporate financial performance (Chakravarthy,
1986); it is unlikely, however, that any one corporate performance indicator could
sufficiently capture this performance dimension (Daily and Dalton, 1992). It is common
to see several indices used because organizations legitimately seek to accomplish a
variety of objectives, ranging from financial profitability to effective asset utilization
and high stockholder returns (Hofer, 1983).
98
There are two broad groups of performance measures - “accounting measures drawn
from the accounting systems used by firms to track their internal affairs and financial
market measures relating to the share prices and dividend streams observed in the
operation of financial markets” (Devinney, Richard, Yip and Johnson, 2005, p.15).
Accounting measures of performance are historical and therefore experience a backward
and inward looking focus. Developed as a reporting mechanism, they represent the
impact of many factors, including the past successes of advice given from the board to
the management team; they are the traditional mainstay of corporate performance
factors (Kiel and Nicholson, 2003). However, accounting measures are “distortable”;
this distortion arises from such sources as accounting procedures and policies,
government policies towards specific activities, human error and purposeful deception
(Devinney et al, 2005). Nevertheless, ROA and ROE are included in this study as
measures of corporate performance; as noted by Muth and Donaldson (1998), ROA and
ROE have been used extensively in research on board composition.
In contrast, market-based measures are forward looking indicators that reflect current
plans and strategies, in theory representing the discounted present value of future cash
flows (Fisher and McGowan, 1983). Related to the value placed on the firm by the
market, market measures are not susceptible to the impact of accounting policy changes
or mere timing effects; they are objective in the sense that they exist outside of the
influence of individuals (Devinney et al, 2005).
Examples of market measures frequently endorsed by the authors in the field of
corporate governance include shareholder return (e.g., Kenser, 1987; Hermalin and
Weisbach, 1988; Molz, 1988; Schellenger et al, 1989; Muth and Donaldson, 1998;
Vafeas and Theodorou, 1998; Calleja, 1999) and Tobin’s q (e.g., Hermalin and
Weisbach, 1991; Yermack, 1996; Agrawal and Knoeber, 1996; Barnhart and
Rosenstein, 1998; Bhagat and Black, 2000; Hossain et al, 2001; Kiel and Nicholson,
2003; Panasian et al, 2003; Anderson and Reeb, 2004; Randoy and Jenssen, 2004; Chin
et al, 2004; Choi et al, 2007; Chan and Li, 2008), which are used in this study. The
acceptance of shareholder return as a performance measure is also encouraged by the
Australian Institute of Company Directors (AICD), Australian Employee Ownership
Association (AEOA) and Australian Shareholders’ Association (ASA) (AICD, AEOA
and ASA, 2007). Table 5.1 presents the definitions of the performance measures
adopted in this research.
99
Table 5.1
Measures of Firm Performance
Measure
Definition
ROA
Ratio of EBIT to book value of total assets
ROE
Ratio of profit after interest and tax to book value of equity
Shareholder return
Realised annual rate of return incorporating capital gains and dividend
payments
Tobin’s q
Ratio of market value to book value of total assets; market value of total
assets is computed as market value of common stocks plus book value of
preferred stocks and long-term debt
The formulas for ROA and ROE are taken from Devinney et al (2005) and Management
Accounting – Financial Strategy issued by the Chartered Institute of Management
Accountants (CIMA, 2006). The definition of shareholder return is essentially the same
as the ones used in prior studies, although it is termed shareholder wealth in Muth and
Donaldson (1998), total return to shareholders in Molz (1988), or stock return in
Hermalin and Weisbach (1988) and Vafeas and Theodorou (1998), among others.
The unavailability of many of the variables comprising the theoretical Tobin’s Q in
Lindenberg and Ross (1981) and Morck, Shleifer and Vishny (1988) prevent similar
calculations being conducted. Instead, like the prior studies (e.g., Yermack, 1996;
Agrawal and Knoeber, 1996; Barnhart and Rosenstein, 1998; Bhagat and Black, 2000;
Hossain et al, 2001; Kiel and Nicholson, 2003; Panasian et al, 2003; Anderson and
Reeb, 2004; Randoy and Jenssen, 2004; Chin et al, 2004; Choi et al, 2007; Chan and Li,
2008), the alternative formula for approximating Tobin’s q in Chung and Pruitt (1994)
is followed.
As discussed in Chapter 3, some prior studies also suffer from the limitation of shortterm observation of firm performance (e.g., Pfeffer, 1972; Molz, 1988; Schellenger et
al, 1989; Daily and Dalton, 1992, 1993; Agrawal and Knoeber, 1996; Klein, 1998;
Vafeas and Theodorou, 1998; Calleja, 1999; Dehaene et al, 2001; Cotter and Silverster,
2003; Bonn et al, 2004; Luan and Tang, 2007; Chan and Li, 2008); generalizability of
their findings would have been enhanced if they had used data from a longer period
(Bonn et al, 2004).
100
Shrader et al (1984), in examining the literature on the empirical relationship between
strategic planning and organizational performance, found that most studies surrounding
the topic had chosen 3- or 5-year periods as their time frames, as suggested to be
appropriate for a given strategic planning intervention to take effect. Therefore, to
reduce the influence of short-term fluctuations, the performance figures in the study are
the three-year averages over the 2000-2003 and 2003-2006 financial years.
5.4.3
Control Variables
From Appendix 1 and 2 which provide a summary of major research in Australia and
overseas, it appears that some of the papers are cross sectional without the benefit of
control variables (e.g., Pfeffer, 1972; Baysinger and Bulter, 1985; Kesner, 1987; Molz,
1988; Fosberg, 1989; Schellenger et al, 1989; Daily and Dalton, 1992; Dalton et al,
1998; Calleja, 1999; Dehaene et al, 2001; Kiel and Nicholson, 2003; Dulewicz and
Herbert, 2004; Chin et al, 2004; Chang and Leng, 2004).
In Bathala and Rao (1995) and Coles et al (2001), it is suggested that the mixed
evidence on the correlation between board composition and firm performance may be
attributed to the omission of other variables that affect firm performance. Schellenger et
al (1989) argued that the conflicting findings with respect to the existence or nonexistence of a board composition effect on financial performance could be due to failure
to control firm risk. In order to identify the specific effect of board independence on
firm performance, and the effect of firm performance on board independence, a number
of covariates are introduced into the models in this study to control for confounding
influences on performance and independence.
As pointed out by Bathala and Rao (1995), while the agency literature recognizes the
importance of board of directors in monitoring of management decisions, this is only
one of the mechanisms used to control agency conflicts. The literature identifies a few
other devices which ensure that managers’ interests are aligned with those of
shareholders, such as managerial ownership, dividend payout and leverage; the
theoretical underpinnings for each of these are outlined below.
Jensen and Meckling (1976) asserted that increasing managerial ownership could
mitigate agency conflicts; the higher the proportion of equity owned by managers, the
greater the alignment between managers and shareholder interests. The empirical
101
evidence supporting this view could be found in Morck et al (1988), Kim, Lee and
Francis (1988) and Hudson, Jahera and Lloyd (1992).
In relation to leverage and dividend payout, Jensen (1986) argued that the payment of
dividends and the contractual obligations associated with debt reduced the amount of
discretionary funds available to management, thereby reducing their incentive to engage
in non-optimal activities.
Similarly, Grossman and Hart (1982) suggested that increased debt would cause
managers to become more efficient in order to lessen the probability of bankruptcy, and
loss of control and reputation. According to Easterbrook (1984), the regular payment of
dividends would force firms to go to the capital markets for investment funding;
scrutiny of firms accessing the markets would act as a deterrent to opportunistic
behaviours by managers. Harris and Raviv (1991) confirmed that the empirical evidence
was broadly consistent with the proposition that debt could mitigate agency conflicts.
In addition to the control mechanisms as discussed in Bathala and Rao (1995), the
analysis in this research includes several control variables, which capture the firm
characteristics likely to be associated with board composition and firm performance,
drawing on the empirical models identified in prior studies into the determinants of
board composition or firm performance. These variables include:

board size (Barnhart and Rosenstein, 1998; Lawrence and Stapledon, 1999;
Bhagat and Black, 2000; Singh and Davidson III, 2003; Randoy and Jenssen,
2004; Choi et al, 2007; Chan and Li, 2008);

blockholder ownership (Bhagat and Black, 2000; Coles et al, 2001; Singh and
Davidson III, 2003; Randoy and Jenssen, 2004);

diversification (Hermalin and Weisbach, 1988; Yermack, 1996; Agrawal and
Knoeber, 1996; Hossain et al, 2001);

firm age (Daily and Dalton, 1993; Denis and Sarin, 1999; Bonn et al, 2004;
Balatbat et al, 2004; Anderson and Reeb, 2004; Peng, 2004; Randoy and
Jenssen, 2004; Krivogorsky, 2006; Choi et al, 2007);

firm size (Hermalin and Weisbach, 1988, 1991; Pearce II and Zahra, 1992;
Yermack, 1996; Agrawal and Knoeber, 1996; Muth and Donaldson, 1998;
Barnhart and Rosenstein, 1998; Lawrence and Stapledon, 1999; Denis and Sarin,
1999; Bhagat and Black, 2000; Coles et al, 2001; Hossain et al, 2001; Cotter and
102
Silverster, 2003; Singh and Davidson III, 2003; Panasian et al, 2003; Anderson
and Reeb, 2004; Peng, 2004; Randoy and Jenssen, 2004; Chen et al, 2005;
Krivogorsky, 2006; Luan and Tang, 2007; Choi et al, 2007; Chan and Li, 2008);
and

risk (Muth and Donaldson, 1998; Klein, 1998; Denis and Sarin, 1999; Anderson
and Reeb, 2004; Choi et al, 2007).
The measures selected for board size, blockholder ownership, diversification, dividend
payout, firm age, firm size, leverage, management shareholdings and risk are described
below.
Table 5.2
Measures of Control Variables
Control
Measure
Definition
Board size
Board size
Number of directors on the board
Blockholder ownership
Blockholder shareholdings
The percentage of common stocks held
by the top 20 shareholders
Diversification
Diversification
Number of industrial and geographical
segments
Dividend payout
Dividend ratio
Ratio of dividend payments to profit after
interest and tax
Firm age
Firm age
Number of years listed on the ASX and
one of the stock exchanges which were
amalgamated to form the ASX in 1987
Firm size
Market capitalisation
Market value of common stocks
Leverage
Gearing ratio
Ratio of short-term and long-term debt to
book value of equity
Managerial ownership
Executive director
The percentage of equity, including
shareholdings
options as well as common stocks, held
by executive directors
Firm risk
Standard deviation of returns
The measure of a firm’s total risk, i.e., the
volatility of expected returns
The measures for dividend payout, firm size and leverage are taken from Huntleys’
Shareholder (2003). These measures, along with the indicators for board size,
103
diversification, firm age and managerial ownership as listed in the table, have been
typically used in the research surrounding this topic.
Like Coles et al (2001) and Randoy and Jenssen (2004), in which blockholder
ownership is defined as the proportion of equity owned by major shareholders, in this
study the variable blockholder ownership represents the cumulative percentage of the
company’s issued equity held by the top 20 shareholders; ASX Listing Rule 4.10.9
requires each company to include in its annual report the names of its 20 largest
shareholders and the percentage of issued capital each hold.
Firm risk could be measured in a number of ways (Baird and Thomas, 1990; Beatty and
Zajac, 1994). Baird and Thomas (1990) reviewed how risk had been conceptualized in
different disciplines of management, finance, marketing and psychology, and concluded
that researchers in the area of strategic management typically defined risk as
unpredictability of business outcome variables, e.g., variability of accounting or market
return. Finance literature suggests that total risk, i.e., the uncertainty of expected returns,
consists of systematic risk - the risk of the market, and unsystematic risk – the risk
unique to the firm (e.g., Brigham, 1985; Reilly, 1985; Ross and Westerfield, 1988;
Ross, Westerfield and Jaffe, 2005; Reilly and Brown, 2006). Schellenger et al (1989)
asserted that board of directors could influence both the systematic and unsystematic
risk of the firm. According to Hill and Snell (1988), Lorsch and MacIver (1989),
Baysinger et al (1991), Davis and Thompson (1994), Heslin and Donaldson (1999) and
Donaldson (2000), directors may raise or reduce total risk of the firm. Thus, it is
decided to choose a measure of total risk, namely, the standard deviation of stock
returns.
Consistent with the performance figures, the figures for dividend payout, firm size and
leverage are the three-year averages of 2000-2003 and 2003-2006; firm risk is also
calculated for the periods of 2000-2003 and 2003-2006. Like the measures of board
independence, data on board size, blockholder and executive director shareholdings,
diversification and firm age are collected for the 2003 financial year.
5.5
Data Analysis
In addition to descriptive statistics and correlation analysis, in this project, OLS and
logit regressions are conducted for the research variables as described in the last section.
104
It is noted that a number of scholars have used simultaneous equations, such as two- and
three-stage least squares to model the relationships between board variables and
performance (e.g., Agrawal and Knoeber, 1996; Bhagat and Black, 2000; Balatbat et al,
2004; Anderson and Reeb, 2004; Chan and Li, 2008).
However, in examining the sensitivity of simultaneous equation techniques in corporate
governance research, Barnhart and Rosenstein (1998, p.2) found that “current theory
provides little guidance in the specification of corporate governance models, and the
econometric literature points out that misspecification of any of the equations in a
system may result in serious bias in all of the equations. In fact, ordinary least squares
(OLS) tends to be less sensitive to misspecification error …” Their arguments are
summarised as follows.
It is well known that OLS estimation of simultaneous equations models yields
estimators that are biased and inconsistent (Judge, Hill, Griffiths, Lutkepohl and Lee,
1982). Although the 2SLS and 3SLS estimators are consistent, these estimators are
biased and their exact distributions are known only for special cases, leading to
questionable point estimates and statistical tests; for correctly specified models, the
choice of instruments involves tradeoffs between bias and efficiency (Phillips, 1980).
In Pindyck and Rubinfeld (1991, p.315), it is noted that a serious specification error in
one equation could affect the parameter estimates in the other equations; thus systems
estimation “involves a trade-off between the gain in efficiency and the potential costs of
specification error.” Rhodes and Westbrook (1981), after an investigation of the exact
density functions of OLS and 2SLS estimators when exogenous variables are wrongly
excluded, concluded that under misspecification, OLS might be the superior estimation
technique.
In their study on the combined influence of ownership structure and board composition
on corporate performance, Barnhart and Rosenstein (1998) reported that the empirical
results were strongly dependent on the specification of the overall model and of the
first-stage regressions; relatively minor changes in either have profound effects on
overall results.
It is therefore suggested that “sensitivity analysis is essential in most corporate
governance research, where no formal structural model has been developed and a
105
variety of models exist that are similar in concept but different in specification,
functional form, and control variables. In situations such as this, where the structure of
empirical models is uncertain, systems estimation results should be interpreted
cautiously, sensitivity analysis should be conducted, and OLS results should not be
casually dismissed” (Barnhart and Rosenstein, 1998, p.2).
As introduced in Chapter 3, some researchers, for example, Yermack (1996), Anderson
and Reeb (2004), Chang and Leng (2004), Chen et al (2005) and Choi et al (2007), have
performed panel regression analysis using either fixed-effect or random-effect models.
These models are not tested in this study, because, if panel data is used, the sample
would be further reduced. OLS and logit regressions are employed to overcome some of
the limitations identified in prior research, including short-term observation of firm
performance and failure to examine whether board characteristics are endogenously
related to performance.
In Chapter 4, based on agency theory, stewardship theory and organizational portfolio
theory, five testable hypotheses are developed:
H1:
There is a negative relationship between board independence and past firm
performance (organizational portfolio theory);
H2 :
There is a negative relationship between board independence and subsequent
firm performance (stewardship theory, organizational portfolio theory);
H3:
There is positive relationship between board independence and subsequent
firm performance (agency theory);
H4 :
There is a negative relationship between board independence and subsequent
firm risk (organizational portfolio theory); and
H5:
There is a positive relationship between board independence and subsequent
firm risk (agency theory).
In the regressions to test H 1 , board independence serves as the dependent variable; the
independent variables include performance, board size, blockholder and managerial
shareholdings, diversification, dividend payout, firm age, firm size, leverage, and risk.
The measures of board independence, board size, blockholder and managerial
ownership, diversification, firm age use the 2003 data; the figures for firm performance,
106
dividend payout, firm size, leverage and risk are for the years 2000-2003. An algebraic
statement of the models is as follows:
Yi    1 ( Performance) i   2 ( BoardSize) i   3 ( BlockholderOwnership) i
  4 ( Diversification) i   5 ( DividendPayout ) i   6 ( FirmAge) i   7 ( FirmSize) i
  8 ( Leverage) i   9 ( ManagerialOwnership) i   10 ( Risk ) i   i
Where, for the i th company
Y
= Full board independence, monitoring committee
independence or chairman independence

= Constant of the equation

= Coefficient of the variable
Performance
= ROA, ROE, shareholder return or Tobin’s q
Board Size
= Number of directors on the board
Blockholder Ownership = Blockholder shareholdings
Diversification
= Number of industrial and geographical segments
Dividend Payout
= Dividend ratio
Firm Age
= Number of years listed on the ASX
Firm Size
= Natural logarithm of market capitalisation
Leverage
= Gearing ratio
Managerial Ownership
= Executive director shareholdings
Firm Risk
= Standard deviation of return

= Error term
In the models to test H 2 and H 3 , firm performance is the dependent variable, and the
independent variables consist of board independence and other controls. The measures
for performance, dividend payout, firm size, leverage and risk use the 2003-2006
figures; the rests use the 2003 data. The models can be described as:
Yi    1 ( Independence) i   2 ( BoardSize) i   3 ( BlockholderOwnership) i
  4 ( Diversification) i   5 ( DividendPayout ) i   6 ( FirmAge) i   7 ( FirmSize) i
  8 ( Leverage) i   9 ( ManagerialOwnership ) i   10 ( Risk ) i   i
Where, for the i th company
Y
= ROA, ROE, shareholder return or Tobin’s q
107

= Constant of the equation

= Coefficient of the variable
Independence
= Full board independence, monitoring committee
independence or chairman independence
Board Size
= Number of directors on the board
Blockholder Ownership = Blockholder shareholdings
Diversification
= Number of industrial and geographical segments
Dividend Payout
= Dividend ratio
Firm Age
= Number of years listed on the ASX
Firm Size
= Natural logarithm of market capitalisation
Leverage
= Gearing ratio
Managerial Ownership
= Executive director shareholdings
Firm Risk
= Standard deviation of return

= Error term
In the models to test H 4 and H 5 , the dependent variable is firm risk; the independent
factors include board independence, performance and other control variables. Firm risk,
performance, firm size, leverage and dividend payout are measured for the period 20032006; other variables use the 2003 data.
Yi    1 ( Independence) i   2 ( BoardSize) i   3 ( BlockholderOwnership) i
  4 ( Diversification) i   5 ( DividendPayout ) i   6 ( FirmAge) i   7 ( FirmSize) i
  8 ( Leverage) i   9 ( ManagerialOwnership ) i   10 ( Performance) i   i
Where, for the i th company
Y
= Standard deviation of return

= Constant of the equation

= Coefficient of the variable
Independence
= Full board independence, monitoring committee
independence or chairman independence
Board Size
= Number of directors on the board
Blockholder Ownership = Blockholder shareholdings
Diversification
= Number of industrial and geographical segments
Dividend Payout
= Dividend ratio
108
Firm Age
= Number of years listed on the ASX
Firm Size
= Natural logarithm of market capitalisation
Leverage
= Gearing ratio
Managerial Ownership
= Executive director shareholdings
Performance
= Shareholder return

= Error term
As discussed earlier in this chapter, the agency literature gives some guidelines in
relation to the effects of dividend payout, leverage and managerial ownership on
corporate performance (Bathala and Rao, 1995). In Coles et al (2001) and Singh and
Davidson III (2003), it is argued that large block-holding shareholders may have greater
incentives to monitor management than small investors as they have more at stake.
According to resource dependence theory, increased board size may yield benefits by
creating a network with the external environment and securing a broader resource base
(Pfeffer, 1972; Pfeffer and Salancik, 1978; Zahra and Pearce II, 1989; Pearce II and
Zahra, 1992). In addition, diversification has been shown to be value destroying by
some authors (e.g., Berger and Ofek, 1996; Servaes, 1996; Denis, Denis and Sarin,
1997).
However, the potential effects of firm age and firm size on performance are unclear in
the literature. It seems that no formal structure has been developed for the influences of
board size, blockholder and managerial shareholdings, diversification, dividend payout,
firm age, firm size, leverage and risk on board independence, although these variables
have been extensively used as controls in the research seeking to uncover the correlation
between board composition and firm performance. In Bhagat and Black (2000), it is
acknowledged that the factors that determine board composition are not well
understood. As it is the case that “… the structure of empirical models is uncertain”
(Barnhart and Rosenstein (1998, p.2), sensitivity tests using different performance
measures, i.e., ROA, ROE, shareholder return and Tobin’s q, are provided to assess the
robustness of the regression results for H 1 ; additional tests on the models for H 1 , H 2 ,
H 3 , H 4 and H 5 without firm size control are also performed over the sample periods.
In statistics there is no specific rule of thumb for parsimony. As shown in Appendix 2,
there are ten independent variables in Yermack (1996) and Hutchinson and Gul (2004),
and eleven in Hermalin and Weisbach (1988) and Choi et al (2007). Since additional
109
tests without firm size are preformed, it appears that the concern that the regression
models may not be parsimonious could not be justified.
5.6
Summary
To identify the specific effect of board independence on firm performance, and the
effect of firm performance on board independence, this study uses an archival research
design, which is traditionally employed by the literature surrounding this topic.
Most Australian studies and some overseas papers suffer from the limitation of small
sample size. It is decided to use the top 500 companies listed on the ASX in 2003,
ranked by market capitalisation, as the initial dataset. The sources of data required to
conduct this research are available within the public domain.
The most popular measurement of board independence is the proportion of outside or
independent directors on the board. Drawing on the recommendations of the ASX in its
Guidelines, five empirical proxies are developed in the study to represent full board
independence, monitoring committee independence and chairman independence, among
Australian public companies.
There are four measures of firm performance – market-based measures of Tobin’s q and
shareholder return, and accounting-based measures of ROA and ROE; they are the
frequently used performance indicators in the field of corporate governance research.
Following the approach endorsed by some researchers, board characteristics of sample
companies are examined at one point in time: mid-2003. To correct the limitation of
short-term observation of firm performance identified in some papers, the performance
figures use the three-year averages over the 2000-2003 and 2003-2006 financial years.
Some control variables are introduced into the data analysis, including board size,
blockholder ownership, diversification, dividend payout, firm age, firm size, leverage,
managerial ownership and firm risk. OLS and logit models in which board
independence, firm performance and risk serve as the dependent variables are
developed; the robustness of the findings is investigated through a series of tests using
different measures for firm performance and/or without firm size control.
110
Chapter 6. Univariate Analysis
6.1
Introduction
As disclosed in Chapter 5, after removing financial institutions from the 2003 list of top
500 companies, a sample of 384 companies is obtained, which is further reduced to 243
firms due to missing data. Individual directors are assessed in terms of their
independence from management, based on the information included in the 2003 annual
reports, with the definition of independence espoused by the ASX being adopted. These
data are hand collected, making the evaluation of directors a time-intensive process.
It is found that, among the 243 sample firms, 116 (47.74%) had an independent board
chairman; 102 (41.98%), 163 (67.08%), 68 (28.40%) or 122 (50.21%) had a majority of
independent directors sitting on the board, audit committee, nomination committee or
remuneration committee, respectively.
In 2003 some of the sample companies had undertaken reviews of their corporate
governance practices in light of the recently released ASX Guidelines; some companies
proposed that they would conduct such reviews in the next financial year. There are
some companies which asserted that they had already been in compliance with the ASX
recommendations; however, such announcements should be read with caution. For
example, one company declared that “[a]ll current members of the board are
‘independent’ within the ASX definition, to the extent that the components of that
definition can be objectively assessed”, although there was a managing director, who
was also the chief executive of the company, on the board.
This chapter presents the descriptive statistics and correlation analysis of research
variables; the abbreviations for these variables adopted in the analysis are listed below.
The remainder of this chapter is organized as follows. Section 2 shows preliminary
statistics of the dataset. In Section 3, in order to explore the relationship between board
independence and past performance, Pearson correlations for the sample period 20002003 are examined. Section 4 provides a correlation analysis for the period 2003-2006,
to identify the influence of board independence on subsequent performance and risk. A
summary of the findings is then produced in the last section.
111
Table 6.1
Abbreviations of Research Variables
Abbreviation
Variable
FIND
Percentage of independent directors on the board
ACIND
Percentage of independent directors on the audit committee
NCIND
Percentage of independent directors on the nomination committee
RCIND
Percentage of independent directors on the remuneration committee
CMIND
A binary variable to assess whether or not the chairman is an independent
director
ROA1
Return on assets for the period 2000-2003
ROA2
Return on assets for the period 2003-2006
ROE1
Return on equity for the period 2000-2003
ROE2
Return on equity for the period 2003-2006
SHRET1
Shareholder return for the period 2000-2003
SHRET2
Shareholder return for the period 2003-2006
TOBQ1
Tobin’s q for the period 2000-2003
TOBQ2
Tobin’s q for the period 2003-2006
SIZE
Number of directors on the board
BLOCK
Percentage of equity held by the largest 20 shareholders
SEGMT
Number of industrial and geographical segments
DIVR1
Dividend ratio for the period 2000-2003
DIVR2
Dividend ratio for the period 2003-2006
AGE
Number of years listed on the ASX and one of the stock exchanges which were
amalgamated to form the ASX in 1987
MCAP1
Market capitalisation (in $million) for the period 2000-2003
MCAP2
Market capitalisation (in $million) for the period 2003-2006
Log(MCAP)
Natural logarithms of market capitalisation
GEAR1
Gearing ratio for the period 2000-2003
GEAR2
Gearing ratio for the period 2003-2006
EQED
Percentage of equity held by executive directors
112
RISK1
Standard deviation of shareholder return for the period 2000-2003
RISK2
Standard deviation of shareholder return for the period 2003-2006
6.2
Preliminary Statistics
Schmidt (2005, p.24) observed that “[i]t is customary to include a table in your paper
showing the means and standard deviations of every variable in the data set so that the
reader can get a sense of what the data look like.” Table 6.2 gives a description of board
characteristics for the 243 sample firms in 2003.
Table 6.2
Descriptive Statistics: Boards of Directors
Sample Period:
2003
Included Observations:
243
*
Variable
Mean
Median
Maximum
Minimum
Std. Dev
Skewness
Kurtosis
FIND
41.65%
40.00%
100%
0%
0.22
0.03
2.56
ACIND*
54.57%
60.00%
100%
0%
0.34
-0.25
2.06
NCIND*
23.29%
0%
100%
0%
0.33
1.07
2.78
RCIND*
41.15%
50.00%
100%
0%
0.36
0.24
1.78
SIZE
6.33
6.00
15.00
3.00
2.05
1.02
4.53
For a firm without audit, nomination or remuneration committee, its ACIND, NCIND or RCIND
is deemed to be 0%
Kurtosis included in the table measures the peakedness or flatness of the distribution of
the data. The kurtosis of the normal distribution is 3. If the kurtosis exceeds 3, the
distribution is peaked relative to the normal; if the kurtosis is less than 3, the
distribution is flat relative to the normal.
Casual observation of Table 6.2 reveals that the sample contains a wide range of firms.
The proportion of independent directors on the board, audit committee, nomination
committee or remuneration committee varies between 0% and 100%, with a mean of
41.65%, 54.57%, 23.29% or 41.15%, respectively. The total number of directors on the
board ranges from a low of 3 to a high of 15, with an average of just over 6.
Based on the mean, median and standard deviation of the percentage of independent
directors on the nomination committee, it could be concluded that Australian public
113
companies, in general, had not been in compliance with the recommendations that each
company should establish a nomination committee and a majority of its members
should be independent directors. Most firms, however, had an audit committee which
had been dominated by independent members.
The above findings may be explained by the changes in the listing requirements of the
ASX. In January 2003, the ASX introduced Listing Rule 12.7 which provides that the
top 500 companies must have an audit committee and that the composition of the audit
committee must comply with the best practice recommendations of the ASX Corporate
Governance Council; however, it is not mandatory for these companies to have a
nomination committee and a remuneration committee. The firm characteristics for the
sample in 2003 are summarized below.
Table 6.3
Descriptive Statistics: Other Research Variables
Sample Period:
2003
Included Observations:
243
Variable
Mean
Median
Maximum
Minimum
Std. Dev
Skewness
Kurtosis
BLOCK
65.10%
67.09%
99.86%
13.60%
0.18
-0.42
2.74
SEGMT
4.46
4.00
11.00
1.00
2.23
0.84
3.19
AGE
16.90
11.00
132.00
3.00
17.81
2.90
15.39
EQED
11.84%
2.21%
80.99%
0%
0.18
1.70
4.89
It is confirmed in the table above that the sample is comprised of firms with widely
differing attributes. The number of years listed on the stock exchange varies from 3 to
132, and number of industrial and geographical segments ranges from 1 to 11. The
proportion of equity held by the top 20 shareholders ranges from 13.60% to 99.86%,
and proportion of equity held by executive directors varies between 0% and 80.99%.
Startz (2007, p.190) noted that “[t]here are relatively few places in econometrics where
normality of the data is important. In particular, there is no requirement that the
variables in a regression be normally distributed. I don’t know where this myth comes
from.” Nevertheless, the Jarque-Bera tests for normality are performed; the findings are
displayed in Table 6.4, as part of the preliminary statistics. Unless otherwise indicated,
the levels of significance reported in this paper are for two-tailed tests.
114
Table 6.4
Jarque-Bera Statistics
Sample Period:
2003
Included Observations:
243
Variable
Statistic
Probability
FIND
1.98
0.3710
ACIND
11.62
0.0030
NCIND
46.78
0
RCIND
17.35
0.0001
SIZE
66.06
0
BLOCK
7.84
0.0198
SEGMT
28.88
0
AGE
1895.10
0
EQED
152.71
0
The Jarque-Bera statistic measures the difference of the skewness and kurtosis of the
data with those from the normal distribution. The reported p-value is the probability that
a Jarque-Bera statistic exceeds the observed value under the null hypothesis of a normal
distribution - a small p-value leads to the rejection of the null hypothesis. As shown in
the table, the hypothesis of normal distribution is rejected, for every variable other than
the percentage of independent directors on the board, at the 1% or 5% significance
level. Thus, in this sample most data is not normally distributed.
6.3
Correlations: The Sample Period 2000-2003
Table 6.5 gives Pearson product-moment correlations among the measures for board
independence and past performance, and shows several significant correlation
coefficients.
115
Table 6.5
Pearson Correlations: 2000-2003
Sample Period:
2000-2003
Included Observations:
243
Correlation
t-Statistic
FIND
FIND
1.000
ACIND
NCIND
RCIND
CMIND ROA1
ROE1
SHRET1 TOBQ1
----ACIND
0.752
1.000
17.731** ----NCIND
RCIND
CMIND
ROA1
ROE1
SHRET1
TOBQ1
*
0.441
0.368
1.000
7.630**
6.136**
-----
0.623
0.552
0.523
1.000
12.350** 10.268** 9.527**
-----
0.531
0.358
0.265
0.441
1.000
9.736**
5.943**
4.267**
7.618**
-----
-0.013
0.076
0.038
-0.006
-0.070
1.000
-0.195
1.187
0.593
-0.086
-1.095
-----
0.071
0.059
0.046
0.020
0.004
0.313
1.000
1.109
0.919
0.716
0.315
0.060
5.111**
-----
-0.064
-0.049
-0.126
-0.155
-0.077
-0.127
-0.090
1.000
-0.989
-0.766
-1.966
-2.443*
-1.196
-1.988*
-1.396
-----
0.012
-0.069
-0.095
0.031
0.006
-0.367
-0.160
0.043
0.192
-1.080
-1.483
0.487
0.097
-6.118** -2.517* 0.674
Significance at the 5% level
**
1.000
-----
Significance at the 1% level
First, the positive relations between full board independence, committee independence
and chairman independence are significant at the 1% level. Therefore a company with a
higher percentage of independent directors on the board tends to have higher
percentages of independent directors on the monitoring committees, with a higher
chance that the chairman of the board is also an independent director.
The performance variables fall into two clusters - accounting measures of ROA and
ROE, and market-based measures of shareholder return and Tobin’s q; there is a strong
positive correlation between ROA and ROE. Both shareholder return and Tobin’s q are
negatively related to ROA; Tobin’s q is also inversely related to ROE at the 5% level of
116
significance. The findings are consistent with the Australian paper of Muth and
Donaldson (1998), in which the correlation analysis shows that the performance
variables fall into three distinct clusters – profit performance, shareholder return and
sales growth; as noted by Muth and Donaldson (1998), similar results were obtained by
Hamilton and Shergill (1992) in New Zealand when the authors subjected individual
performance variables to factor analysis to generate a composite index of company
performance.
However, Table 6.5 indicates that, in general, there is no statistically significant
association between past firm performance and board independence, although the
average shareholder return for the past three years is negatively correlated with
remuneration committee independence at the 5% level of significance.
A comprehensive analysis of all research variables for the sample period 2000-2003 is
provided in a list format, with p-values, in Appendix 4. There are quite a few significant
coefficients in the correlations; the findings in relation to the variables which show
some influences on board independence are summarised below.
According to Appendix 4, larger firms as measured by market capitalisation have higher
percentages of independent directors on the board and board committees. Companies
with longer trading history on the stock exchange, or lower managerial shareholdings,
have higher levels of full board and nomination committee independence.
In addition, board size and diversification are positively related to full board and
monitoring committee independence. It appears that higher blockholder ownership may
lower the level of independence on the board, and audit and remuneration committees.
Dividend payout has a positive effect on nomination and remuneration independence.
Lastly, firm risk gives a negative impact on audit committee independence.
6.4
Correlations: The Sample Period 2003-2006
The correlations for board independence, subsequent performance and firm risk are
exhibited in the following table. Similar to the findings in Table 6.5, for the sample
period 2003-2006 there is a positive relation between ROA and ROE; Tobin’s q is
inversely related to ROA and ROE at the 1% level of significance.
117
Table 6.6
Pearson Correlations: 2003-2006
Sample Period:
2003-2006
Included Observations:
243
Correlation
t-Statistic
FIND
FIND
1.000
ACIND NCIND RCIND CMIND ROA2
ROE2 SHRET2 TOBQ2 RISK2
----ACIND
0.752
1.000
17.731** ----NCIND
0.441
0.368
1.000
7.630** 6.136** ----RCIND
0.623
0.552
0.523
1.000
12.350** 10.268** 9.527** ----CMIND
0.531
0.358
0.265
0.441
1.000
9.736** 5.943** 4.267** 7.618** ----ROA2
ROE2
SHRET2
TOBQ2
RISK2
*
-0.046
-0.003
-0.019
-0.036
-0.078
1.000
-0.719
-0.050
-0.288
-0.554
-1.220
-----
-0.055
-0.045
-0.028
-0.024
-0.066
0.328
-0.851
-0.699
-0.439
-0.370
-1.024
5.390** -----
-0.023
-0.041
-0.052
-0.032
0.005
0.005
0.029
1.000
-0.355
-0.632
-0.805
-0.504
0.071
0.071
0.452
-----
0.073
-0.021
-0.001
0.004
0.092
-0.727
-0.197
-0.010
1.141
-0.326
-0.015
0.060
1.428
16.451** 3.126** -0.154
-----
-0.079
-0.081
-0.010
-0.067
-0.013
-0.044
-0.010
0.955
-0.008
-1.230
-1.259
-1.559
-1.037
-0.204
-0.677
-0.151
49.797** -0.126
Significance at the 5% level
**
1.000
1.000
1.000
-----
Significance at the 1% level
From Table 6.6, it appears that full board independence, monitoring committee
independence and chairman independence do not have any influence on subsequent firm
performance and risk.
In Appendix 5, a detailed analysis of all research variables for the period 2003-2006 is
provided. In addition to the findings with respect of the relationships between board
size, blockholder shareholdings, diversification, firm age, firm size or managerial
ownership, and measures of board independence as reported in Section 6.3, Appendix 5
118
identifies a positive effect of board size on ROA, and a negative effect of board size on
Tobin’s q.
According to Appendix 4 and 5, the absolute values of correlations for the independent
variables are well below 0.8 or 0.9, the rule of thumb for multicollinearity. Although
there are high correlations among the various board independence measures, as
introduced in Section 5.5 there is only one independence measure tested in each of the
regressions. Therefore, there is no multicollinearity concern for the regression results,
which are reported in the next chapter.
6.5
Summary
The sample chosen in this study includes 243 firms drawn from the 2003 list of top 500
Australian companies; data is collected from databases and corporate annual reports.
The sample is comprised of firms with widely differing attributes. It appears that in
2003 Australian publicly listed companies, in general, had not been in compliance with
the recommendations that each company should establish a nomination committee and a
majority of its members should be independent directors. However, most companies had
an audit committee dominated by independent directors.
To investigate the relationships between board independence, firm performance and
risk, correlation analyses for the periods 2000-2003 and 2003-2006 are conducted. The
results suggest that companies with a higher percentage of independent directors on the
board tend to have higher percentages of independent directors on the monitoring
committees, with higher chance that the chairman is also independent. The performance
measures fall into two clusters - accounting and market-based measures.
It is reported that larger firms have higher percentages of independent directors on the
board and board committees. Companies with longer trading history or lower
managerial ownership have higher levels of board and nomination committee
independence. Board size and diversification are positively related to board and
committee independence. Higher blockholder shareholdings may reduce the level of
independence on the board, and audit and remuneration committees. Dividend payout
has a positive effect on nomination and remuneration independence; firm risk shows a
negative impact on audit independence.
119
Although a negative influence of shareholder return on remuneration committee
independence is identified, there is no significant correlation between other measures
for board independence, firm performance and risk. Therefore, the Pearson correlations
indicate that the predictive power of agency theory, stewardship theory and
organizational portfolio theory, with respect of the relationships between board
independence and firm performance and risk as discussed in Chapter 4, may be limited.
120
Chapter 7. Multivariate Analysis
7.1
Introduction
As illustrated in Chapter 4, there are three theoretical frameworks providing different
expectations on the relationships between board independence and firm performance.
According to agency theory, firms benefit from the oversight a board could provide by
shielding the invested stakes of equity and debt holders from potential managerial selfinterest; where the board of directors is more independent of management, corporate
performance should be higher. Stewardship theory offers opposing predictions about the
structuring of effective boards; it is argued that managers have a wide range of motives
beyond self-interest, and board of directors with a lower level of independence may lead
to higher performance.
As a new theory waiting for empirical testing, organizational portfolio model proposes
that poor performance may trigger the installation of an independent chair and a higher
proportion of independent directors on the board; the resulting risk-averse governance
would foster a gradual decline in firm performance. From the above propositions
several research hypotheses are developed:
H1:
There is a negative relationship between board independence and past firm
performance (organizational portfolio theory);
H2 :
There is a negative relationship between board independence and subsequent
firm performance (stewardship theory, organizational portfolio theory);
H3:
There is positive relationship between board independence and subsequent
firm performance (agency theory);
H4 :
There is a negative relationship between board independence and subsequent
firm risk (organizational portfolio theory); and
H5:
There is a positive relationship between board independence and subsequent
firm risk (agency theory).
To test these hypotheses, in this chapter a regression analysis of the research variables is
undertaken. Section 2 reports the findings of OLS and logit models estimated for the
effects of firm performance and other variables on board independence. The regressions
121
specified for the influences of board independence and other variables on performance
and risk are introduced in Section 3 and 4, followed by a summary in the last section.
7.2
Regressions: Board Independence and Past Performance
As discussed in Chapter 5, in the regressions to test H 1 board independence serves as
the dependent variable. The independent variables include firm performance, board size,
blockholder and managerial ownership, diversification, dividend payout, firm age and
size, leverage and firm risk. The models are shown as follows:
Yi    1 ( Performance) i   2 ( BoardSize) i   3 ( BlockholderOwnership) i
  4 ( Diversification) i   5 ( DividendPayout ) i   6 ( FirmAge) i   7 ( FirmSize) i
  8 ( Leverage) i   9 ( ManagerialOwnership) i   10 ( Risk ) i   i
Where, for the i th company
Y
= FIND, ACIND, NCIND, RCIND or CMIND

= Constant of the equation

= Coefficient of the variable
Performance
= ROA1, ROE1, SHRET1 or TOBQ1
Board Size
= SIZE
Blockholder Ownership
Diversification
Dividend Payout
Firm Age
= BLOCK
=
SEGMT
= DIVR1
= AGE
Firm Size
= Log(MCAP1)
Leverage
= GEAR1
Managerial Ownership
Firm Risk

= EQED
= RISK1
= Error term
Table 7.1 provides regression results for the effects of ROA and other variables on
board independence; the explanatory variables together account for 3.30%-21.20% of
the cross sectional variation in independence measures. In the table, past ROA presents
a negative influence on remuneration committee independence at 5% level of
significance.
122
Table 7.1
OLS and Logit Regressions:
Board Independence and Past Performance (ROA)
Sample Period:
2000-2003
Included Observations:
243
Coefficient
t/z-Statistic
FIND
ACIND
NCIND
RCIND
CMIND
Intercept
0.427
0.534
-0.187
0.147
0.403
5.720**
4.710**
-1.794
1.277
0.558
-0.050
0.031
-0.109
-0.166
-0.870
-0.985
0.405
-1.532
-2.102*
-1.596
-0.001
0.029
0.011
0.024
-0.056
-0.142
2.020*
0.827
1.684
-0.620
-0.258
-0.384
-0.155
-0.372
-1.088
-3.246**
-3.186**
-1.393
-3.033**
-1.416
0.006
-0.003
0.005
-0.004
-0.044
0.768
-0.303
0.470
-0.360
-0.595
-0.001
0.025
0.026
0.083
0.343
-0.036
0.507
0.579
1.661
1.076
0.0007
0.0009
-2.78E-05
-0.0002
-0.002
0.868
0.743
-0.024
-0.169
-0.240
0.023
0.011
0.077
0.060
0.125
1.743
0.563
4.095**
2.888**
0.964
0.013
0.015
0.007
0.015
0.132
1.314
1.046
0.531
1.017
1.008
-0.033
0.0007
-0.014
0.083
-0.404
-0.404
0.005
-0.127
0.660
-0.505
-0.003
-0.0002
-0.007
-0.012
-0.096
-0.548
-0.026
-0.855
-1.421
-0.989
0.118
0.105
0.212
0.195
0.033
0.079
0.067
0.178
0.160
Std Error (Regression)
0.213
0.324
0.298
0.329
0.500
F/LR-Statistic
3.089
2.734
6.252
5.626
11.226
ROA1
SIZE
BLOCK
SEGMT
DIVR1
AGE
Log(MCAP1)
GEAR1
EQED
RISK1
R 2 /McFadden R 2
Adjusted R
2
123
Probability (F/LR-Statistic)
0.001
0.003
0.000
0.000
Durbin-Watson
1.685
1.906
2.152
1.761
*
Significance at the 5% level
**
0.340
Significance at the 1% level
Durbin-Watson is the classic test statistic for serial correlation; a number close to 2 is
consistent with no serial correlation, while a number closer to 0 means there probably is
a serial correlation. Therefore for the above models there is no indicator of serial
correlation.
Table 7.2 displays the effects of ROE and other variables on board independence; the
independent variables account for 2.50%-20.40% of the variance in each of the
independence measures. No significant relationship between past ROE and board
independence is found.
124
Table 7.2
OLS and Logit Regressions:
Board Independence and Past Performance (ROE)
Sample Period:
2000-2003
Included Observations:
243
Coefficient
t/z-Statistic
FIND
ACIND
NCIND
RCIND
CMIND
Intercept
0.462
0.539
-0.145
0.202
0.697
6.315**
4.851**
-1.410
1.769
0.988
0.031
0.032
0.003
-0.012
0.018
1.309
0.887
0.083
-0.336
0.077
-0.001
0.029
0.011
0.025
-0.053
-0.106
2.025*
0.856
1.708
-0.593
-0.275
-0.390
-0.172
-0.392
-1.222
-3.472**
-3.238**
-1.537
-3.168**
-1.599
0.005
-0.004
0.004
-0.005
-0.047
0.697
-0.314
0.411
-0.421
-0.638
-0.013
0.025
0.009
0.060
0.213
-0.414
0.531
0.205
1.207
0.694
0.0006
0.0009
-0.0001
-0.0003
-0.003
0.750
0.709
-0.093
-0.235
-0.320
0.021
0.011
0.073
0.055
0.099
1.552
0.562
3.903**
2.640**
0.778
0.011
0.015
0.006
0.014
0.117
1.188
1.012
0.449
0.928
0.952
-0.059
-0.020
-0.024
0.080
-0.453
-0.709
-0.160
-0.207
0.620
-0.565
-0.002
-0.0002
-0.005
-0.010
-0.068
-0.285
0.027
-0.663
-1.203
-0.800
0.120
0.108
0.204
0.180
0.025
0.082
0.069
0.170
0.145
Std Error (Regression)
0.213
0.323
0.300
0.332
0.503
F/LR-Statistic
3.173
2.804
5.958
5.101
8.331
ROE1
SIZE
BLOCK
SEGMT
DIVR1
AGE
Log(MCAP1)
GEAR1
EQED
RISK1
R 2 /McFadden R 2
Adjusted R
2
125
Probability (F/LR-Statistic)
0.0008
0.003
0.000
0.000001
Durbin-Watson
1.609
1.882
2.124
1.762
*
Significance at the 5% level
**
0.597
Significance at the 1% level
The regression results for shareholder return on board independence are presented in
Table 7.3; the explanatory variables account for 2.60%-21.60% of the variance in the
measures of board independence. A negative impact of shareholder return on
remuneration committee independence, at 5% level of significance, is identified.
126
Table 7.3
OLS and Logit Regressions:
Board Independence and Past Performance (Shareholder Return)
Sample Period:
2000-2003
Included Observations:
243
Coefficient
t/z-Statistic
FIND
ACIND
NCIND
RCIND
CMIND
Intercept
0.448
0.529
-0.135
0.227
0.720
6.183**
4.814**
-1.332
2.042*
1.031
-0.023
-0.059
-0.120
-0.180
-0.275
-0.509
-0.855
-1.889
-2.584*
-0.631
-0.001
0.028
0.011
0.025
-0.053
-0.124
2.009*
0.849
1.719
-0.598
-0.269
-0.389
-0.190
-0.425
-1.262
-3.381**
-3.229**
-1.711
-3.480**
-1.650
0.005
-0.005
0.002
-0.009
-0.053
0.662
-0.395
0.174
-0.761
-0.710
-0.006
0.036
0.022
0.077
0.246
-0.200
0.748
0.505
1.578
0.795
0.0007
0.001
0.0001
2.41E-05
-0.002
0.876
0.849
0.113
0.019
-0.248
0.021
0.012
0.072
0.052
0.097
1.611
0.587
3.874**
2.565*
0.757
0.013
0.017
0.010
0.019
0.125
1.323
1.172
0.707
1.259
1.015
-0.037
0.0002
-0.028
0.063
-0.458
-0.460
0.002
-0.243
0.505
-0.581
0.011
0.033
0.064
0.094
0.089
0.409
0.821
1.709
2.284*
0.338
0.115
0.108
0.216
0.203
0.026
0.077
0.069
0.183
0.168
Std Error (Regression)
0.213
0.323
0.297
0.328
0.503
F/LR-Statistic
3.009
2.798
6.405
5.901
8.726
SHRET1
SIZE
BLOCK
SEGMT
DIVR1
AGE
Log(MCAP1)
GEAR1
EQED
RISK1
R 2 /McFadden R 2
Adjusted R
2
127
Probability (F/LR-Statistic)
0.001
0.003
0.000
0.000
Durbin-Watson
1.664
1.907
2.127
1.792
*
Significance at the 5% level
**
0.558
Significance at the 1% level
Table 7.4 provides regression estimates in relation to Tobin’s q on full board
independence, committee independence and chairman independence. The models
explain 2.50%-20.70% of the variation in dependent variables. According to the results,
there is no statistically significant association between Tobin’s q and independence
measures.
128
Table 7.4
OLS and Logit Regressions:
Board Independence and Past Performance (Tobin’s Q)
Sample Period:
2000-2003
Included Observations:
243
Coefficient
t/z-Statistic
FIND
ACIND
NCIND
RCIND
CMIND
Intercept
0.430
0.532
-0.121
0.159
0.650
5.689**
4.639**
-1.138
1.355
0.894
0.005
-0.003
-0.007
0.014
0.011
0.736
-0.278
-0.856
1.478
0.181
0.0004
0.028
0.009
0.030
-0.049
0.045
1.900
0.646
2.004*
-0.538
-0.258
-0.384
-0.182
-0.375
-1.200
-3.240**
-3.172**
-1.630
-3.033**
-1.566
0.006
-0.004
0.003
-0.003
-0.045
0.824
-0.323
0.296
-0.232
-0.607
-0.004
0.027
0.001
0.073
0.227
-0.120
0.551
0.030
1.468
0.728
0.0008
0.0009
-0.0003
-4.68E-05
-0.002
0.926
0.712
-0.214
-0.036
-0.286
0.019
0.014
0.078
0.046
0.093
1.381
0.669
4.009**
2.154*
0.708
0.013
0.015
0.005
0.015
0.119
1.327
1.038
0.379
1.040
0.960
-0.050
0.011
0.0009
0.027
-0.474
-0.605
0.087
0.008
0.210
-0.587
-0.002
-0.0006
-0.005
-0.010
-0.068
-0.428
-0.076
-0.686
-1.163
-0.810
0.116
0.105
0.207
0.187
0.025
0.078
0.067
0.173
0.152
Std Error (Regression)
0.213
0.324
0.299
0.331
0.503
F/LR-Statistic
3.041
2.725
6.049
5.353
8.358
TOBQ1
SIZE
BLOCK
SEGMT
DIVR1
AGE
Log(MCAP1)
GEAR1
EQED
RISK1
R 2 /McFadden R 2
Adjusted R
2
129
Probability (F/LR-Statistic)
0.001
0.003
0.000
0.000
Durbin-Watson
1.675
1.907
2.108
1.770
*
Significance at the 5% level
**
0.594
Significance at the 1% level
There are some consistent findings in Table 7.1, 7.2, 7.3 and 7.4 with respect to the
relationships between blockholder ownership, firm size and board composition. The
tables indicates that companies with higher blockholder shareholdings have lower
percentages of independent directors on the board, and audit and remuneration
committees; larger firms have relatively more independent directors on nomination and
remuneration committees.
The results for sensitivity tests without firm size control are reported in Appendix 6, 7, 8
and 9. The link between ROA and remuneration committee independence ceases to be
significant; instead, a positive impact of Tobin’s q on remuneration committee
independence emerges. In addition, there is a transfer of the positive effects on
nomination and remuneration committee independence from firm size to board size; as
introduced in Chapter 6, board size and firm size are strongly correlated.
7.3
Regressions: Board Independence and Subsequent Performance
In the models to test H 2 and H 3 , performance is the dependent variable; the
independent variables consist of board independence and other controls. The models are
described as:
Yi    1 ( Independence) i   2 ( BoardSize) i   3 ( BlockholderOwnership) i
  4 ( Diversification) i   5 ( DividendPayout ) i   6 ( FirmAge) i   7 ( FirmSize) i
  8 ( Leverage) i   9 ( ManagerialOwnership ) i   10 ( Risk ) i   i
Where, for the i th company
Y
= ROA2, ROE2, SHERT2 or TOBQ2

= Constant of the equation

= Coefficient of the variable
Independence
= FIND, ACIND, NCIND, RCIND or CMIND
Board Size
= SIZE
Blockholder Ownership
= BLOCK
Diversification
= SEGMT
130
Dividend Payout
Firm Age
= DIVR2
= AGE
Firm Size
= Log(MCAP2)
Leverage
= GEAR2
Managerial Ownership
Firm Risk

= EQED
= RISK2
= Error term
The influences of full board independence and other variables on firm performance are
reported in Table 7.5; the explanatory variables account for 10.60%-94.50% of the
variance in performance measures. In the table, full board independence gives a positive
contribution to Tobin’s q, and a negative contribution to ROE, at 5% level of
significance.
131
Table 7.5
OLS Regressions:
Full Board Independence and Subsequent Performance
Sample Period:
2003-2006
Included Observations:
243
Coefficient
t-Statistic
ROA2
ROE2
SHERT2
TOBQ2
Intercept
-0.226
0.407
-0.625
2.153
-1.112
0.740
-7.125**
1.816
-0.319
-1.088
0.097
1.987
-1.853
-2.339*
1.307
1.982*
-0.003
-0.070
-0.017
-0.352
-0.120
-1.093
-1.666
-2.533*
-0.088
-1.203
0.135
0.918
-0.403
-2.051*
1.440
0.726
-0.0008
0.105
-0.014
-0.103
-0.043
1.984*
-1.639
-0.909
0.200
0.532
0.070
-1.040
2.445*
2.404*
1.980*
-2.181*
0.001
-0.002
0.0001
-0.014
0.471
-0.410
0.135
-1.093
0.061
0.157
0.107
0.307
2.007*
1.906
8.150**
1.728
-0.019
-0.703
-0.016
-0.016
-1.083
-14.604**
-2.130*
-0.150
-0.366
0.062
-0.125
3.582
-1.656
0.104
-1.316
2.780**
-0.002
0.048
0.579
-0.054
-0.081
0.797
60.540**
-0.420
0.106
0.502
0.945
0.111
0.068
0.481
0.942
0.072
Std Error (Regression)
0.560
1.514
0.242
3.264
F-Statistic
2.754
23.416
397.120
2.882
FIND
SIZE
BLOCK
SEGMT
DIVR2
AGE
Log(MCAP2)
GEAR2
EQED
RISK2
R2
Adjusted R
2
132
Probability (F-Statistic)
0.003
0.000
0.000
0.002
Durbin-Watson
2.052
2.078
2.014
1.926
*
Significance at the 5% level
**
Significance at the 1% level
Table 7.6 displays regression results for audit committee independence and other
variables on performance; the independent variables account for 9.70%-94.40% of the
variance in ROA, ROE, shareholder return and Tobin’s q. As shown below, there is a
negative influence of audit committee independence on ROE at the 5% level.
133
Table 7.6
OLS Regressions:
Audit Committee Independence and Subsequent Performance
Sample Period:
2003-2006
Included Observations:
243
Coefficient
t-Statistic
ROA2
ROE2
SHERT2
TOBQ2
Intercept
-0.298
0.294
-0.599
2.769
-1.496
0.547
-6.972**
2.377*
-0.126
-0.681
0.029
0.468
-1.104
-2.216*
0.600
0.703
0.001
-0.048
-0.018
-0.369
0.060
-0.741
-1.745
-2.612**
-0.051
-1.176
0.120
0.569
-0.235
-2.006*
1.284
0.447
-0.003
0.097
-0.013
-0.092
-0.144
1.835
-1.568
-0.805
0.205
0.561
0.069
-1.056
2.490*
2.529*
1.938
-2.194*
0.001
-0.002
0.0002
-0.013
0.445
-0.401
0.161
-1.036
0.055
0.139
0.109
0.350
1.809
1.691
8.346**
1.969
-0.020
-0.705
-0.016
-0.015
-1.093
-14.625**
-2.117*
-0.147
-0.359
0.086
-0.128
3.535
-1.615
0.144
-1.336
2.724**
-0.001
0.049
0.578
-0.059
-0.056
0.814
60.353**
-0.451
0.098
0.501
0.944
0.097
0.059
0.480
0.942
0.058
Std Error (Regression)
0.563
1.516
0.242
3.288
F-Statistic
2.510
23.307
394.693
2.503
ACIND
SIZE
BLOCK
SEGMT
DIVR2
AGE
Log(MCAP2)
GEAR2
EQED
RISK2
R2
Adjusted R
2
134
Probability (F-Statistic)
0.007
0.000
0.000
0.007
Durbin-Watson
2.036
2.046
2.020
1.934
*
Significance at the 5% level
**
Significance at the 1% level
The regression results in relation to the nomination committee independence are
provided in Table 7.7; the explanatory variables account for 10.00%-94.50% of the
variance in performance measures. No relationship between nomination committee
independence and subsequent performance is identified.
135
Table 7.7
OLS Regressions:
Nomination Committee Independence and Subsequent Performance
Sample Period:
2003-2006
Included Observations:
243
Coefficient
t-Statistic
ROA2
ROE2
SHERT2
TOBQ2
Intercept
-0.392
-0.109
-0.588
3.112
-2.067*
-0.211
-7.176**
2.798**
-0.229
-0.361
-0.046
0.795
-1.897
-1.094
-0.872
1.122
0.003
-0.061
-0.016
-0.372
0.112
-0.928
-1.573
-2.651**
-0.038
-0.969
0.102
0.510
-0.178
-1.668
1.108
0.409
3.80E-05
0.104
-0.013
-0.103
0.002
1.937
-1.524
-0.892
0.195
0.523
0.069
-1.021
2.389*
2.340*
1.963
-2.129*
0.0009
-0.003
0.0002
-0.013
0.394
-0.504
0.190
-1.006
0.065
0.149
0.112
0.317
2.099*
1.769
8.399**
1.756
-0.017
-0.700
-0.016
-0.023
-0.974
-14.382**
-2.094*
-0.221
-0.363
0.081
-0.129
3.551
-1.644
0.135
-1.349
2.740**
-0.002
0.048
0.578
-0.055
-0.111
0.801
60.326**
-0.420
0.107
0.493
0.945
0.100
0.068
0.471
0.942
0.062
Std Error (Regression)
0.560
1.528
0.242
3.282
F-Statistic
2.773
22.577
395.414
2.587
NCIND
SIZE
BLOCK
SEGMT
DIVR2
AGE
Log(MCAP2)
GEAR2
EQED
RISK2
R2
Adjusted R
2
136
Probability (F-Statistic)
0.003
0.000
0.000
0.005
Durbin-Watson
2.044
2.038
2.015
1.947
*
Significance at the 5% level
**
Significance at the 1% level
Table 7.8 gives regression estimates for the effect of remuneration committee
independence on performance measures; the regressions explain 10.10%-94.50% of the
variation in dependent variables. It is found that remuneration committee independence
is inversely associated with the accounting performance measures of ROA and EOE, at
5% level of significance.
137
Table 7.8
OLS Regressions:
Remuneration Committee Independence and Subsequent Performance
Sample Period:
2003-2006
Included Observations:
243
Coefficient
t-Statistic
ROA2
ROE2
SHERT2
TOBQ2
Intercept
-0.317
0.066
-0.573
2.858
-1.668
0.128
-6.955**
2.559*
-0.221
-0.617
-0.048
0.740
-2.032*
-2.090*
-1.030
1.159
0.005
-0.048
-0.016
-0.380
0.210
-0.734
-1.505
-2.689**
-0.094
-1.168
0.089
0.694
0.665
-1.988*
0.850
0.546
-0.003
0.099
-0.013
-0.093
-0.138
1.865
-1.593
-0.812
0.207
0.551
0.072
-1.061
2.534*
2.483*
2.034*
-2.211*
0.0008
-0.003
0.0002
-0.013
0.361
-0.541
0.173
-0.986
0.063
0.157
0.112
0.324
2.055*
1.891
8.450**
1.811
-0.021
-0.707
-0.017
-0.012
-1.156
-14.626**
-2.183*
-0.117
-0.340
0.141
-0.124
3.471
-1.538
0.235
-1.296
2.677**
3.76E-05
0.053
0.578
-0.063
0.002
0.890
60.451**
-0.486
0.109
0.500
0.945
0.101
0.070
0.478
0.942
0.062
Std Error (Regression)
0.559
1.518
0.242
3.282
F-Statistic
2.831
23.200
395.952
2.596
RCIND
SIZE
BLOCK
SEGMT
DIVR2
AGE
Log(MCAP2)
GEAR2
EQED
RISK2
R2
Adjusted R
2
138
Probability (F-Statistic)
0.002
0.000
0.000
0.005
Durbin-Watson
2.033
2.073
1.993
1.938
*
Significance at the 5% level
**
Significance at the 1% level
An analysis of chairman independence and firm performance is presented in Table 7.9.
The independent variables account for 10.50%-94.40% of the variation in performance
measures. The table suggests that chairman independence does not have significant
effect on ROA, ROE, shareholder return and Tobin’s q.
139
Table 7.9
OLS Regressions:
Chairman Independence and Subsequent Performance
Sample Period:
2003-2006
Included Observations:
243
Coefficient
t-Statistic
ROA2
ROE2
SHERT2
TOBQ2
Intercept
-0.287
0.081
-0.585
2.584
-1.477
0.154
-6.956**
2.276*
-0.127
-0.242
0.004
0.710
-1.743
-1.216
0.114
1.664
-0.004
-0.072
-0.017
-0.344
-0.177
-1.110
-1.669
-2.471*
-0.043
-0.991
0.110
0.615
-0.203
-1.703
1.192
0.493
-0.004
0.097
-0.013
-0.085
-0.201
1.813
-1.574
-0.746
0.207
0.544
0.070
-1.079
2.527*
2.434*
1.971*
-2.254*
0.0008
-0.003
0.0002
-0.012
0.348
-0.535
0.193
-0.965
0.058
0.140
0.109
0.329
1.920
1.694
8.328**
1.854
-0.018
-0.701
-0.016
-0.022
-1.018
-14.421**
-2.137*
-0.213
-0.370
0.068
-0.128
3.597
-1.670
0.112
-1.332
2.784**
-0.0004
0.052
0.578
-0.063
-0.018
0.859
60.301**
-0.485
0.105
0.494
0.944
0.106
0.066
0.472
0.942
0.068
Std Error (Regression)
0.560
1.527
0.242
3.272
F-Statistic
2.711
22.633
394.069
2.754
CMIND
SIZE
BLOCK
SEGMT
DIVR2
AGE
Log(MCAP2)
GEAR2
EQED
RISK2
R2
Adjusted R
2
140
Probability (F-Statistic)
0.004
0.000
0.000
0.003
Durbin-Watson
2.047
2.033
2.013
1.933
*
Significance at the 5% level
**
Significance at the 1% level
Regarding the control variables used in the analysis, some consistent patterns emerge
from the above tables. It appears that larger board or lower managerial shareholdings
could lead to poor performance as measured by Tobin’s q. During the test period,
dividend payments of sample firms reflect the accounting performance measures of
ROA and ROE, however, diverge from the market measure of Tobin’s q. In general,
larger firms or firms with lower leverage have better shareholder return.
The regression results are assessed by additional tests without firm size control, which
are reported in Appendix 10, 11, 12, 13 and 14. The tests discern a positive effect of full
board independence on shareholder return; the negative correlation between
remuneration committee independence and accounting performance measures, however,
disappears.
7.4
Regressions: Board Independence and Firm Risk
In the models to test H 4 and H 5 , the dependent variable is firm risk; the independent
factors include board characteristics, firm performance and other control variables.
Yi    1 ( Independence) i   2 ( BoardSize) i   3 ( BlockholderOwnership) i
  4 ( Diversification) i   5 ( DividendPayout ) i   6 ( FirmAge) i   7 ( FirmSize) i
  8 ( Leverage) i   9 ( ManagerialOwnership ) i   10 ( Performance) i   i
Where, for the i th company
Y
= RISK2

= Constant of the equation

= Coefficient of the variable
Independence
= FIND, ACIND, NCIND, RCIND or CMIND
Board Size
= SIZE
Blockholder Ownership
= BLOCK
Diversification
= SEGMT
Dividend Payout
= DIVR2
Firm Age
= AGE
141
Firm Size
= Log(MCAP2)
Leverage
= GEAR2
Managerial Ownership
= EQED
Performance
= SHERT2

= Error term
As shown in Table 7.10, the models explain 94.50% of the variance in firm risk; no
significant relationship is identified between firm risk and measures of board
independence. According to the regressions, firm risk may be jointly determined by
dividend payout, firm size, leverage and shareholder return, i.e., smaller companies,
companies with higher gearing or shareholder return, or companies with lower dividend
payout tend to be riskier.
142
Table 7.10
OLS Regressions:
Board Independence and Firm Risk
Sample Period:
2003-2006
Included Observations:
243
Coefficient
t-Statistic
Intercept
FIND
RISK2
1.072
1.027
1.007
0.981
1.001
7.327**
7.172**
7.354**
7.140**
7.131**
-0.168
1.354
ACIND
-0.053
-0.641
NCIND
0.062
0.703
RCIND
0.085
1.073
CMIND
-0.003
-0.066
SIZE
BLOCK
SEGMT
DIVR2
AGE
Log(MCAP2)
GEAR2
EQED
0.026
0.027
0.025
0.023
0.026
1.486
1.572
1.413
1.322
1.491
-0.123
-0.098
-0.068
-0.043
-0.079
-0.783
-0.623
-0.442
-0.274
-0.507
0.021
0.020
0.019
0.020
0.020
1.476
1.401
1.369
1.428
1.410
-0.146
-0.144
-0.146
-0.150
-0.147
-2.482*
-2.438*
-2.471*
-2.540*
-2.478*
-3.23E-05
-7.21E-05
-0.0001
-9.35E-05
-0.0001
-0.020
-0.045
-0.077
-0.059
-0.078
-0.180
-0.184
-0.187
-0.188
-0.184
-8.182**
-8.386**
-8.398**
-8.499**
-8.375**
0.029
0.028
0.028
0.029
0.029
2.216*
2.203*
2.189*
2.271*
2.223*
0.117
0.120
0.122
0.114
0.120
0.728
0.746
0.758
0.707
0.744
143
SHERT2
1.626
1.626
1.627
1.626
1.626
60.540**
60.353**
60.326**
60.451**
60.301**
0.945
0.945
0.945
0.945
0.945
0.943
0.943
0.943
0.943
0.943
Std Error (Regression)
0.405
0.406
0.406
0.405
0.406
F-Statistic
402.324
399.738
399.891
401.084
398.998
Probability (F-Statistic)
0.000
0.000
0.000
0.000
0.000
Durbin-Watson
1.994
1.998
1.995
1.973
R2
Adjusted R
*
2
Significance at the 5% level
**
Significance at the 1% level
Robustness tests without firm size control are conducted; the results, which are shown
in Appendix 15, discern a negative contribution of full board independence on firm risk;
it seems that the role of firm size in reducing risk is replaced by board size. Moreover,
without firm size control managerial shareholdings display a positive effect on risk.
7.5
Summary
To investigate the specific influence of firm performance on board independence, OLS
and logit regressions in which board independence serves as the dependent variable, and
firm performance and some other factors serve as the explanatory variables, were
carried out. It is found that companies with higher blockholder shareholdings tend to
reduce the percentages of independent directors on the board, and audit and
remuneration committees; larger firms have relatively more independent members
sitting on nomination and remuneration committees.
Although poor performance in terms of ROA and shareholder return may lead to a
higher proportion of independent directors on remuneration committee, the regressions
indicate that, past performance, as measured by ROA, ROE, shareholder return and
Tobin’s q, have no significant effect on the level of independence on the board, audit
committee and nomination committees, and the decision to appoint an independent
chairman.
To search for the potential impact of board independence on firm performance, OLS
models, in which performance measures are used as the dependent variables, and the
independent variables consist of board independence and other controls, were tested.
144
The resulting evidence looks ambiguous; full board independence gives a positive
contribution on Tobin’s q, and a negative contribution on ROE. Higher level of
independence on audit and remuneration committees may lower accounting
performance; chairman independence and nomination committee independence,
however, do not affect subsequent performance.
Additional findings include that larger board or lower managerial shareholdings could
lead to poor performance as measured by Tobin’s q. Dividend payments of sample
firms reflect the accounting performance measures of ROA and ROE, however, diverge
from the market measure of Tobin’s q. Moreover, during the test period larger firms and
firms with lower leverage have better shareholder return.
According to the regressions specified for board independence and other variables on
risk, there is no significant relationship between board independence and subsequent
firm risk; smaller companies, companies with higher gearing or shareholder return, or
companies with lower dividend payout tend to be riskier. The results of sensitivity tests
without firm size control are disclosed in the appendices, which, along with the findings
as summarised above, are discussed further in Chapter 8, to address each of the five
hypotheses, and the general research questions raised earlier in this thesis.
145
Chapter 8. Discussion and Conclusions
8.1
Introduction
This thesis attempts to test the applicability of several theories which make different
predictions about the effect of board independence on firm performance and vice versa;
unlike the prior studies which do not ask whether board characteristics are
endogenously related to performance, two research questions are raised.

Does board independence have any influence on firm performance among
Australian listed companies?

Does firm performance have any influence on board independence among
Australian listed companies?
In this final chapter the results emanating from the data analysis are discussed; the
discussion responds specifically to the above questions. There are five sections in the
chapter; the next section provides an examination of the key findings presented in
Chapter 6 and 7, which leads to the conclusions and recommendations in Section 3.
Limitations in the current study and possible areas for future research are introduced in
Section 4, followed by a summary in the last section.
8.2
Discussion of Findings
In Chapter 4, regarding the potential links between board independence, corporate
performance and risk, five testable hypotheses were developed from agency theory,
stewardship theory and organizational portfolio model. This section summarises and
discusses the results for hypothesis tests as reported in the preceding chapters.
8.2.1
Board Independence and Past Performance
The correlation analysis for the period 2000-2003 indicates that the average shareholder
return in the past three years is inversely related to remuneration committee
independence; there is no association between other measures of performance and board
independence. Similarly, the regression models locate a negative impact of ROA and
shareholder return on remuneration committee independence; past performance, as
measured by ROA, ROE, shareholder return and Tobin’s q, does not influence full
board independence, audit and nomination committee independence, and chairman
independence.
146
Since the explanatory power of the regression models, as displayed in Tables 7.1-7.4, is
quite low, and the link between ROA and remuneration committee independence
becomes insignificant in the sensitivity tests, the results may be too weak to endorse H 1
(There is a negative relationship between board independence and past firm
performance).
There are several papers which test the effect of prior performance on board
independence. As shown in Table 8.1, the conclusion reached here is consistent with the
evidence in the Australian paper of Lawrence and Stapledon (1999), in which the
authors ran regressions for performance measures during the 1985-1995 periods on
board composition in mid-1995.
Table 8.1
Relationship between Board Independence and Past Performance
Papers
Country
Results
Hermalin and Weisbach (1988)
U.S.
Negative
Pearce II and Zahra (1992)
U.S.
Negative
Lawrence and Stapledon (1999)
Australia
Insignificant
Denis and Sarin (1999)
U.S.
Positive
Bhagat and Black (2000)
U.S.
Negative
Panasian et al (2003)
Canada
Negative
Current Study
Australia
Insignificant
8.2.2
Board Independence and Subsequent Performance
The Pearson correlations for the period 2003-2006 show that full board independence,
monitoring committee independence and chairman independence are not associated
with subsequent performance. The OLS regressions yield ambiguous findings - full
board independence gives a positive contribution on Tobin’s q, and a negative
contribution on ROE, probably due to the fact that the performance variables in this
research fall into two distinct groups – accounting measures and market-based
measures. The findings indicate that the Australian market may tend to reward
companies with relatively more independent board members even there is no
corresponding improvement in operating result. As defined in Table 5.1, Tobin’s q is
147
calculated by dividing market value by book value of total assets. Since this measure is
related to the value placed on the firm by the market, it seems that, in the context of the
global movement to promote board independence, shareholders may expect that
independent directors would enhance the value of their investments.
Although higher levels of independence on audit and remuneration committees may
reduce accounting performance, chairman independence and nomination committee
independence do not have significant effect on performance. Additional tests without
firm size control discern a positive effect of full board independence on shareholder
return; the negative influence of remuneration committee independence on accounting
performance measures, however, disappears. Thus it could be concluded that the data
analysis does not give a clear support to H 2 (There is a negative relationship between
board independence and subsequent firm performance) or H 3 (There is positive
relationship between board independence and subsequent firm performance).
The results, and the evidence provided by prior Australian research as summarised in
Table 8.2, suggest that independent directors may not add value to Australian public
corporations as expected by the ASX Corporate Governance Council. The possible
explanations for the findings are explored in Section 8.3.
Table 8.2
Relationship between Board Independence and Subsequent Performance
Papers
Country
Results
Muth and Donaldson (1998)
Australia
Negative
Calleja (1999)
Australia
Insignificant
Lawrence and Stapledon (1999)
Australia
Negative
Cotter and Silverster (2003)
Australia
Insignificant
Kiel and Nicholson (2003)
Australia
Negative
Bonn et al (2004)
Australia
Positive
Balatbat et al (2004)
Australia
Insignificant
Hutchinson and Gul (2004)
Australia
Insignificant
Current Study
Australia
Insignificant
148
8.2.3
Board Independence and Firm Risk
According to the correlation analysis for 2003-2006 and regressions for the effect of
board independence and other variables on firm risk, full board independence,
monitoring committee independence and chairman independence are not related to
subsequent risk. H 4 (There is a negative relationship between board independence and
subsequent firm risk) and H 5 (There is a positive relationship between board
independence and subsequent firm risk) are therefore rejected.
As introduced in Chapter 3, Schellenger et al (1989) believed that the conflicting
evidence with respect to the existence or non-existence of a board composition effect on
financial performance might be due to failure to control risk; after testing a sample of
526 U.S. firms with complete data for the year 1986, they found that the percentage of
outsiders and standard deviation of returns were negatively correlated. They asserted
that their findings provided support for advocates of non-executive representation on the
boards of directors.
There are two possible reasons why the results in this study are inconsistent with those
in Schellenger et al (1989). First, in this research board composition is measured by the
percentages of independent directors, rather than NEDs, on the board and monitoring
committees. Secondly, as clear in Appendix 2, there may not be enough control
variables in Schellenger et al (1989); similar to the findings in Schellenger et al (1989),
it is reported in Chapter 7 that the tests without firm size control identify a negative
contribution of full board independence on firm risk.
8.2.4
Summary of Other Findings
The data analysis suggests that companies with higher blockholder shareholdings tend
to reduce the percentages of independent directors on the board, and audit and
remuneration committees. The findings are consistent with the conclusion in the
Australian study of Cotter and Silverster (2003) that an absence of substantial
shareholders is compensated for with greater board independence, and support the view
that firms may choose among a number of different governance mechanisms in order to
create the appropriate structure for themselves, given the environment in which they
operate (Coles et al, 2001).
149
It is presumed that blockholders have the capacity to monitor their investments and, by
virtue of the magnitude of their investments, can affect managerial behaviour; the threat
that blockholders will sell large blocks of shares if the firm fails to provide an
acceptable return, or is not responsive to governance concerns that investors view as
critical, is a significant issue for managers (Coles et al, 2001). There is evidence that
institutional investors and other blockholders do impact managerial behaviour (e.g.,
Barclay and Holderness, 1991; Van Nuys, 1993; Brickley, Lease and Smith, 1994;
Shome and Singh, 1995; Bethel, Liebeskind and Opler, 1998; Allen and Phillips, 2000).
The data analysis indicates that larger firms have relatively more independent directors
sitting on nomination and remuneration committees. One possible interpretation is that
larger firms may draw more attention from media, shareholders and other stakeholders;
consequently they restructure their committees to be more independent, in fear of the
criticisms of interest conflicts and excesses, in accordance with the recent demand for
greater accountability (Vafeas and Theodorou, 1998; Cotter and Silverster, 2003).
With respect to the determinants of firm performance, it is reported that smaller board
or higher managerial shareholdings could lead to better performance as measured by
Tobin’s q. For the effect of board size on performance, the literature survey in Finegold,
Benson and Hecht (2007) shows that the empirical evidence is inconclusive, although
the general consensus is that smaller boards are more effective at monitoring
performance (Coles, Naveen and Lalitha, 2008). The argument is that smaller groups
are more cohesive and more productive, while larger groups suffer from the problems
such as social loafing and higher co-ordination costs (Lipton and Lorsch, 1992; Jensen,
1993; Yermack, 1996).
Similarly, although scholars have frequently tested the impact of executive ownership
on firm performance, the evidence is mixed (Sundaramurthy, Rhoades and Rechner,
2005). Jensen and Meckling (1976) proposed that increasing managerial ownership
could mitigate agency conflicts - the higher the proportion of equity owned by
managers, the greater the alignment between managers and shareholder interests; the
studies supporting their view include Morck et al (1988), Kim et al (1988) and Hudson
et al (1992). Some authors, for example Tsetsekos and DeFusco (1990) and
Sundaramurthy et al (2005), could not locate any significant relationship between
managerial shareholdings and performance. There are a number of papers, for example,
150
McConnell and Servaes (1990) and Brailsford, Oliver and Pua (2002), which identify a
non-linear relationship.
It is not surprising that dividend payments of sample firms reflect the accounting
measures of ROA and ROE, however, diverge from the market measure of Tobin’s q,
taking into account that in the correlation analysis the performance variables fall into
two distinct clusters. As discussed in Chapter 5, accounting measures are historical and
therefore experience a backward and inward looking focus; market-based measures are
forward looking indicators that reflect current plans and strategies, and in theory
represent the discounted present value of future cash flows (Devinney et al, 2005;
Fisher and McGowan, 1983). It is therefore concluded that in Australia dividend payout
is based on the historical performance, rather than the market expectation.
Moreover, smaller companies, companies with higher gearing or shareholder return, or
companies with lower dividend payout appear to be riskier. The findings, in general, are
in line with the finance literature (e.g., Brigham, 1985; Reilly, 1985; Ross and
Westerfield, 1988; Ross, Westerfield and Jaffe, 2005; Reilly and Brown, 2006).
For the test period of 2003-2006, larger firms or firms with lower leverage have better
shareholder return; therefore in 2003-2006 the Australian shareholders tended to value
larger companies and companies with lower leverage. It is noted that the negative
consequence of leverage coincides with the results of Alaganar (2004) who examined
the top ASX 100 companies from 1994 to 2003; according to the author, one possible
explanation is that newly acquired debt may be deployed on projects that have a
negative impact on shareholder wealth. This may have been fuelled by the prevailing
low interest rate environment where firms were inclined to undertake such projects
(Alaganar, 2004).
8.3
Conclusions and Recommendations
As discussed in the last section, regarding the relationships between board
independence, corporate performance and risk, the data analysis, in general, does not
support the five research hypotheses as proposed by agency theory, stewardship theory
and organizational portfolio theory. The relevant findings are summarised in Table 8.3.
151
Table 8.3
Results: Board Independence, Firm Performance and Firm Risk
Sample Period:
2000-2006
Included Observations:
243
Relation
FIND
ACIND
NCIND
RCIND
CMIND
ROA
Insignificant
Insignificant
Insignificant
Negative*
Insignificant
ROE
Insignificant
Insignificant
Insignificant
Insignificant
Insignificant
Shareholder Return
Insignificant
Insignificant
Insignificant
Negative*
Insignificant
Tobin’s q
Insignificant
Insignificant
Insignificant
Insignificant
Insignificant
ROA
Insignificant
Insignificant
Insignificant
Negative*
Insignificant
ROE
Negative*
Negative*
Insignificant
Negative*
Insignificant
Shareholder Return
Insignificant
Insignificant
Insignificant
Insignificant
Insignificant
Tobin’s q
Positive*
Insignificant
Insignificant
Insignificant
Insignificant
Insignificant
Insignificant
Insignificant
Insignificant
Past Performance
Subsequent Performance
Subsequent Risk
Standard Deviation of Return Insignificant
*
Significance at the 5% level
As described in Table 6.1, FIND, ACIND, NCIND and RCIND represent the
percentage of independent directors on the full board, audit committee, nomination
committee or remuneration committee respectively; CMIND is a binary variable to
assess whether or not the chairperson is an independent director.
With respect to the general research questions raised earlier, the above results, together
with those of the Australian studies as shown in Appendix 1, suggest that, for Australian
listed companies, there does not appear to be a strong relationship between board
independence, and past or subsequent performance.
The literature gives some possible reasons why the predictive power of agency theory,
stewardship theory and organizational portfolio model, for the board independencefinancial performance link, is so limited. Based on the institutional theory which has
been used to deal with the rationale behind the emergence of practices without obvious
economic value (Myer and Rowan, 1977), Peng (2004) argued that appointing outside
152
directors to the board might merely represent firms’ attempts to comply with
institutional pressures, and therefore might not be necessarily linked to firm
performance.
A core assumption of institutional theory is that organizations would act to protect or
enhance their legitimacy; copying other reputable organizations, even without knowing
the direct benefits of doing so, may be a low cost strategy to gain legitimacy (Peng,
2004). Emerging practices, e.g., total quality management or board independence, are
generally regarded as state-of-the-art techniques (Westphal, Gulati and Shortell, 1997);
jumping on such a “bandwagon” may be perceived “as a form of innovation when it is
contrasted with the more passive act of ignoring industry trends or the more active
stance of rejecting them altogether” (Staw and Epstein, 2000, p.528).
Although firms may comply with the institutional demands for more outside directors
so that they would not be noticed as different and consequently singled out for criticism,
they could still employ a number of tactics to neutralize the power of outsiders (Oliver,
1991; Zajac and Westphal, 1996; Westphal, 1999). This can be done, for example, by
appointing individuals who are demographically similar and therefore more sympathetic
to executives (Westphal and Zajac, 1995), or individuals with experience on other
passive boards instead of more active boards (Zajac and Westphal, 1996), or individuals
who are from strategically irrelevant backgrounds without the knowledge base to
effectively participate in strategic decision making and challenge executives’ power
(Carpenter and Westphal, 2001).
The rising number of external members on the board may therefore “occur as the result
of processes that make organizations more similar without necessarily making them
more efficient” (DiMaggio and Powell, 1983, p.147). According to DiMaggio and
Powell (1983), the concept that best captures the process of homogenization is
isomorphism, which is a constraining process that forces one unit in a population to
resemble other units that face the same set of environmental conditions; they identified
three mechanisms through which institutional isomorphic change could occur, each with
its own antecedents:

Coercive isomorphism that stems from political influence and legitimacy;

Mimetic isomorphism resulting from standard responses to uncertainty; and

Normative isomorphism associated with professionalization.
153
It appears that coercive isomorphism may play an important role behind the rising
number of independent directors on the board; coercive isomorphism results from both
formal and informal pressures exerted on organizations by other organizations upon
which they are dependent, in this case the stock exchanges, and by cultural expectations
in the society in which organizations function. Although the ASX follows a voluntary
approach to promote board independence, in which “[i]f a company considers that a
recommendation is inappropriate to its particular circumstances, it has the flexibility not
to adopt it – a flexibility tempered by the requirement to explain why” (Guidelines,
2003, p.5), it is noted that the pressures for isomorphism could be felt as persuasion, or
as invitations to join in collusion, as well as force (DiMaggio and Powell, 1983).
Mimetic isomorphism may also help us understand some of the dynamics in appointing
outsiders on corporate boards. Uncertainty is a powerful force that encourages imitation;
when an organization faces a problem with ambiguous causes or unclear solutions, it
may model itself after similar organizations that it perceives to be more legitimate or
successful (DiMaggio and Powell, 1983). As discussed in Chapter 2, although corporate
governance has become a prominent topic in recent years, there are significant
disagreements in the field of corporate governance research (Murphy and Topyan, 2005;
Gillan, 2006). In Pettigrew (1992), for example, it is noted that corporate governance
lacks any form of coherence, either empirically, methodologically or theoretically, with
only piecemeal attempts to understand and explain how the modern corporation is run.
Tricker (2000) contended that corporate governance did not have an accepted
theoretical base or commonly accepted paradigm, and the term “corporate governance”
was scarcely used until 1980. Murphy and Topyan (2005) maintained that researchers
investigated corporate governance less as a planned, systematic inquiry, and more as a
response to observed problems in corporations. In the situation some firms may decide
to appoint independent outsiders to their boards, as a response to the uncertainty in
corporate governance issues.
Regarding the relationship between board characteristics and firm risk, as shown earlier
in Chapter 4, some agency theorists asserted that conflicts relating to managerial risk
aversion may arise because of portfolio diversification constraints of managerial
income; the conflicts may be heightened when executive compensation is composed
largely of a fixed salary, or where their specific skills are difficult to transfer from one
154
company to another (Fama, 1980; Knoeber, 1986; Baysinger and Hoskisson, 1990;
Prentice, 1993; Vafeas and Theodorou, 1998; Coles et al, 2001; Godfrey et al, 2003).
Risk increasing investment decisions may increase the likelihood of bankruptcy; such a
corporate event could severely damage a manager’s reputation, making it difficult to
find alternative employment (Jensen, 1986; McColgan, 2001). Managerial risk aversion
may also affect the financial policy of the firm. Higher debt is believed to reduce agency
conflicts and carries potentially valuable tax shields (Jensen, 1986; Haugen and
Sendbet, 1986); managers, however, may prefer equity financing because debt increases
the risk of bankruptcy and default (Brennan, 1995).
It is corporate governance mechanisms, including board of directors due to its presumed
independence, that would harmonize these agency conflicts and safeguard invested
capital. The board could ensure that managers are not the sole evaluators of their own
performance, and the board’s legal responsibilities to hire, fire, and reward executives
are seen as key elements in controlling conflicts of interest (Fama and Jensen, 1983;
Williamson, 1984; Baysinger and Hoskisson, 1990; McColgan, 2001).
However, it is found in this research that the level of board independence does not affect
subsequent firm risk. The results indicate that there may not be any significant
difference between the risk preferences of independent directors and executives, or, the
concern over agency conflicts relating to managerial risk aversion may not be justified.
According to Heslin and Donaldson (1999), since independent directors are often
appointed in order to curb the ostensibly radical excesses of management, they may tend
to be risk-averse; the pressure of strong public criticism and threat of legal action for
failure in their fiduciary responsibility may reinforce the risk-aversion of outside
directors (Davis and Thompson, 1994).
Baysinger et al (1991) demonstrated that executives would be more likely to approve
risky proposals such as increasing expenditures on R&D; this probably reflects their
intimate knowledge of the business and resulting confidence that anticipated benefits
would flow from their proposed investments (Lorsch and MacIver, 1989). In contrast,
external board members may have less first-hand familiarity with the business; they
tend to emphasise those factors that are relatively certain, e.g., costs, while being more
155
sceptical about less certain factors, e.g., the chance of anticipated benefits being realised
(Baysinger et al, 1991).
In addition, Hill and Snell (1988), Baysinger et al (1991) and Westphal (1999) reported
that outside directors would lead to increased diversification which could lower the
level of firm risk. Chandler (1994) documented that non-executives might be more
reluctant to make the R&D investments in capital intensive, technologically complex
industries. Daily and Dalton (1994) concluded that outside directors would tend to
prevent performance from dropping to the level that may cause bankruptcy.
Appointing independent directors to corporate boards could become a widespread
practice in Australia, following the release of the ASX Corporate Governance
Guidelines in 2003, in which the monitoring role of independent directors hypothesized
by agency theory is endorsed. The evidence offered in this dissertation, however, casts
doubts on the hope that promoting board independence would improve corporate
performance, and calls for more attention on the actual roles played by independent
directors in public companies.
As introduced in Chapter 2, claims are often made that the Australian market is an
outsider system of corporate governance (Scott, 1997; Weimar and Paper, 1999;
Bradley et al, 1999; Campbell, 2002), in which the main concern is the agency conflicts
between strong managers and weak dispersed shareholders. However, it is found in
Dignam and Galanis (2004) that the Australian listed market is characterized by:

significant blockholders engaged in private rent extraction;

institutional investor powerlessness;

a strong relationship between management and blockholders, which results in a
weak market for corporate control; and

a historic weakness in public and private securities regulation, which allows the
creation and perpetuation of crucial blocks to information flow.
These characteristics suggest that Australia may have been misclassified as an outsider
system; rather, it may tend towards an insider system. Dignam and Galanis (2004,
p.651) commented that “… a central assumption of Australian’s recent reform process –
that the reform initiatives from the UK and the US should be adopted in Australia – may
be incorrect”. Therefore, the regulatory bodies in Australia and other countries should
156
be mindful of the differences between the markets when they look for the solutions to
their corporate governance issues.
Moreover, some academics, for example, Kole (1995), Himmelberg, Hubbard and Palia
(1999) and McColgan (2001), noted that agency conflicts might be heterogeneous
across different firms in different industries and cultures. Himmelberg et al (1999)
referred to differing firms with different contracting environments, which refreshes an
important point from Jensen and Meckling (1976) original theory that no two firms
would have the same “nexus of contacts”. The scope of agency conflicts may differ
from one company to another, as would the effectiveness of governance mechanisms in
reducing them; thus what is required is a more detailed understanding of what makes
these mechanisms important for some companies and ineffective for others (McColgan,
2001).
Tipgos (2007) confirmed that agency theory was the most influential basis for the recent
development in corporate governance; he then questioned the foundation of the theory,
the principal-agent assumption of shareholders and managers. It is illustrated that
shareholders are not owners/principals of the modern public corporations; they are
investors whose interests are defined by their risk-return models. Consequently agency
theory may be inadequate to describe the complex relationships inherent in the public
corporations today.
It could be argued that some types of independent directors may be valuable, while
others may not (Chan and Li, 2008); the argument, however, would lead to the
conclusion that to push for greater board independence may be fruitless, unless the
independent directors have some particular attributes, which are currently unclear, other
than their independence from management. Therefore, for policy-makers, practitioners
and scholars in Australia and elsewhere, the findings reported here suggest that, despite
agency theory’s theoretical logic and policy influence, whether certain corporate
governance practices recommended by the perspective would improve corporate
performance should be empirically tested.
8.4
Limitations and Future Research
Although this thesis tries to address some of the limitations identified in prior research,
such as small sample size, short-term observation of firm performance, limited
157
performance measures and control variables, and simplistic dichotomy of inside and
outside directors as an empirical proxy for board independence, it is still subject to a
number of limitations. For example, as reliance is placed on the disclosures within the
corporate annual reports, certain weaknesses are evidenced in the collection of data on
board members.
The ASX Corporate Governance Council (2003, p.19) acknowledged that “[a]n
independent director is independent of management and free of any business or other
relationship that could materially interfere with – or could reasonably be perceived to
materially interfere with – the exercise of their unfettered and independent judgement.”
This statement notes that there may be other relationships, e.g., friendship and
demographically similarity as explored in Westphal and Zajac (1995), which might
compromise the independence of the directors. Whilst the possible existence of these
impediments to independence may be present and may limit the assessment of
independence in this study, there is a lack of available data to identify such a
relationship.
Moreover, the use of three-year averages may hide the richness of raw data on
performance. The weak results achieved on the tests of hypotheses may indicate that
corporate governance mechanisms may have a complementary or substitution effect on
each other. As argued by Larcker et al (2007), the inconsistent results for the association
between typical measures of corporate governance and performance outcomes may be
partially attributed to the difficulty in generating reliable and valid measures for the
complex construct that is termed “corporate governance”. So the use of a composite
corporate governance index or board independence index may provide stronger
statistical relationships with performance than modelling these mechanisms separately.
Future research could therefore consider running other methods of analysis, such as
confirmatory factor analysis, which have been used by some academics in the U.S. (e.g.,
Molz, 1988; Larcker et al, 2007), and hierarchical and step-wise regressions.
Cho (1998), Hermalin and Weisbach (1998), Himmelberg et al (1999) and Dafinone
(2001) noted that corporate governance involved complex interrelated mechanisms,
such as board composition, dividends, blockholder and managerial shareholdings, and
leverage; this study provides some insights on this topic, e.g., the correlation between
board composition and blockholder ownership. Further research may investigate the
158
substitute and complementary effects of corporate governance variables on
performance, perhaps with the use of structural equation modelling. Although Azim and
Shailer (2006) found some inconsistent evidence for the effects between board
monitoring, auditor monitoring and shareholder monitoring, in Australia the relevant
literature is still limited.
The ASX Guidelines highlights the need to apply recommendations regarding board
composition and structure flexibly. It is unclear whether merely complying with the
recommendations would improve accountability; to address this issue future research
may consider a survey of shareholders, regulation bodies and other stakeholders. It is
also recommended to conduct a survey of directors’ perceptions of the extent to which
they
believe
the
recommendations
could
improve
board
effectiveness
and
accountability.
Another interesting question to be investigated is who would be risk averse,
independent directors or executives. The evidence offered in this project suggests that
there may not be any significant difference between their risk preferences, or, managers
may not be as risk averse as believed by some agency theorists. Currently there appears
to be very little empirical work carried out to deal with this issue, which could involve
an attitudinal survey of independent directors and managers.
8.5
Summary
To address the general research questions raised earlier in the thesis, the univariate and
multivariate analyses in relation to board independence, firm performance and risk are
reviewed. It is concluded that the results do not support the hypotheses developed from
agency theory, stewardship theory and organizational portfolio model. For Australian
listed companies, there does not appear to be a strong relationship between board
independence, and past or subsequent firm performance.
The literature provides some possible reasons why the explanatory power of these
theories with respect to the board independence-financial performance link is so limited.
Some authors argued that appointing outside directors to the board might merely
represent firms’ attempts to comply with institutional pressures, and therefore might not
be necessarily linked to performance; although firms may comply with the demands for
159
more outside directors, they could employ a number of tactics to neutralize the power of
outsiders.
It is discovered that independent directors, in general, do not have any significant
influence on the level of performance risk. The potential explanations for the findings
include that independent directors may not be significantly different from executives in
terms of risk preference, or, the concern over managerial risk aversion may not be
justified.
After the ASX Corporate Governance Council introduced its Guidelines in 2003,
appointing independent directors to corporate boards may have become a popular
practice. This study casts doubts on the hope that promoting board independence would
improve performance; it is recommended that whether certain corporate governance
practices developed from the agency perspective would lead to better performance may
need to be tested. The limitations of this study and future research opportunities are also
discussed.
160
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Appendix 1
Summary of Australian Research
Author
Sample
Variable*
Board Characteristics
Firm Performance
Control
Test
Relevant Findings
Muth and
145 Australian
Board independence
Shareholder wealth, sales
Firm size, firm
Correlations,
A higher board independence
Donaldson (1998)
firms
factor composed of board
growth, and profit
risk, leverage and
rotated factor
factor leads to lower subsequent
size, CEO duality,
performance factor
industry rate of
analysis, ANOVA
shareholder wealth and sales
percentage of NEDs and
composed of profit
return
and multivariate
growth
interest alignment with
margin, ROA and ROE
regressions
owners
Calleja (1999)
83 Australian
Board size, percentage of
Shareholder return
None
firms
NEDs and number of
statistics and OLS
board committees
regressions
Lawrence and
100 Australian
The percentage of
Share price performance,
Board size and firm
Stapledon (1999)
firms
independent directors or
total assets, revenue, net
size
executive directors
profit, EBIT, number of
employees, cash flow,
revenue to assets, net
profit to revenue, revenue
to employees, cash flow
to revenue, and
190
Descriptive
OLS regressions
No significant relation is found
The proportion of independent
directors is negatively related to
the revenue to assets ratio
percentage growth in
assets, revenue, net profit,
EBIT and cash flow
Cotter and
109 Australian
The percentage of
Silverster (2003)
firms
Market value of equity
Firm size
Descriptive
Neither board nor committee
independent directors on
statistics,
independence is significantly
the board, on the audit or
correlations and
associated with firm value
compensation committee,
OLS regressions
and absence of the CEO
from the committee
Tobin’s q and ROA
Descriptive
Tobin’s q is negatively related to
outside directors and CEO
statistics,
the proportion of outside
duality
correlations,
directors, and positively related
ANOVA and
to board size
Kiel and Nicholson
348 Australian
Board size, percentage of
(2003)
firms
None
multivariate
regressions
Bonn et al (2004)
104 Australian
Board size, and
firms and 160
Japanese firms
ROA and MBT
Firm age and
Correlations and
For Australian firms, the
percentage of outside
average age of
multivariate
proportion of outside directors is
directors or female
directors
regressions
positively related to ROA, and
directors
the female ratio is positively
associated with MBT; for
Japanese firms, board size and
the average age of directors are
negatively associated with MBT
191
Balatbat et al
1,316 firm-year
The percentage of
(2004)
observations of
Australian 313
Operating return
Firm age, leverage,
Descriptive
There is no evidence that board
independent directors and
retained ownership,
statistics, and OLS
composition is associated with
CEO duality
and the extent to
and 2SLS
variation in performance; firms
which firm is
regressions
with dual leadership are found to
IPOs
comprised of asset-
perform better
in-place rather than
options
Hutchinson and
310 Australian
The ratio of non-
Gul (2004)
firms
ROE
Firm size, leverage,
Descriptive
executive to executive
prior performance,
statistics,
directors
executive director
correlations and
shareholdings,
OLS regressions
No significant relation is found
managers’
remuneration and
interaction terms
*
This table summarises the variables for board composition and structure as defined in Chapter 2 (p.19), and firm performance and control variables used in relevant
studies
192
Appendix 2
Summary of Overseas Research
Author
Pfeffer (1972)
Sample
80 U.S. firms
Variable*
Board Characteristics
Firm Performance
Board size and percentage
Net income to sales
of inside directors
Control
None
Test
Relevant Findings
Correlations and
Firms that deviate more from an
and net income to
multivariate
optimal inside-outside director
stockholders’
regressions
orientation are less successful when
investment
compared to industry standards than
those that deviate less from an
optimal board composition
Baysinger and
266 U.S. firms
Butler (1985)
Kenser (1987)
250 U.S. firms
The percentage of
Industry-adjusted
independent directors
ROE
None
Descriptive
Firms that had invited relatively
statistics,
more independent directors onto their
correlations and
boards in 1970 enjoyed relatively
cross-lagged
better records of financial
regressions
performance in 1980
Descriptive
The proportion of inside directors is
The percentage of inside
ROA, ROE, EPS,
directors
profit margin, stock
statistics and
positively related to current
market performance
correlations
performance in terms of ROA and
None
and total return to
profit margin, and future
investors
performance measured by total return
to investors
Hermalin and
1,521 firm-year
The departures or
Stock return and
Firm size, number and
193
Descriptive
Poor stock return leads to the
Weisbach (1988)
observations of
additions of inside or
142 U.S. firms
outside directors
earnings change
median tenure of inside
statistics,
resignations of inside directors;
or outside directors,
correlations and
outside directors are added after poor
CEO retirement and
Poisson models
performance measured by both stock
tenure, current board
return and earnings change
composition and
possible vacancies, and
change in the number of
industries
Molz (1988)
50 U.S. firms
Managerial control factor
ROA, ROE and total
consisting of joint
return to shareholders
Correlations,
There was no significant relationship
confirmatory factor
between the degree of managerial
chairman/CEO,
analysis,
control on the board and financial
chairman/CEO tenure,
discriminant
performance
outside-dominated social
analysis, ANOVA
responsibility committee,
and MANOVA
inside versus outside
directors, frequency of
board meetings, salary
ratio of the highest paid to
the second highest-paid
executive, inside and
outside director
stockholdings, and
woman and minority
group representation
194
None
Fosberg (1989)
127 pairs of U.S.
The percentage of outside
ROE, sales, expenses,
firms
directors
number of
None
Paired sample
There is no relationship between the
analysis
proportion of outside directors and
employees, sales to
managerial performance
total assets, expenses
to total assets and
number of employees
to total assets
Schellenger et al
526 U.S. firms
(1989)
The percentage of outside
ROA, ROE,
directors
None
Descriptive
ROA and risk-adjusted shareholder
shareholder return,
statistics and
return correlate positively with the
and risk-adjusted
correlations
percentage of outside directors
Descriptive
The appointments of an outside
statistics,
director are accompanied by positive
frequency
excess returns, even though most
distribution, and
boards are dominated by outsiders
parametric and
before the appointments
shareholder return
Rosenstein and
1,251 outside
The appointments of only
Stock abnormal
Wyatt (1990)
director
one outside director and
returns
announcements
no inside directors
None
nonparametric tests
Hermalin and
1,521 firm-year
The percentage of inside
Weisbach (1991)
observations of
or outside directors
Tobin’s q and EBIT
142 U.S. firms
195
Firm size, R&D and
OLS regressions
There does not appear to be a relation
advertising expenses,
between board composition and firm
CEO tenure, median
performance, although firms with
tenures of insiders and
longer median tenures of outsiders
outsiders, and family
tend to have higher performance
company control
measured as q
Pearce II and
119 U.S. firms
Zahra (1992)
The percentage of
ROA, ROE, EPS and
affiliated or independent
net profit margin
Firm size
directors
Canonical analysis,
Effective past performance is
ANOVA, and
associated with larger boards and
MANOVA
lower outsiders’ representation; large
boards and high representation of
outsiders are associated positively
with future performance
Daily and Dalton
100 U.S. firms
(1992)
The number and
ROA, ROE and
percentage of outside
price/earnings ratio
None
Descriptive
There is a positive relation between
statistics,
total numbers and proportion of
directors, and CEO
correlations,
outside directors and firm
duality
contingency
performance measured by
analysis and
price/earnings ratio
MANOVA
Daily and Dalton
186 U.S. firms
(1993)
The number and
ROA, ROE and
Firm age and industry
Descriptive
The results demonstrate a positive
percentage of outside
price/earnings ratio
control
statistics,
relationship between total numbers
directors, and CEO
correlations,
and proportion of outside directors
duality
contingency
and financial performance
analysis and
MANOVA
Yermack (1996)
3,438 firm-year
Board size and percentage
Tobin’s q, ROA,
Firm size, profitability,
Descriptive
In the OLS model there is a negative
observations of
of outside directors
sales to assets and
investment and growth
statistics, OLS
association between the percentage
return on sales
opportunities,
regressions, and
of outside directors and q; in the
diversification, insider
fixed-effect, Probit
fixed-effect model a positive relation
ownership, stockholder-
and Poisson
is found. Firms are valued more
452 U.S. firms
196
directors, CEO duality,
models
and industry and
highly when the CEO and chairman
positions are separated
individual year controls
Agrawal and
383 U.S. firms
Knoeber (1996)
The percentage of outside
Tobin’s q
directors
Rosenstein and
170 inside
The appointments of one
Stock abnormal
Wyatt (1997)
director
or more inside directors
returns
announcements
and not outside directors
Klein (1998)
485 U.S. firms
Firm size,
OLS and 2SLS
Fewer outside directors lead to
diversification,
regressions
improved firm performance or, better
regulated firms and
performance may lead to fewer
founding CEOs
outsiders on the board
None
Descriptive
The market reaction to the
statistics,
announcements is negative when
frequency
inside directors own less than 5% of
distribution, and
the firm’s stock, and positive when
parametric and
their ownership level is between 5%
nonparametric tests
and 25%
The percentage of inside
ROA, stock abnormal
Firm risk, director
Descriptive
There are positive linkages between
directors
returns, Jensen
shareholdings, director
statistics and OLS
the percentages of inside directors on
Productivity and
quality, R&D,
regressions
finance and investment committees
market returns
relationship investing,
and performance measures; firms
capital expenditures,
increasing inside director
and CEO influence
representation on these committees
experience higher abnormal returns
than firms decreasing the percentage
of inside directors on these two
committees
197
Barnhart and
321 U.S. firms
Rosenstein
Board size and percentage
Tobin’s q
of independent directors
(1998)
Firm size, leverage,
Descriptive
There may be a curvilinear relation
R&D and advertising
statistics,
between the proportion of
expenses, institutional
correlations, and
independent directors and firm
ownership and industry
OLS and 3SLS
performance
control
regressions
None
Meta-analyses
Dalton et al
228 samples of
The percentage of inside,
Accounting and
(1998)
U.S. firms
outside, affiliate,
market performance
effect on accounting and market
independent or
indicators
performance indicators; there is no
Board composition has virtually no
interdependent directors,
relationship between board
and chairman leadership
leadership structure and firm
performance
Vafeas and
250 U.K. firms
The percentage of
ROA, MBT, market
ROA, sales, leverage,
Descriptive
There is no significant link between
Theodorou
independent or “grey”
to book value of
R&D expenses,
statistics and OLS
board characteristics and firm
(1998)
directors on the board,
equity, and stock
dividend yield and
regressions
performance
percentage of NEDs on
return
industry control
the audit, nomination or
remuneration committee,
and chairman
independence
Denis and Sarin
4,563 firm-year
Board size and percentage
Market-adjusted
Firm size, firm age,
Descriptive
Large changes in outside
(1999)
observations of
of independent directors
stock return
firm risk, leverage,
statistics,
representation and board size are
growth opportunities,
correlations,
associated with CEO replacements
new CEOs, control
frequency
and corporate control threats, and
583 U.S. firms
198
threats, and firms in
distribution, and
stock return appears to be higher
which founders left
OLS regressions
among firms that subsequently
increase the proportion of
independent directors
Bhagat and
934 U.S. firms
Black (2000)
Board size, and board
Tobin’s q, ROA,
Firm size, CEO
Descriptive
There is a correlation between poor
independence level
market-adjusted stock
ownership, outside
statistics, and OLS
performance and subsequent increase
proxied by the percentage
price return and sales
director ownership,
and 3SLS
in board independence
of independent directors
to assets
blockholder ownership,
regressions
minus percentage of
firm and industry sales
inside directors
growth, and industry
control
Coles et al
144 U.S. firms
(2001)
The percentage of
EVA and MVA
independent directors and
Firm size, blockholder
Descriptive
There is a positive contribution of
ownership, and industry
statistics,
CEO duality to EVA, and a negative
correlations and
influence of independent directors
multivariate
and CEO salary sensitivity on MVA
CEO duality
regressions
Dehaene et al
122 Belgian
Board size, percentage of
Industry-adjusted
(2001)
firms
outside directors and CEO
ROA and ROE
None
duality
Descriptive
There is a positive relation between
statistics and
the number of outside directors and
multivariate
ROE; however, where the functions
regressions
of CEO and chairman are combined,
ROA appears higher
Hossain et al
633 firm-year
Board size, percentage of
(2001)
observations of
independent directors and
Tobin’s q
199
Firm size, leverage,
Descriptive
The proportion of independent
diversification and
statistics,
directors has a positive influence on
New Zealand
CEO duality
growth opportunities
firms
correlations and
firm performance
OLS regressions
Singh and
236 firm-year
Board size, and
Asset turnover and
Firm size, leverage,
Descriptive
Boar composition does not seem to
Davidson III
observations of
percentage of inside,
SG&A expenses to
managerial ownership,
statistics and
significantly influence agency costs;
(2003)
U.S. firms
affiliated or independent
sales
blockholder ownership
multivariate
boar size is negatively related to asset
and industry
regressions
turnover, but unrelated to
directors
discretionary expenses
Tobin’s q
Firm size, ROA, capital
Descriptive
For firms with prior average q less
unrelated directors and
structure, blockholder
statistics and fixed-
than one, there is a positive
CEO duality
ownership, intangibles
effect models
correlation between the proportion of
Panasian et al
274 Canadian
Board size, percentage of
(2003)
firms
to total assets, and
unrelated directors and performance
investment
opportunities
Anderson and
2,686 firm-year
The percentage of
Reeb (2004)
observations of
403 U.S. firms
Peng (2004)
Tobin’s q
Firm size, firm age,
Descriptive
Among firms with founding-family
independent, affiliated or
firm risk, ROA and
statistics, fixed-
ownership, there is a positive relation
family directors
investment
effect models and
between the proportion of
opportunities
2SLS regressions
independent directors and q
1,211 firm-year
The percentage of
ROE and sales
Firm size, firm age,
Descriptive
Outside directors do make a
observations of
affiliated or non-affiliated
growth
prior performance,
statistics,
difference in firm performance, if
405 Chinese
outside directors and CEO
inside or outside
correlations, and
such performance is measured by
firms
duality
director ownership, and
weighted
sales growth; they have little impact
state ownership and
generalized least-
on financial performance such as
200
state directors
squares and
ROE
proportional
hazards regressions
Dulewicz and
86 U.K. firms
Herbert (2004)
Board size, NED presence
CFROTA and sales
factor consisting of the
turnover
None
Descriptive
The number of executive directors is
statistics,
positively associated with CFROTA,
number and percentage of
correlations and
and the number and proportion of
NEDs in relation to board
rotated factor
NEDs are negatively related to sales;
size or executive
analysis
companies with a chairman who is
directors, and chairman
not the CEO or is a NED tend to
independence factor
perform better in terms of CFROTA
consisting of nonexecutive chairman versus
executive chairman
Randoy and
294 firm-year
Board size and percentage
Jenssen (2004)
observations of
of outside directors
Tobin’s q and ROE
98 Swedish firms
Firm size, firm age,
Correlations and
Among firms facing high levels of
leverage, blockholder
OLS regressions
product market competition, there is
ownership and foreign
a negative relation between the
exchange listings
percentage of outside directors and
firm performance measured as q and
ROE; there is a positive relation
between the percentage of outsiders
and q among firms facing low levels
of product market competition
Chin et al (2004)
426 firm-year
Board size and percentage
Tobin’s q
None
201
Descriptive
No significant relation is found
observations of
of outside directors
statistics,
New Zealand
correlations and
firms
OLS regressions
Chang and Leng
231 firm-year
The percentage of NEDs,
ROE and dividend
(2004)
observations of
NED chairman on the
payout
77 Malaysia
audit committee and CEO
firms
duality
1,648 firm-year
Board size, percentage of
ROA, ROE, and
observations of
independent NEDs,
MBT
412 Hong Kong
firms
Chen et al (2005)
None
Fixed-effect
Board characteristics do not have any
models
influence on firm performance
Firm size, leverage and
Descriptive
Board composition has little impact
sales growth
statistics,
on firm performance; there is a
presence of audit
frequency
negative association between CEO
committee, outsider-
distribution and
duality and MBT
dominated board and
fixed-effect models
CEO duality
Krivogorsky
87 continental
The percentage of inside
(2006)
European firms
directors, independent
Firm size, firm age,
Descriptive
The percentage of independent
leverage and growth
statistics,
directors has a positive correlation
directors, or scholars and
correlations and
with ROA and ROE
CEO duality
OLS regressions
Luan and Tang
259 Taiwanese
Independent director
(2007)
firms
assignment
Choi et al (2007)
1,834 firm-year
Board size, percentage of
ROA, ROE and MBT
ROE
Tobin’s q
Firm size, prior
Descriptive
After controlling for a firm’s past
performance and
statistics,
performance, independent director
absorptive capacity,
correlations and
appointments have a positive impact
OLS regressions
on a firm’s performance
Descriptive
The results indicate that outside
Firm size, firm age,
202
observations of
outside, independent or
leverage, chaebol
statistics,
directors have significant and
South Korea
affiliated directors, and
affiliation, depository
correlations and
positive effects on firm performance;
firms
foreign outside directors
receipt, exports to sales,
random-effect
the effects are stronger for
R&D expenditure to
models
independent directors than for “grey”
sales, ROA, beta, and
directors who may have professional
industry and individual
ties with the firm
year controls
Chan and Li
(2008)
*
200 U.S. firms
Board size, committee
Tobin’s q
Firm size, number of
Descriptive
The independence of audit committee
size, percentage of
employees, director’s
statistics and
results in higher firm value when a
independent or expert-
age and tenure, number
simultaneous
majority of expert-independent
independent directors on
of other directorships,
equation models
directors serve on the board; the
the board or audit
Fortune 500 rank, ROA
presence of CEO duality is related to
committee, and CEO
and holding period
negative q
duality
return
This table summarises the variables for board composition and structure as defined in Chapter 2 (p.19), and firm performance and control variables used in relevant
studies
203
Appendix 3
Theories and Hypotheses in Prior Research
Author
Pfeffer (1972)
Theory
Organizational theories
Hypothesis*
Organizations that deviate relatively more from a
Conclusion
The hypothesis is supported
preferred inside-outside director orientation should be
relatively less successful when compared to industry
standards than those that deviate less from a preferred
board composition
Baysinger and Butler
Legalistic view, agency theory and
(1985)
transaction costs, and strategy
board composition would be inappropriate in an economy
formulation and implementation
where firms are different and are continually changing
Kenser (1987)
Hermalin and
Financial dependence perspective
None
Weisbach (1988)
Molz (1988)
None
A public policy prescription in favour of any particular
The proportion of inside directors serving on a firm’s
Higher inside representation is associated with greater
board is positively related to organizational performance
profitability and higher asset utilization
The CEO succession process and firm performance will
The findings are consistent with both hypotheses
affect board composition
None
Firms with managerial dominated boards will have
The hypothesis is not supported
superior financial performance
Fosberg (1989)
Schellenger et al
Agency theory
Agency theory
Increasing the percentage of outside directors on the
Agency theory could not be confirmed by the analysis in
board enhances management performance
this study
None
The findings provides support for advocates of outsider
(1989)
representation on the boards of corporations
204
Rosenstein and Wyatt
None
None
The addition of an outside director increases firm value;
(1990)
outside directors are selected, on average, in the interests
of shareholders
Hermalin and
Agency theory
None
There appears to be no relation between board
Weisbach (1991)
composition and firm performance
Pearce II and Zahra
Strategic contingency model (i.e.,
(1992)
resource dependence theory)

Poor past performance is associated positively with
The strategic contingency approach is a viable means of
small board size and low outsider’ representation;
studying board of directors’ composition
and

Large board size and higher representation of outside
directors on the board are associated positively with
future corporate financial performance
Daily and Dalton
None

(1992)

CEO duality will be associated with lower firm
There is modest support for the proposition that firms
performance;
with greater numbers of outside directors outperform
Fewer total outside directors will be associated with
those with fewer outside directors
lower firm performance; and

The proportion of outside directors will be associated
with higher firm performance
Daily and Dalton
None

(1993)

CEO duality will be associated with lower firm
It seems that firms adhering to suggested board reforms
performance;
realize performance advantages
Fewer total outside directors will be associated with
lower firm performance; and

Proportion of outside directors will be associated
205
with higher firm performance
Yermack (1996)
None
None
The effect of the board composition variable is
ambiguous and appears sensitive to the inclusion of firm
effects in the model
Agrawal and
Agency theory
None
The negative effect of outsiders on the board on firm
Knoeber (1996)
performance suggests that firms tend to have too many
outside directors
Rosenstein and Wyatt
Agency theory
None
The expected benefits of an inside director’s expert
(1997)
knowledge outweigh the expected costs of managerial
entrenchment only when managerial and outside
shareholder interests are closely aligned
Muth and Donaldson
Agency theory, stewardship theory
(1998)
and resource dependence theory


Where board members are more independent of
Agency theory predictions relating to board independence
management, company performance will be higher
and firm performance are not upheld while those of
(agency theory); and
stewardship theory are supported
Boards with a lower level of board independence
lead to higher company performance (stewardship
theory)
Klein (1998)
Agency theory
None
Inside directors provide valuable information to boards
about the firms’ long-term investment decisions
Barnhart and
None
None
There may be a curvilinear relation between the
Rosenstein (1998)
proportion of independent directors and firm
performance; board composition, managerial ownership
206
and performance may be jointly determined
Dalton et al (1998)
Agency theory, stewardship theory
None
The findings provide support for neither agency theory
and resource dependence theory
Vafeas and
Agency theory
nor stewardship theory

Theodorou (1998)

There is a positive association between the fraction
The results are consistent with governance needs varying
of non-executive directors on the board and firm
across firms, and contrast the notion that uniform board
value;
structures should be mandated
There is a positive association between the split in
the roles of the CEO and the chairman of the board
(dual leadership structure) and firm value; and

There is a positive association between the fraction
of non-executive directors serving on monitoring
committees and firm value
Calleja (1999)
None
None
The small sample size made it difficult to reach any firm
conclusions
Lawrence and
Agency theory
None
Independent directors did not appear to have added value
Stapledon (1999)
Denis and Sarin
to Australian largest listed companies
None
None
The predominant factors associated with ownership and
(1999)
control changes appear to be top executive changes, prior
stock price performance and corporate control threats
Bhagat and Black
None
None
There is a reasonably strong correlation between poor
(2000)
performance and subsequent increase in board
independence; there is no evidence that greater board
207
independence leads to improved firm performance
Coles et al (2001)
Agency theory and stewardship

theory

Firms that separate the positions of CEO and chair of
While there is evidence to support that firms may use
the board will have better performance than will
governance packages to deal with agency issues, further
firms that join the two positions; and
research could provide important evidence on these
Firms that select higher proportions of independent
issues by focusing on examining a more refined,
outsiders to serve on their board of directors will
industry-level context
have better performance than will firms with a higher
proportion of insides on the board
Dehaene et al (2001)
Agency theory
None
Distinct corporate governance models for companies
exist because they operate in different business context;
comparing these models in isolation can lead to futile
conclusions
Hossain et al (2001)
Agency theory
None
The legislation, directly designed to increase the fiduciary
responsibilities of directors, did not seem to enhance or
weaken the positive relationship between outside board
representation and firm performance
Cotter and Silverster
Agency theory
(2003)
Kiel and Nicholson
Agency theory, stewardship theory
(2003)
and resource dependence theory
There is a positive relationship between the independence
There is no evidence that firm value is enhanced through
of boards of directors (and their monitoring committees)
stronger monitoring committee or full board
and firm value
independence


Board size is positively correlated with firm
The arguments put forward by stewardship theory are
performance;
supported
The proportion of outside directors is uncorrelated
208
with firm performance; and

Separation of chairman and CEO is uncorrelated
with firm performance
Singh and Davidson
Agency theory
None
Independent outsiders on a board do not appear to protect
III (2003)
Panasian et al (2003)
the firm from agency costs
Agency theory
None
The increase of outside directors is most beneficial for
firms that are most likely to have agency problems
Bonn et al (2004)
Agency theory and resource

dependence theory

Board size is positively associated with firm
There may be different agency relationships in different
performance in Australian firms;
countries
Board size is negatively associated with firm
performance in Japanese firms;

The proportion of outside directors on the board is
positively associated with firm performance for
Australian firms; and

The proportion of outside directors on the board is
negatively associated with firm performance for
Japanese firms
Balatbat et al (2004)
Agency theory
None
The circumstances faced by IPO firms may frequently
render more traditional corporate governance practices
irrelevant, especially as they relate to monitoring
managers who provide highly firm-specific human capital
as a key component of the firm’s value
209
Hutchinson and Gul
Agency theory
None
The results demonstrate the importance of corporate
(2004)
governance for firms with more growth opportunities
Anderson and Reeb
Agency theory and stewardship
(2004)
theory


The greater the fraction of independent directors in
The findings highlight the importance of independent
public firms with founding-family ownership, the
directors in mitigating conflicts between shareholder
better the performance of the firm;
groups and imply that the interests of minority investors
At low (high) levels of family board representation
are best protected when, through independent directors,
relative to independent directors, the higher the ratio
they have power relative to family shareholders
of family directors to independent directors, the
better (poorer) the performance of the firm; and

The greater the fraction of affiliated directors on the
board in public firms with founding-family
ownership, the poorer (agency theory) better
(stewardship theory) the performance of the firm
Peng (2004)
Agency theory, resource

dependence theory and
institutional theory

Greater representation on the board by outside
While agency theory hypotheses typically fail to be
directors has a positive effect on firm performance;
supported in emerging economies, resource dependence
Greater representation on the board by outside
and institutional claims tend to be substantiated
directors has a negligible effect on firm performance;

There is a positive relationship between poor prior
performance of the firm in a previous year and the
appointment of outside directors to the board in a
given year;

There is a positive relationship between a young firm
age in a previous year and the appointment of outside
210
directors to the board in a given year; and

The strength of the relationship between (a) poor
prior performance, (b) large firm size, and (c) young
firm age on one hand and the appointment of outside
directors to the board on the other hand will decrease
over time
Dulewicz and
Agency theory, stewardship theory
Herbert (2004)
and stakeholder theory

Where the roles of chairman and CEO are separated
The results generally provide scant support for the main
(agency theory) combined (stewardship theory),
theories of board of directors
company performance will be higher;

A higher proportion of outside directors (agency
theory) executive directors (stewardship theory) on
the board leads to higher company performance;

Larger (agency theory) smaller (stewardship theory)
boards will have higher company performance; and

Where board members are more (agency theory) less
(stewardship theory) independent of management,
company performance will be higher
Randoy and Jenssen
Agency theory and stewardship
(2004)
theory


Board independence has a negative influence on firm
Board independence is less relevant or even redundant in
performance in firms that face a high level of product
highly competitive industries, where the firm is already
market competition, and
monitored by a competitive product market; board
Board independence has a positive influence on firm
independence enhances firm performance among
performance in firms that face a less competitive
companies facing less competitive product market
product market
211
Chin et al (2004)
Agency theory


There is a positive correlation between the
There does not seem to be a rise-fall relationship in
percentage of outside directors and firm
performance relating to the percentage of outside
performance; and
directors, nor to board size
There is an inverse relationship between board size
and firm performance
Chang and Leng
Agency theory
None
Several corporate governance variables do not have any
(2004)
impact on corporate performance in Malaysia, including
the proportion of NEDs, CEO duality and NED chairman
of the audit committee
Chen et al (2005)
Agency theory
None
More effort is needed in order to ensure the true
independence of non-executive directors and that they are
able to perform an adequate monitoring function
Krivogorsky (2006)
Agency theory


The proportion of independent directors and scholars
The theoretical predictions of agency theory on a positive
on the board has a strong effect on the profitability of
relationship between outside (independent) director and
the company;
firm performance are also applicable in the European
The proportion of inside directors does not have a
environment
strong effect on the profitability of the company; and

power concentration (CEO=Chairman) negatively
affects the supervisory ability of the board and, thus,
the profitability of the company
Luan and Tang
Agency theory, stewardship theory
(2007)
and resource dependence theory

Ceteris paribus, appointing independent outside
The findings suggest that firms that chose to appoint
directors on the board has a positive effect on firm
independent outside directors have a higher corporate
212
performance; and

profit
Absorptive capacity of the firms has a positive effect
on firm performance when appointing independent
outside directors on the board
Choi et al (2007)
Agency theory
Firm Performance increases with board independence
The presence of independent outsiders is critical in an
emerging market that is subject to external shocks and
that may lack sufficient liquidity as well as indigenous
institutional infrastructure
Chan and Li (2008)
*
Agency theory
Independence of audit committee does not affect firm
The presence of expert-independent directors on the
value
board and audit committee enhances firm value
This table exhibits the hypotheses explicitly stated in the studies, regarding the relationships between board composition and structure as defined in Chapter 2 (p.19),
and firm performance
213
Appendix 4
Pearson Correlations: 2000-2003
Sample Period:
2000-2003
Included Observations:
243
Variable
Correlation
t-Statistic
Probability
FIND
FIND
1.000000
-----
-----
ACIND
FIND
0.752380
17.73122
0.0000
ACIND
ACIND
1.000000
-----
-----
NCIND
FIND
0.441090
7.629908
0.0000
NCIND
ACIND
0.367563
6.135615
0.0000
NCIND
NCIND
1.000000
-----
-----
RCIND
FIND
0.622563
12.35004
0.0000
RCIND
ACIND
0.551664
10.26792
0.0000
RCIND
NCIND
0.523030
9.526538
0.0000
RCIND
RCIND
1.000000
-----
-----
CMIND
FIND
0.531313
9.736099
0.0000
CMIND
ACIND
0.357522
5.943042
0.0000
CMIND
NCIND
0.265020
4.266787
0.0000
CMIND
RCIND
0.440519
7.617651
0.0000
CMIND
CMIND
1.000000
-----
-----
ROA1
FIND
-0.012554
-0.194902
0.8456
ROA1
ACIND
0.076213
1.186596
0.2366
ROA1
NCIND
0.038183
0.593186
0.5536
ROA1
RCIND
-0.005512
-0.085569
0.9319
ROA1
CMIND
-0.070382
-1.095334
0.2745
ROA1
ROA1
1.000000
-----
-----
ROE1
FIND
0.071257
1.109022
0.2685
ROE1
ACIND
0.059075
0.918697
0.3592
ROE1
NCIND
0.046069
0.715949
0.4747
ROE1
RCIND
0.020257
0.314545
0.7534
214
ROE1
CMIND
0.003849
0.059747
0.9524
ROE1
ROA1
0.312705
5.110788
0.0000
ROE1
ROE1
1.000000
-----
-----
SHRET1
FIND
-0.063596
-0.989275
0.3235
SHRET1
ACIND
-0.049272
-0.765830
0.4445
SHRET1
NCIND
-0.125631
-1.965900
0.0505
SHRET1
RCIND
-0.155481
-2.443429
0.0153
SHRET1
CMIND
-0.076792
-1.195667
0.2330
SHRET1
ROA1
-0.127047
-1.988416
0.0479
SHRET1
ROE1
-0.089536
-1.395585
0.1641
SHRET1
SHRET1
1.000000
-----
-----
TOBQ1
FIND
0.012342
0.191612
0.8482
TOBQ1
ACIND
-0.069391
-1.079844
0.2813
TOBQ1
NCIND
-0.095079
-1.482743
0.1394
TOBQ1
RCIND
0.031365
0.487150
0.6266
TOBQ1
CMIND
0.006217
0.096509
0.9232
TOBQ1
ROA1
-0.366648
-6.117966
0.0000
TOBQ1
ROE1
-0.160041
-2.516939
0.0125
TOBQ1
SHRET1
0.043346
0.673538
0.5013
TOBQ1
TOBQ1
1.000000
-----
-----
SIZE
FIND
0.134638
2.109356
0.0359
SIZE
ACIND
0.221020
3.518154
0.0005
SIZE
NCIND
0.332164
5.466970
0.0000
SIZE
RCIND
0.302538
4.927567
0.0000
SIZE
CMIND
0.001162
0.018043
0.9856
SIZE
ROA1
0.191112
3.022564
0.0028
SIZE
ROE1
0.082249
1.281182
0.2014
SIZE
SHRET1
-0.109309
-1.707158
0.0891
SIZE
TOBQ1
-0.226900
-3.616774
0.0004
215
SIZE
SIZE
1.000000
-----
-----
BLOCK
FIND
-0.235016
-3.753562
0.0002
BLOCK
ACIND
-0.194588
-3.079688
0.0023
BLOCK
NCIND
-0.099272
-1.548766
0.1228
BLOCK
RCIND
-0.179168
-2.827188
0.0051
BLOCK
CMIND
-0.112494
-1.757532
0.0801
BLOCK
ROA1
0.098244
1.532577
0.1267
BLOCK
ROE1
0.142809
2.239950
0.0260
BLOCK
SHRET1
0.013232
0.205433
0.8374
BLOCK
TOBQ1
-0.056240
-0.874467
0.3827
BLOCK
SIZE
0.050692
0.787958
0.4315
BLOCK
BLOCK
1.000000
-----
-----
SEGMT
FIND
0.178790
2.821021
0.0052
SEGMT
ACIND
0.132247
2.071221
0.0394
SEGMT
NCIND
0.274461
4.430932
0.0000
SEGMT
RCIND
0.193908
3.068509
0.0024
SEGMT
CMIND
-0.005431
-0.084309
0.9329
SEGMT
ROA1
0.166541
2.622023
0.0093
SEGMT
ROE1
0.066234
1.030499
0.3038
SEGMT
SHRET1
-0.100931
-1.574920
0.1166
SEGMT
TOBQ1
-0.172673
-2.721477
0.0070
SEGMT
SIZE
0.463862
8.128477
0.0000
SEGMT
BLOCK
-0.110906
-1.732414
0.0845
SEGMT
SEGMT
1.000000
-----
-----
DIVR1
FIND
0.048966
0.761068
0.4474
DIVR1
ACIND
0.104408
1.629755
0.1045
DIVR1
NCIND
0.145403
2.281512
0.0234
DIVR1
RCIND
0.179599
2.834212
0.0050
DIVR1
CMIND
0.062330
0.969501
0.3333
DIVR1
ROA1
0.327495
5.380822
0.0000
216
DIVR1
ROE1
0.163276
2.569198
0.0108
DIVR1
SHRET1
-0.135804
-2.127953
0.0344
DIVR1
TOBQ1
-0.229225
-3.655879
0.0003
DIVR1
SIZE
0.236187
3.773373
0.0002
DIVR1
BLOCK
0.037580
0.583805
0.5599
DIVR1
SEGMT
0.165504
2.605242
0.0098
DIVR1
DIVR1
1.000000
-----
-----
AGE
FIND
0.136348
2.136643
0.0336
AGE
ACIND
0.121245
1.896216
0.0591
AGE
NCIND
0.134395
2.105475
0.0363
AGE
RCIND
0.098822
1.541673
0.1245
AGE
CMIND
0.006702
0.104043
0.9172
AGE
ROA1
0.135286
2.119697
0.0351
AGE
ROE1
0.071293
1.109583
0.2683
AGE
SHRET1
0.000659
0.010226
0.9918
AGE
TOBQ1
-0.206636
-3.278609
0.0012
AGE
SIZE
0.194783
3.082895
0.0023
AGE
BLOCK
-0.068960
-1.073100
0.2843
AGE
SEGMT
0.278588
4.503129
0.0000
AGE
DIVR1
0.186591
2.948445
0.0035
AGE
AGE
1.000000
-----
-----
Log(MCAP1)
FIND
0.215770
3.430458
0.0007
Log(MCAP1)
ACIND
0.204916
3.250120
0.0013
Log(MCAP1)
NCIND
0.434249
7.483795
0.0000
Log(MCAP1)
RCIND
0.347302
5.749455
0.0000
Log(MCAP1)
CMIND
0.054389
0.845592
0.3986
Log(MCAP1)
ROA1
0.274635
4.433977
0.0000
Log(MCAP1)
ROE1
0.114678
1.792106
0.0744
Log(MCAP1)
SHRET1
-0.136846
-2.144589
0.0330
Log(MCAP1)
TOBQ1
-0.072846
-1.133889
0.2580
217
Log(MCAP1)
SIZE
0.682392
14.49218
0.0000
Log(MCAP1)
BLOCK
-0.007428
-0.115323
0.9083
Log(MCAP1)
SEGMT
0.554557
10.34559
0.0000
Log(MCAP1)
DIVR1
0.298028
4.846890
0.0000
Log(MCAP1)
AGE
0.294663
4.786941
0.0000
Log(MCAP1)
Log(MCAP1)
1.000000
-----
-----
GEAR1
FIND
0.099450
1.551574
0.1221
GEAR1
ACIND
0.098929
1.543360
0.1241
GEAR1
NCIND
0.089434
1.393982
0.1646
GEAR1
RCIND
0.112031
1.750202
0.0814
GEAR1
CMIND
0.081559
1.270372
0.2052
GEAR1
ROA1
0.095074
1.482669
0.1395
GEAR1
ROE1
0.081022
1.261956
0.2082
GEAR1
SHRET1
-0.014963
-0.232319
0.8165
GEAR1
TOBQ1
-0.085129
-1.326366
0.1860
GEAR1
SIZE
0.113373
1.771441
0.0778
GEAR1
BLOCK
0.024304
0.377409
0.7062
GEAR1
SEGMT
-0.038995
-0.605822
0.5452
GEAR1
DIVR1
0.081045
1.262312
0.2081
GEAR1
AGE
0.054459
0.846689
0.3980
GEAR1
Log(MCAP1)
0.153891
2.417837
0.0164
GEAR1
GEAR1
1.000000
-----
-----
EQED
FIND
-0.146766
-2.303371
0.0221
EQED
ACIND
-0.104789
-1.635771
0.1032
EQED
NCIND
-0.149318
-2.344318
0.0199
EQED
RCIND
-0.103623
-1.617373
0.1071
EQED
CMIND
-0.072204
-1.123845
0.2622
EQED
ROA1
-0.012381
-0.192223
0.8477
EQED
ROE1
0.183276
2.894227
0.0041
EQED
SHRET1
0.100503
1.568169
0.1182
218
EQED
TOBQ1
0.218672
3.478904
0.0006
EQED
SIZE
-0.179533
-2.833130
0.0050
EQED
BLOCK
0.243215
3.892606
0.0001
EQED
SEGMT
-0.183199
-2.892973
0.0042
EQED
DIVR1
-0.034604
-0.537522
0.5914
EQED
AGE
-0.185882
-2.936853
0.0036
EQED
Log(MCAP1)
-0.257292
-4.133399
0.0000
EQED
GEAR1
-0.039258
-0.609918
0.5425
EQED
EQED
1.000000
-----
-----
RISK1
FIND
-0.062750
-0.976068
0.3300
RISK1
ACIND
-0.045748
-0.710939
0.4778
RISK1
NCIND
-0.104178
-1.626130
0.1052
RISK1
RCIND
-0.131980
-2.066969
0.0398
RISK1
CMIND
-0.076923
-1.197711
0.2322
RISK1
ROA1
-0.170313
-2.683162
0.0078
RISK1
ROE1
-0.118134
-1.846860
0.0660
RISK1
SHRET1
0.977674
72.22970
0.0000
RISK1
TOBQ1
0.045601
0.708659
0.4792
RISK1
SIZE
-0.102204
-1.594979
0.1120
RISK1
BLOCK
0.030118
0.467769
0.6404
RISK1
SEGMT
-0.076942
-1.198007
0.2321
RISK1
DIVR1
-0.169281
-2.666428
0.0082
RISK1
AGE
-0.020402
-0.316786
0.7517
RISK1
Log(MCAP1)
-0.131366
-2.057178
0.0407
RISK1
GEAR1
-0.046672
-0.725338
0.4689
RISK1
EQED
0.109994
1.717998
0.0871
RISK1
RISK1
1.000000
-----
-----
219
Appendix 5
Pearson Correlations: 2003-2006
Sample Period:
2003-2006
Included Observations:
243
Variable
Correlation
t-Statistic
Probability
FIND
FIND
1.000000
-----
-----
ACIND
FIND
0.752380
17.73122
0.0000
ACIND
ACIND
1.000000
-----
-----
NCIND
FIND
0.441090
7.629908
0.0000
NCIND
ACIND
0.367563
6.135615
0.0000
NCIND
NCIND
1.000000
-----
-----
RCIND
FIND
0.622563
12.35004
0.0000
RCIND
ACIND
0.551664
10.26792
0.0000
RCIND
NCIND
0.523030
9.526538
0.0000
RCIND
RCIND
1.000000
-----
-----
CMIND
FIND
0.531313
9.736099
0.0000
CMIND
ACIND
0.357522
5.943042
0.0000
CMIND
NCIND
0.265020
4.266787
0.0000
CMIND
RCIND
0.440519
7.617651
0.0000
CMIND
CMIND
1.000000
-----
-----
ROA2
FIND
-0.046246
-0.718706
0.4730
ROA2
ACIND
-0.003196
-0.049621
0.9605
ROA2
NCIND
-0.018568
-0.288305
0.7734
ROA2
RCIND
-0.035684
-0.554320
0.5799
ROA2
CMIND
-0.078351
-1.220083
0.2236
ROA2
ROA2
1.000000
-----
-----
ROE2
FIND
-0.054760
-0.851385
0.3954
ROE2
ACIND
-0.045002
-0.699333
0.4850
ROE2
NCIND
-0.028291
-0.439366
0.6608
ROE2
RCIND
-0.023827
-0.370005
0.7117
220
ROE2
CMIND
-0.065815
-1.023942
0.3069
ROE2
ROA2
0.328017
5.390445
0.0000
ROE2
ROE2
1.000000
-----
-----
SHRET2
FIND
-0.022836
-0.354610
0.7232
SHRET2
ACIND
-0.040670
-0.631896
0.5281
SHRET2
NCIND
-0.051806
-0.805329
0.4214
SHRET2
RCIND
-0.032458
-0.504146
0.6146
SHRET2
CMIND
0.004554
0.070691
0.9437
SHRET2
ROA2
0.004599
0.071397
0.9431
SHRET2
ROE2
0.029088
0.451761
0.6518
SHRET2
SHRET2
1.000000
-----
-----
TOBQ2
FIND
0.073300
1.140987
0.2550
TOBQ2
ACIND
-0.021016
-0.326333
0.7445
TOBQ2
NCIND
-0.000980
-0.015212
0.9879
TOBQ2
RCIND
0.003885
0.060315
0.9520
TOBQ2
CMIND
0.091602
1.428048
0.1546
TOBQ2
ROA2
-0.727304
-16.45134
0.0000
TOBQ2
ROE2
-0.197391
-3.125840
0.0020
TOBQ2
SHRET2
-0.009940
-0.154325
0.8775
TOBQ2
TOBQ2
1.000000
-----
-----
SIZE
FIND
0.134638
2.109356
0.0359
SIZE
ACIND
0.221020
3.518154
0.0005
SIZE
NCIND
0.332164
5.466970
0.0000
SIZE
RCIND
0.302538
4.927567
0.0000
SIZE
CMIND
0.001162
0.018043
0.9856
SIZE
ROA2
0.152030
2.387902
0.0177
SIZE
ROE2
0.067511
1.050446
0.2946
SIZE
SHRET2
-0.027501
-0.427090
0.6697
SIZE
TOBQ2
-0.193652
-3.064286
0.0024
221
SIZE
SIZE
1.000000
-----
-----
BLOCK
FIND
-0.235016
-3.753562
0.0002
BLOCK
ACIND
-0.194588
-3.079688
0.0023
BLOCK
NCIND
-0.099272
-1.548766
0.1228
BLOCK
RCIND
-0.179168
-2.827188
0.0051
BLOCK
CMIND
-0.112494
-1.757532
0.0801
BLOCK
ROA2
-0.011262
-0.174837
0.8614
BLOCK
ROE2
-0.054571
-0.848427
0.3970
BLOCK
SHRET2
0.136493
2.138957
0.0334
BLOCK
TOBQ2
0.046301
0.719556
0.4725
BLOCK
SIZE
0.050692
0.787958
0.4315
BLOCK
BLOCK
1.000000
-----
-----
SEGMT
FIND
0.178790
2.821021
0.0052
SEGMT
ACIND
0.132247
2.071221
0.0394
SEGMT
NCIND
0.274461
4.430932
0.0000
SEGMT
RCIND
0.193908
3.068509
0.0024
SEGMT
CMIND
-0.005431
-0.084309
0.9329
SEGMT
ROA2
0.114218
1.784816
0.0755
SEGMT
ROE2
0.161249
2.536444
0.0118
SEGMT
SHRET2
-0.047912
-0.744654
0.4572
SEGMT
TOBQ2
-0.132743
-2.079120
0.0387
SEGMT
SIZE
0.463862
8.128477
0.0000
SEGMT
BLOCK
-0.110906
-1.732414
0.0845
SEGMT
SEGMT
1.000000
-----
-----
DIVR2
FIND
0.040177
0.624224
0.5331
DIVR2
ACIND
0.098798
1.541292
0.1246
DIVR2
NCIND
0.077777
1.211099
0.2270
DIVR2
RCIND
0.108367
1.692271
0.0919
DIVR2
CMIND
0.059763
0.929440
0.3536
DIVR2
ROA2
0.192989
3.053394
0.0025
222
DIVR2
ROE2
0.058814
0.914628
0.3613
DIVR2
SHRET2
-0.098499
-1.536583
0.1257
DIVR2
TOBQ2
-0.132364
-2.073081
0.0392
DIVR2
SIZE
0.196521
3.111510
0.0021
DIVR2
BLOCK
0.112978
1.765184
0.0788
DIVR2
SEGMT
0.084908
1.322906
0.1871
DIVR2
DIVR2
1.000000
-----
-----
AGE
FIND
0.136348
2.136643
0.0336
AGE
ACIND
0.121245
1.896216
0.0591
AGE
NCIND
0.134395
2.105475
0.0363
AGE
RCIND
0.098822
1.541673
0.1245
AGE
CMIND
0.006702
0.104043
0.9172
AGE
ROA2
0.121209
1.895650
0.0592
AGE
ROE2
0.088235
1.375133
0.1704
AGE
SHRET2
0.032754
0.508747
0.6114
AGE
TOBQ2
-0.118192
-1.847786
0.0659
AGE
SIZE
0.194783
3.082895
0.0023
AGE
BLOCK
-0.068960
-1.073100
0.2843
AGE
SEGMT
0.278588
4.503129
0.0000
AGE
DIVR2
0.120315
1.881459
0.0611
AGE
AGE
1.000000
-----
-----
Log(MCAP2)
FIND
0.231315
3.691076
0.0003
Log(MCAP2)
ACIND
0.197470
3.127135
0.0020
Log(MCAP2)
NCIND
0.387699
6.529388
0.0000
Log(MCAP2)
RCIND
0.310960
5.079215
0.0000
Log(MCAP2)
CMIND
0.080945
1.260743
0.2086
Log(MCAP2)
ROA2
0.237853
3.801569
0.0002
Log(MCAP2)
ROE2
0.086819
1.352895
0.1774
Log(MCAP2)
SHRET2
0.038968
0.605413
0.5455
Log(MCAP2)
TOBQ2
-0.100862
-1.573827
0.1168
223
Log(MCAP2)
SIZE
0.645477
13.11962
0.0000
Log(MCAP2)
BLOCK
-0.009569
-0.148554
0.8820
Log(MCAP2)
SEGMT
0.500235
8.968501
0.0000
Log(MCAP2)
DIVR2
0.262399
4.221455
0.0000
Log(MCAP2)
AGE
0.327850
5.387357
0.0000
Log(MCAP2)
Log(MCAP2)
1.000000
-----
-----
GEAR2
FIND
0.005548
0.086127
0.9314
GEAR2
ACIND
-0.016345
-0.253784
0.7999
GEAR2
NCIND
0.058644
0.911974
0.3627
GEAR2
RCIND
-0.013825
-0.214649
0.8302
GEAR2
CMIND
0.047822
0.743254
0.4581
GEAR2
ROA2
-0.047507
-0.738336
0.4610
GEAR2
ROE2
-0.668375
-13.94949
0.0000
GEAR2
SHRET2
-0.014255
-0.221319
0.8250
GEAR2
TOBQ2
0.007060
0.109601
0.9128
GEAR2
SIZE
-0.007503
-0.116475
0.9074
GEAR2
BLOCK
-0.026620
-0.413405
0.6797
GEAR2
SEGMT
-0.035968
-0.558728
0.5769
GEAR2
DIVR2
0.096079
1.498486
0.1353
GEAR2
AGE
-0.063307
-0.984768
0.3257
GEAR2
Log(MCAP2)
0.072461
1.127860
0.2605
GEAR2
GEAR2
1.000000
-----
-----
EQED
FIND
-0.146766
-2.303371
0.0221
EQED
ACIND
-0.104789
-1.635771
0.1032
EQED
NCIND
-0.149318
-2.344318
0.0199
EQED
RCIND
-0.103623
-1.617373
0.1071
EQED
CMIND
-0.072204
-1.123845
0.2622
EQED
ROA2
-0.161353
-2.538129
0.0118
EQED
ROE2
-0.084041
-1.309302
0.1917
EQED
SHRET2
-0.144474
-2.266621
0.0243
224
EQED
TOBQ2
0.190904
3.019147
0.0028
EQED
SIZE
-0.179533
-2.833130
0.0050
EQED
BLOCK
0.243215
3.892606
0.0001
EQED
SEGMT
-0.183199
-2.892973
0.0042
EQED
DIVR2
0.060777
0.945266
0.3455
EQED
AGE
-0.185882
-2.936853
0.0036
EQED
Log(MCAP2)
-0.321018
-5.262038
0.0000
EQED
GEAR2
0.055542
0.863572
0.3887
EQED
EQED
1.000000
-----
-----
RISK2
FIND
-0.078967
-1.229744
0.2200
RISK2
ACIND
-0.080858
-1.259384
0.2091
RISK2
NCIND
-0.099949
-1.559433
0.1202
RISK2
RCIND
-0.066631
-1.036691
0.3009
RISK2
CMIND
-0.013159
-0.204306
0.8383
RISK2
ROA2
-0.043583
-0.677241
0.4989
RISK2
ROE2
-0.009704
-0.150647
0.8804
RISK2
SHRET2
0.954684
49.79724
0.0000
RISK2
TOBQ2
-0.008087
-0.125556
0.9002
RISK2
SIZE
-0.119215
-1.864010
0.0635
RISK2
BLOCK
0.121476
1.899885
0.0586
RISK2
SEGMT
-0.108621
-1.696283
0.0911
RISK2
DIVR2
-0.175115
-2.761174
0.0062
RISK2
AGE
-0.028643
-0.444847
0.6568
RISK2
Log(MCAP2)
-0.135237
-2.118916
0.0351
RISK2
GEAR2
0.002996
0.046518
0.9629
RISK2
EQED
-0.076994
-1.198821
0.2318
RISK2
RISK2
1.000000
-----
-----
225
Appendix 6
OLS and Logit Regressions:
Board Independence and Past Performance (ROA)
Sample Period:
2000-2003
Included Observations:
243
Coefficient
t/z-Statistic
FIND
ACIND
NCIND
RCIND
CMIND
Intercept
0.474
0.557
-0.032
0.269
0.659
6.793**
5.285**
-0.316
2.461*
0.327
-0.039
0.037
-0.073
-0.138
-0.814
-0.772
0.479
-1.000
-1.731
-1.517
0.007
0.033
0.039
0.046
-0.009
0.922
2.742**
3.432**
3.741**
-0.124
-0.255
-0.383
-0.144
-0.364
-1.066
-3.193**
-3.178**
-1.258
-2.922**
-1.392
0.010
-0.001
0.020
0.007
-0.021
1.426
-0.122
1.887
0.632
-0.300
0.006
0.028
0.048
0.101
0.381
0.172
0.579
1.041
1.989*
1.192
0.0009
0.001
0.0005
0.0002
-0.001
1.063
0.812
0.418
0.149
-0.137
0.015
0.016
0.014
0.021
0.145
1.548
1.131
1.039
1.384
1.101
-0.054
-0.010
-0.083
0.029
-0.533
-0.667
-0.079
-0.718
0.231
-0.677
-0.003
-0.0003
-0.007
-0.013
-0.102
-0.589
-0.040
-0.926
-1.471
-1.034
0.106
0.104
0.155
0.166
0.031
0.071
0.070
0.123
0.134
Std Error (Regression)
0.214
0.323
0.308
0.334
0.500
F/LR-Statistic
3.068
3.012
4.761
5.161
10.291
Probability (F/LR-Statistic)
0.002
0.002
0.000008
0.000002
0.327
Durbin-Watson
1.702
1.912
2.157
1.7870.658
ROA1
SIZE
BLOCK
SEGMT
DIVR1
AGE
GEAR1
EQED
RISK1
R 2 /McFadden R 2
Adjusted R
*
2
Significance at the 5% level
**
226
Significance at the 1% level
Appendix 7
OLS and Logit Regressions:
Board Independence and Past Performance (ROE)
Sample Period:
2000-2003
Included Observations:
243
Coefficient
t/z-Statistic
FIND
ACIND
NCIND
RCIND
CMIND
Intercept
0.502
0.561
-0.004
0.308
0.890
7.305**
5.400**
-0.040
2.843**
1.346
0.033
0.033
0.011
-0.006
0.027
1.403
0.925
0.316
-0.171
0.120
0.007
0.033
0.038
0.045
-0.016
0.849
2.751**
3.368**
3.633**
-0.210
-0.272
-0.388
-0.159
-0.383
-1.200
-3.418**
-3.228**
-1.385
-3.055**
-1.574
0.009
-0.001
0.019
0.006
-0.028
1.296
-0.131
1.788
0.496
-0.404
-0.006
0.029
0.035
0.079
0.248
-0.187
0.622
0.767
1.593
0.811
0.0008
0.001
0.0004
8.05E-05
-0.002
0.928
0.778
0.339
0.062
-0.235
0.013
0.016
0.013
0.019
0.128
1.403
1.098
0.949
1.275
1.035
-0.078
-0.031
-0.094
0.028
-0.557
-0.955
-0.250
-0.791
0.215
-0.703
-0.002
7.16E-05
-0.006
-0.011
-0.072
-0.335
0.009
-0.768
-1.273
-0.831
0.111
0.107
0.152
0.156
0.023
0.077
0.072
0.119
0.123
Std Error (Regression)
0.213
0.323
0.309
0.336
0.502
F/LR-Statistic
3.238
3.090
4.643
4.771
7.723
Probability (F/LR-Statistic)
0.001
0.002
0.00001
0.000008
0.562
Durbin-Watson
1.627
1.888
2.138
1.787
ROE1
SIZE
BLOCK
SEGMT
DIVR1
AGE
GEAR1
EQED
RISK1
R 2 //McFadden R 2
Adjusted R
*
2
Significance at the 5% level
**
227
Significance at the 1% level
Appendix 8
OLS and Logit Regressions:
Board Independence and Past Performance (Shareholder Return)
Sample Period:
2000-2003
Included Observations:
243
Coefficient
t/z-Statistic
FIND
ACIND
NCIND
RCIND
CMIND
Intercept
0.489
0.551
0.002
0.327
0.905
7.168**
5.360**
0.016
3.093**
1.381
-0.026
-0.060
-0.129
-0.187
-0.288
-0.567
-0.878
-1.973
-2.648**
-0.662
0.007
0.033
0.038
0.044
-0.017
0.864
2.747**
3.341**
3.601**
-0.230
-0.265
-0.387
-0.176
-0.415
-1.239
-3.321**
-3.217**
-1.545
-3.361**
-1.624
0.009
-0.002
0.016
0.001
-0.035
1.268
-0.211
1.511
0.099
-0.492
0.002
0.041
0.050
0.097
0.283
0.056
0.853
1.101
1.987*
0.920
0.0009
0.001
0.0007
0.0004
-0.001
1.073
0.928
0.566
0.325
-0.159
0.015
0.018
0.017
0.024
0.136
1.560
1.270
1.230
1.617
1.101
-0.056
-0.010
-0.091
0.017
-0.553
-0.699
-0.084
-0.789
0.133
-0.710
0.012
0.034
0.068
0.097
0.091
0.452
0.839
1.764
2.328*
0.346
0.105
0.106
0.166
0.180
0.024
0.070
0.072
0.133
0.149
Std Error (Regression)
0.214
0.323
0.306
0.332
0.502
F/LR-Statistic
3.034
3.079
5.140
5.690
8.150
Probability (F/LR-Statistic)
0.002
0.002
0.000002
0.000
0.519
Durbin-Watson
1.683
1.913
2.131
1.808
SHRET1
SIZE
BLOCK
SEGMT
DIVR1
AGE
GEAR1
EQED
RISK1
R 2 /McFadden R 2
Adjusted R
*
2
Significance at the 5% level
**
228
Significance at the 1% level
Appendix 9
OLS and Logit Regressions:
Board Independence and Past Performance (Tobin’s Q)
Sample Period:
2000-2003
Included Observations:
243
Coefficient
t/z-Statistic
FIND
ACIND
NCIND
RCIND
CMIND
Intercept
0.455
0.550
-0.017
0.220
0.776
6.201**
4.957**
-0.161
1.923
1.100
0.007
-0.001
0.002
0.020
0.022
1.138
-0.106
0.199
2.103*
0.384
0.008
0.033
0.039
0.048
-0.013
0.985
2.749**
3.380**
3.844**
-0.171
-0.251
-0.378
-0.153
-0.358
-1.161
-3.152**
-3.139**
-1.331
-2.878**
-1.521
0.010
-0.001
0.019
0.007
-0.027
1.417
-0.087
1.814
0.582
-0.383
0.005
0.033
0.038
0.095
0.271
0.161
0.701
0.829
1.927
0.881
0.0009
0.001
0.0005
0.0004
-0.001
1.144
0.823
0.381
0.289
-0.183
0.015
0.017
0.013
0.020
0.132
1.557
1.157
0.982
1.381
1.049
-0.073
-0.006
-0.091
-0.027
-0.593
-0.891
-0.045
-0.767
-0.214
-0.750
-0.003
-0.0008
-0.006
-0.011
-0.073
-0.477
-0.101
-0.805
-1.232
-0.840
0.109
0.103
0.152
0.171
0.023
0.074
0.069
0.119
0.139
Std Error (Regression)
0.214
0.323
0.309
0.333
0.503
F/LR-Statistic
3.155
2.985
4.636
5.349
7.856
Probability (F/LR-Statistic)
0.001
0.002
0.00001
0.00001
0.549
Durbin-Watson
1.696
1.915
2.147
1.797
TOBQ1
SIZE
BLOCK
SEGMT
DIVR1
AGE
GEAR1
EQED
RISK1
R 2 /McFadden R 2
Adjusted R
*
2
Significance at the 5% level
**
229
Significance at the 1% level
Appendix 10
OLS Regressions:
Full Board Independence and Subsequent Performance
Sample Period:
2003-2006
Included Observations:
243
Coefficient
t-Statistic
ROA2
ROE2
SHERT2
TOBQ2
Intercept
-0.120
0.680
-0.439
2.688
-0.606
1.274
-4.575**
2.339*
-0.272
-0.969
0.178
2.220
-1.587
-2.090*
2.141*
2.225*
0.021
-0.009
0.025
-0.232
1.009
-0.163
2.442*
-1.920
-0.049
-1.105
0.202
1.110
-0.227
-1.880
1.912
0.877
0.009
0.130
0.003
-0.055
0.463
2.517*
0.336
-0.496
0.229
0.606
0.121
-0.894
2.827**
2.769**
3.072**
-1.897
0.002
-0.0004
0.002
-0.010
0.842
-0.066
1.444
-0.791
-0.014
-0.691
-0.008
0.009
-0.814
-14.398**
-0.916
0.084
-0.485
-0.243
-0.333
2.986
-2.261*
-0.419
-3.206**
2.395*
-0.005
0.039
0.573
-0.071
-0.227
0.656
53.110**
-0.546
0.091
0.495
0.929
0.099
0.055
0.475
0.926
0.064
Std Error (Regression)
0.564
1.523
0.273
3.278
F-Statistic
2.579
25.328
338.756
2.846
Probability (F-Statistic)
0.008
0.000
0.000
0.003
Durbin-Watson
2.019
2.047
1.990
1.917
FIND
SIZE
BLOCK
SEGMT
DIVR2
AGE
GEAR2
EQED
RISK2
R2
Adjusted R
*
2
Significance at the 5% level
**
230
Significance at the 1% level
Appendix 11
OLS Regressions:
Audit Committee Independence and Subsequent Performance
Sample Period:
2003-2006
Included Observations:
243
Coefficient
t-Statistic
ROA2
ROE2
SHERT2
TOBQ2
Intercept
-0.187
0.574
-0.377
3.477
-0.981
1.119
-4.061**
3.119**
-0.118
-0.660
0.046
0.520
-1.029
-2.142*
0.818
0.777
0.023
0.006
0.024
-0.233
1.081
0.101
2.368*
-1.878
-0.024
-1.108
0.174
0.739
-0.112
-1.888
1.632
0.579
0.006
0.120
0.005
-0.035
0.326
2.335*
0.510
-0.311
0.231
0.628
0.121
-0.889
2.840**
2.861**
3.044**
-1.865
0.002
-0.0005
0.002
-0.009
0.791
-0.087
1.531
-0.678
-0.015
-0.694
-0.008
0.013
-0.851
-14.472**
-0.870
0.122
-0.468
-0.190
-0.345
2.839
-2.180*
-0.328
-3.296**
2.259*
-0.004
0.041
0.572
-0.078
-0.194
0.685
52.636**
-0.599
0.085
0.495
0.928
0.082
0.050
0.475
0.925
0.047
Std Error (Regression)
0.565
1.522
0.276
3.308
F-Statistic
2.402
25.376
332.748
2.321
Probability (F-Statistic)
0.013
0.000
0.000
0.016
Durbin-Watson
2.007
2.023
2.005
1.928
ACIND
SIZE
BLOCK
SEGMT
DIVR2
AGE
GEAR2
EQED
RISK2
R2
Adjusted R
*
2
Significance at the 5% level
**
231
Significance at the 1% level
Appendix 12
OLS Regressions:
Nomination Committee Independence and Subsequent Performance
Sample Period:
2003-2006
Included Observations:
243
Coefficient
t-Statistic
ROA2
ROE2
SHERT2
TOBQ2
Intercept
-0.255
0.206
-0.351
3.783
-1.423
0.422
-4.006**
3.607**
-0.182
-0.252
0.036
1.027
-1.520
-0.773
0.624
1.470
0.026
-0.006
0.025
-0.257
1.232
-0.111
2.351*
-2.060*
-0.004
-0.890
0.161
0.677
-0.017
-1.530
1.540
0.542
0.010
0.126
0.004
-0.055
0.511
2.416*
0.425
-0.487
0.226
0.594
0.123
-0.869
2.794**
2.629**
3.106**
-1.834
0.002
-0.001
0.002
-0.009
0.790
-0.179
1.555
-0.690
-0.013
-0.689
-0.008
-0.0004
-0.715
-14.208**
-0.932
-0.004
-0.486
-0.202
-0.342
2.947
-2.267*
-0.346
-3.258**
2.348*
-0.006
0.041
0.572
-0.070
-0.253
0.679
52.560**
-0.539
0.090
0.486
0.928
0.088
0.055
0.467
0.925
0.053
Std Error (Regression)
0.564
1.535
0.276
3.297
F-Statistic
2.554
24.514
332.318
2.510
Probability (F-Statistic)
0.008
0.000
0.000
0.009
Durbin-Watson
2.009
2.008
1.997
1.944
NCIND
SIZE
BLOCK
SEGMT
DIVR2
AGE
GEAR2
EQED
RISK2
R2
Adjusted R
*
2
Significance at the 5% level
**
232
Significance at the 1% level
Appendix 13
OLS Regressions:
Remuneration Committee Independence and Subsequent Performance
Sample Period:
2003-2006
Included Observations:
243
Coefficient
t-Statistic
ROA2
ROE2
SHERT2
TOBQ2
Intercept
-0.195
0.372
-0.355
3.491
-1.072
0.753
-3.979**
3.274**
-0.188
-0.536
0.010
0.909
-1.739
-1.824
0.182
1.432
0.028
0.010
0.026
-0.260
1.318
0.170
2.431*
-2.073*
-0.054
-1.068
0.160
0.900
-0.249
-1.816
1.503
0.708
0.007
0.124
0.005
-0.041
0.392
2.409*
0.493
-0.364
0.236
0.623
0.123
-0.913
2.906**
2.831**
3.087**
-1.921
0.002
-0.001
0.002
-0.008
0.757
-0.187
1.576
-0.654
-0.015
-0.694
-0.008
0.014
-0.870
-14.425**
-0.884
0.137
-0.465
-0.172
-0.346
2.825
-2.174*
-0.296
-3.304**
2.255*
-0.004
0.044
0.572
-0.082
-0.160
0.739
52.555**
-0.628
0.093
0.492
0.928
0.088
0.057
0.473
0.925
0.053
Std Error (Regression)
0.563
1.526
0.276
3.298
F-Statistic
2.640
25.103
331.772
2.496
Probability (F-Statistic)
0.006
0.000
0.000
0.010
Durbin-Watson
2.003
2.041
2.002
1.930
RCIND
SIZE
BLOCK
SEGMT
DIVR2
AGE
GEAR2
EQED
RISK2
R2
Adjusted R
*
2
Significance at the 5% level
**
233
Significance at the 1% level
Appendix 14
OLS Regressions:
Chairman Independence and Subsequent Performance
Sample Period:
2003-2006
Included Observations:
243
Coefficient
t-Statistic
ROA2
ROE2
SHERT2
TOBQ2
Intercept
-0.173
0.356
-0.370
3.229
-0.928
0.704
-4.068**
2.973**
-0.115
-0.213
0.027
0.780
-1.572
-1.067
0.746
1.824
0.019
-0.017
0.026
-0.214
0.906
-0.297
2.563*
-1.771
-0.015
-0.921
0.164
0.778
-0.068
-1.581
1.567
0.622
0.006
0.120
0.005
-0.031
0.301
2.318*
0.518
-0.277
0.235
0.610
0.121
-0.925
2.887**
2.759**
3.050**
-1.952
0.002
-0.001
0.002
-0.008
0.721
-0.217
1.587
-0.622
-0.014
-0.690
-0.008
0.003
-0.766
-14.266**
-0.918
0.032
-0.484
-0.207
-0.342
2.953
-2.257*
-0.355
-3.260**
2.360*
-0.004
0.044
0.572
-0.081
-0.167
0.726
52.612**
-0.627
0.090
0.485
0.928
0.093
0.055
0.468
0.925
0.058
Std Error (Regression)
0.564
1.533
0.276
3.289
F-Statistic
2.573
24.631
332.574
2.650
Probability (F-Statistic)
0.008
0.000
0.000
0.006
Durbin-Watson
2.015
2.008
2.002
1.926
CMIND
SIZE
BLOCK
SEGMT
DIVR2
AGE
GEAR2
EQED
RISK2
R2
Adjusted R
*
2
Significance at the 5% level
**
234
Significance at the 1% level
Appendix 15
OLS Regressions:
Board Independence and Firm Risk
Sample Period:
2003-2006
Included Observations:
243
Coefficient
t-Statistic
Intercept
FIND
RISK2
0.766
0.622
0.616
0.621
0.646
4.779**
4.261**
4.197**
4.161**
4.240**
-0.307
-2.199*
ACIND
-0.081
-0.867
NCIND
-0.080
-
-0.821
RCIND
-0.012
-0.139
CMIND
-0.042
-0.694
SIZE
BLOCK
SEGMT
DIVR2
AGE
GEAR2
EQED
SHERT2
-0.046
-0.045
-0.045
-0.047
-0.048
-2.700**
-2.618**
-2.562*
-2.699**
-2.828**
-0.207
-0.157
-0.136
-0.130
-0.138
-1.161
-0.874
-0.773
-0.726
-0.783
-0.008
-0.011
-0.010
-0.011
-0.011
-0.534
-0.716
-0.606
-0.699
-0.721
-0.240
-0.241
-0.245
-0.245
-0.242
-3.675**
-3.648**
-3.714**
-3.701**
-3.663**
-0.002
-0.002
-0.003
-0.003
-0.003
-1.315
-1.402
-1.422
-1.449
-1.460
0.015
0.014
0.015
0.014
0.015
1.009
0.962
1.040
0.979
1.010
0.440
0.458
0.451
0.460
0.454
2.501*
2.585*
2.536*
2.592*
2.554*
1.612
1.612
1.611
1.612
1.612
53.110**
52.636**
52.560**
52.555**
52.612**
235
R2
0.930
0.929
0.928
0.928
0.928
0.927
0.926
0.926
0.926
0.926
Std Error (Regression)
0.459
0.463
0.463
0.463
0.463
F-Statistic
342.611
336.286
336.164
335.151
335.868
Probability (F-Statistic)
0.000
0.000
0.000
0.000
0.000
Durbin-Watson
1.976
1.989
1.980
1.986
1.990
Adjusted R
*
2
Significance at the 5% level
**
236
Significance at the 1% level