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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

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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

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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.

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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

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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.

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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

Chapter 2. Corporate Governance Reforms 11

2.1 Introduction 11

2.2 Corporate Governance Systems 12

2.3 Corporate Governance Standards 18

2.3.1 Recommendations in the U.K. 19

2.3.2 Listing Rules in the U.S. 24

2.3.3 Australian Guidelines 29

2.4 Summary 33

Chapter 3. 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

3.4 Evidence from Other Regions 54

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3.5 Summary and Limitations 62

3.5.1 Australian Studies 63

3.5.2 Overseas Studies 65

Chapter 4. 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

Chapter 5. 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

5.4.3 Control Variables 101

5.5 Data Analysis 104

5.6 Summary 110

Chapter 6. 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

Chapter 7. Multivariate Analysis 121


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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

Chapter 8. Discussion and Conclusions 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

References 161

Appendices 190

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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)


and Past Performance (ROE)


and Past Performance (Shareholder Return)


and Past Performance (Tobin’s Q)

10. OLS Regressions: Full Board Independence 230

and Subsequent Performance

11. OLS Regressions: Audit Committee Independence 231


12. OLS Regressions: Nomination Committee Independence 232


13. OLS Regressions: Remuneration Committee Independence 233


14. OLS Regressions: Chairman Independence 234


15. OLS Regressions: Board Independence and Firm Risk 235

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List of Figures

Number Page

4.1. Theoretical Development: High Board Independence 86

4.2. Theoretical Development: Low Board Independence 87

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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)


and Past Performance (ROE)


and Past Performance (Shareholder Return)


and Past Performance (TOBQ)

7.5. OLS Regressions: Full Board Independence 132


7.6. OLS Regressions: Audit Committee Independence 134


7.7. OLS Regressions: Nomination Committee Independence 136


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7.8. OLS Regressions: Remuneration Committee Independence 138


7.9. OLS Regressions: Chairman Independence 140


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 152

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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 Cash Flow Return on Total Assets

CIMA 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

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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

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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

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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).

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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 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, 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.

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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

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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,

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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.

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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


Subsequent Firm Risk

Agency Theory Positive

Stewardship Theory Unknown


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

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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 - mid-

2003. 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.

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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.

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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.

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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

12

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.

13

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

14

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 financial-

orientated 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).

15

Employees could exercise voice within corporate governance, for example, through

legal rights to co-determination in Germany or extensive use of joint labour-

management 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 finance-

oriented 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).

16

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 "short-

termist" 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

17

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 Co-

operation 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

18

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 English-

speaking 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).

19

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).

20

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

21

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

22

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;

23

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

24

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 corporate-

governance 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

25

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

26

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-in-

law, 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

27

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”:

28

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 non-

discretionary 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

29

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 non-

compliance 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

30

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;

31

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;

32

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.

33

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

34

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

35

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.

36

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.

37

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

38

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

39

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

40

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

41

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).

42

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

43

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.

44

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

45

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

46

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

47

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).

48

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

49

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

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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

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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.

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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 expert-

independent 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 1981-

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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 stock-

market. 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

54

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

55

(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,

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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

57

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

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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

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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 firm-

year 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 1997-

1998, 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.

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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

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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

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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 super-

independent 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

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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.

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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.

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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.

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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 stock-

price 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.

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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).

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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 composition-

performance 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,

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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

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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.

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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

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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).

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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).

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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

78

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).

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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 long-

term 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;

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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,

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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).

84

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 short-

term 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

85

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 long-

term 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

86

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

Low Firm Performance

High Board Independence


High Firm Performance

Organizational Portfolio Theory

Stewardship Theory & Organizational

Portfolio Theory

Agency Theory

87

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

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:


Low Board Independence



Organizational Portfolio Theory

Agency Theory

Stewardship Theory & Organizational

Portfolio Theory

88

H1 : There is a negative relationship between board independence and past firm

performance (organizational portfolio theory);

H 2 : There is a negative relationship between board independence and subsequent

firm performance (stewardship theory, organizational portfolio theory); and

H 3 : 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:


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:

H 5 : 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

89

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


Does firm performance have any influence on board independence among


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.

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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 (Frankfort-

Nachmias 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

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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 (2000-

2006), 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

95

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.

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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.

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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

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best practice recommendations; the company should identify the recommendations that

have not been followed and give reasons for not following them. Therefore, from mid-

2003 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).

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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.

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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 short-

term 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).

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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 non-

existence 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

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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

103

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

shareholdings

The percentage of equity, including

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,

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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.

105

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

106

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:




firm performance (stewardship theory, organizational portfolio theory);


firm performance (agency theory);


firm risk (organizational portfolio theory); and



In the regressions to test H1 , 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,

107

dividend payout, firm size, leverage and risk are for the years 2000-2003. An algebraic

statement of the models is as follows:

iiii

iiii

iiii

RiskOwnershipManagerialLeverageFirmSizeFirmAgeyoutDividendPaationDiversific

rOwnershipBlockholdeBoardSizeePerformancY

)()()()()()()(

)()()(

1098

7654

321

Where, for the thi 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:

iiii

iiii

iiii


rOwnershipBlockholdeBoardSizeceIndependenY

)()()()()()()(

)()()(

1098

7654

321


Y = ROA, ROE, shareholder return or Tobin’s q

108



Independence = Full board independence, monitoring committee










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 2003-

2006; other variables use the 2003 data.

iiii

iiii

iiii

ePerformancOwnershipManagerialLeverageFirmSizeFirmAgeyoutDividendPaationDiversific


)()()()()()()(

)()()(

1098

7654

321


Y = Standard deviation of return



Independence = Full board independence, monitoring committee






109





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 H1 ; additional tests on the models for H1 , 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

110

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.

111

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 2000-

2003 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.

112

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

113

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

114

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


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.

115

Table 6.4

Jarque-Bera Statistics

Sample Period: 2003


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.

116

Table 6.5

Pearson Correlations: 2000-2003

Sample Period: 2000-2003


Correlation

t-Statistic FIND ACIND NCIND RCIND CMIND ROA1 ROE1 SHRET1 TOBQ1

FIND 1.000

-----

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** -----

ROA1 -0.013 0.076 0.038 -0.006 -0.070 1.000

-0.195 1.187 0.593 -0.086 -1.095 -----

ROE1 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** -----

SHRET1 -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 -----

TOBQ1 0.012 -0.069 -0.095 0.031 0.006 -0.367 -0.160 0.043 1.000

0.192 -1.080 -1.483 0.487 0.097 -6.118** -2.517* 0.674 -----

* Significance at the 5% level ** 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

117

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.

118

Table 6.6




Correlation

t-Statistic FIND ACIND NCIND RCIND CMIND ROA2 ROE2 SHRET2 TOBQ2 RISK2

FIND 1.000

-----

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 -0.046 -0.003 -0.019 -0.036 -0.078 1.000

-0.719 -0.050 -0.288 -0.554 -1.220 -----

ROE2 -0.055 -0.045 -0.028 -0.024 -0.066 0.328 1.000

-0.851 -0.699 -0.439 -0.370 -1.024 5.390** -----

SHRET2 -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 -----

TOBQ2 0.073 -0.021 -0.001 0.004 0.092 -0.727 -0.197 -0.010 1.000

1.141 -0.326 -0.015 0.060 1.428 16.451** 3.126** -0.154 -----

RISK2 -0.079 -0.081 -0.010 -0.067 -0.013 -0.044 -0.010 0.955 -0.008 1.000

-1.230 -1.259 -1.559 -1.037 -0.204 -0.677 -0.151 49.797** -0.126 -----


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

119

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.

120

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.

121

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 self-

interest; 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:




firm performance (stewardship theory, organizational portfolio theory);


firm performance (agency theory);


firm risk (organizational portfolio theory); and



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

122

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 H1 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:

iiii

iiii

iiii


rOwnershipBlockholdeBoardSizeePerformancY

)()()()()()()(

)()()(

1098

7654

321


Y = FIND, ACIND, NCIND, RCIND or CMIND



Performance = ROA1, ROE1, SHRET1 or TOBQ1

Board Size = SIZE

Blockholder Ownership = BLOCK

Diversification = SEGMT

Dividend Payout = DIVR1

Firm Age = AGE

Firm Size = Log(MCAP1)

Leverage = GEAR1

Managerial Ownership = EQED

Firm Risk = 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.

123

Table 7.1

OLS and Logit Regressions:

Board Independence and Past Performance (ROA)



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

ROA1 -0.050 0.031 -0.109 -0.166 -0.870

-0.985 0.405 -1.532 -2.102* -1.596

SIZE -0.001 0.029 0.011 0.024 -0.056

-0.142 2.020* 0.827 1.684 -0.620

BLOCK -0.258 -0.384 -0.155 -0.372 -1.088

-3.246** -3.186** -1.393 -3.033** -1.416

SEGMT 0.006 -0.003 0.005 -0.004 -0.044

0.768 -0.303 0.470 -0.360 -0.595

DIVR1 -0.001 0.025 0.026 0.083 0.343

-0.036 0.507 0.579 1.661 1.076

AGE 0.0007 0.0009 -2.78E-05 -0.0002 -0.002

0.868 0.743 -0.024 -0.169 -0.240

Log(MCAP1) 0.023 0.011 0.077 0.060 0.125

1.743 0.563 4.095** 2.888** 0.964

GEAR1 0.013 0.015 0.007 0.015 0.132

1.314 1.046 0.531 1.017 1.008

EQED -0.033 0.0007 -0.014 0.083 -0.404

-0.404 0.005 -0.127 0.660 -0.505

RISK1 -0.003 -0.0002 -0.007 -0.012 -0.096

-0.548 -0.026 -0.855 -1.421 -0.989

2R /McFadden 2R 0.118 0.105 0.212 0.195 0.033

Adjusted 2R 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

124

Probability (F/LR-Statistic) 0.001 0.003 0.000 0.000 0.340

Durbin-Watson 1.685 1.906 2.152 1.761


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.

125

Table 7.2


Board Independence and Past Performance (ROE)



Coefficient


Intercept 0.462 0.539 -0.145 0.202 0.697

6.315** 4.851** -1.410 1.769 0.988

ROE1 0.031 0.032 0.003 -0.012 0.018

1.309 0.887 0.083 -0.336 0.077

SIZE -0.001 0.029 0.011 0.025 -0.053

-0.106 2.025* 0.856 1.708 -0.593

BLOCK -0.275 -0.390 -0.172 -0.392 -1.222

-3.472** -3.238** -1.537 -3.168** -1.599

SEGMT 0.005 -0.004 0.004 -0.005 -0.047

0.697 -0.314 0.411 -0.421 -0.638

DIVR1 -0.013 0.025 0.009 0.060 0.213

-0.414 0.531 0.205 1.207 0.694

AGE 0.0006 0.0009 -0.0001 -0.0003 -0.003

0.750 0.709 -0.093 -0.235 -0.320

Log(MCAP1) 0.021 0.011 0.073 0.055 0.099

1.552 0.562 3.903** 2.640** 0.778

GEAR1 0.011 0.015 0.006 0.014 0.117

1.188 1.012 0.449 0.928 0.952

EQED -0.059 -0.020 -0.024 0.080 -0.453

-0.709 -0.160 -0.207 0.620 -0.565

RISK1 -0.002 -0.0002 -0.005 -0.010 -0.068

-0.285 0.027 -0.663 -1.203 -0.800

2R /McFadden 2R 0.120 0.108 0.204 0.180 0.025

Adjusted 2R 0.082 0.069 0.170 0.145


F/LR-Statistic 3.173 2.804 5.958 5.101 8.331

126


Durbin-Watson 1.609 1.882 2.124 1.762


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.

127

Table 7.3


Board Independence and Past Performance (Shareholder Return)



Coefficient


Intercept 0.448 0.529 -0.135 0.227 0.720

6.183** 4.814** -1.332 2.042* 1.031

SHRET1 -0.023 -0.059 -0.120 -0.180 -0.275

-0.509 -0.855 -1.889 -2.584* -0.631

SIZE -0.001 0.028 0.011 0.025 -0.053

-0.124 2.009* 0.849 1.719 -0.598

BLOCK -0.269 -0.389 -0.190 -0.425 -1.262

-3.381** -3.229** -1.711 -3.480** -1.650

SEGMT 0.005 -0.005 0.002 -0.009 -0.053

0.662 -0.395 0.174 -0.761 -0.710

DIVR1 -0.006 0.036 0.022 0.077 0.246

-0.200 0.748 0.505 1.578 0.795

AGE 0.0007 0.001 0.0001 2.41E-05 -0.002

0.876 0.849 0.113 0.019 -0.248

Log(MCAP1) 0.021 0.012 0.072 0.052 0.097

1.611 0.587 3.874** 2.565* 0.757

GEAR1 0.013 0.017 0.010 0.019 0.125

1.323 1.172 0.707 1.259 1.015

EQED -0.037 0.0002 -0.028 0.063 -0.458

-0.460 0.002 -0.243 0.505 -0.581

RISK1 0.011 0.033 0.064 0.094 0.089

0.409 0.821 1.709 2.284* 0.338

2R /McFadden 2R 0.115 0.108 0.216 0.203 0.026

Adjusted 2R 0.077 0.069 0.183 0.168


F/LR-Statistic 3.009 2.798 6.405 5.901 8.726

128


Durbin-Watson 1.664 1.907 2.127 1.792


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.

129

Table 7.4


Board Independence and Past Performance (Tobin’s Q)



Coefficient


Intercept 0.430 0.532 -0.121 0.159 0.650

5.689** 4.639** -1.138 1.355 0.894

TOBQ1 0.005 -0.003 -0.007 0.014 0.011

0.736 -0.278 -0.856 1.478 0.181

SIZE 0.0004 0.028 0.009 0.030 -0.049

0.045 1.900 0.646 2.004* -0.538

BLOCK -0.258 -0.384 -0.182 -0.375 -1.200

-3.240** -3.172** -1.630 -3.033** -1.566

SEGMT 0.006 -0.004 0.003 -0.003 -0.045

0.824 -0.323 0.296 -0.232 -0.607

DIVR1 -0.004 0.027 0.001 0.073 0.227

-0.120 0.551 0.030 1.468 0.728

AGE 0.0008 0.0009 -0.0003 -4.68E-05 -0.002

0.926 0.712 -0.214 -0.036 -0.286

Log(MCAP1) 0.019 0.014 0.078 0.046 0.093

1.381 0.669 4.009** 2.154* 0.708

GEAR1 0.013 0.015 0.005 0.015 0.119

1.327 1.038 0.379 1.040 0.960

EQED -0.050 0.011 0.0009 0.027 -0.474

-0.605 0.087 0.008 0.210 -0.587

RISK1 -0.002 -0.0006 -0.005 -0.010 -0.068

-0.428 -0.076 -0.686 -1.163 -0.810

2R /McFadden 2R 0.116 0.105 0.207 0.187 0.025

Adjusted 2R 0.078 0.067 0.173 0.152


F/LR-Statistic 3.041 2.725 6.049 5.353 8.358

130


Durbin-Watson 1.675 1.907 2.108 1.770


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:

iiii

iiii

iiii



)()()()()()()(

)()()(

1098

7654

321


Y = ROA2, ROE2, SHERT2 or TOBQ2



Independence = FIND, ACIND, NCIND, RCIND or CMIND

Board Size = SIZE



131


Firm Age = AGE


Leverage = GEAR2


Firm Risk = 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.

132

Table 7.5

OLS Regressions:

Full Board Independence and Subsequent Performance



Coefficient

t-Statistic ROA2 ROE2 SHERT2 TOBQ2

Intercept -0.226 0.407 -0.625 2.153

-1.112 0.740 -7.125** 1.816

FIND -0.319 -1.088 0.097 1.987

-1.853 -2.339* 1.307 1.982*

SIZE -0.003 -0.070 -0.017 -0.352

-0.120 -1.093 -1.666 -2.533*

BLOCK -0.088 -1.203 0.135 0.918

-0.403 -2.051* 1.440 0.726

SEGMT -0.0008 0.105 -0.014 -0.103

-0.043 1.984* -1.639 -0.909

DIVR2 0.200 0.532 0.070 -1.040

2.445* 2.404* 1.980* -2.181*

AGE 0.001 -0.002 0.0001 -0.014

0.471 -0.410 0.135 -1.093

Log(MCAP2) 0.061 0.157 0.107 0.307

2.007* 1.906 8.150** 1.728

GEAR2 -0.019 -0.703 -0.016 -0.016

-1.083 -14.604** -2.130* -0.150

EQED -0.366 0.062 -0.125 3.582

-1.656 0.104 -1.316 2.780**

RISK2 -0.002 0.048 0.579 -0.054

-0.081 0.797 60.540** -0.420

2R 0.106 0.502 0.945 0.111

Adjusted 2R 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

133

Probability (F-Statistic) 0.003 0.000 0.000 0.002

Durbin-Watson 2.052 2.078 2.014 1.926


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.

134

Table 7.6

OLS Regressions:

Audit Committee Independence and Subsequent Performance



Coefficient


Intercept -0.298 0.294 -0.599 2.769

-1.496 0.547 -6.972** 2.377*

ACIND -0.126 -0.681 0.029 0.468

-1.104 -2.216* 0.600 0.703

SIZE 0.001 -0.048 -0.018 -0.369

0.060 -0.741 -1.745 -2.612**

BLOCK -0.051 -1.176 0.120 0.569

-0.235 -2.006* 1.284 0.447

SEGMT -0.003 0.097 -0.013 -0.092

-0.144 1.835 -1.568 -0.805

DIVR2 0.205 0.561 0.069 -1.056

2.490* 2.529* 1.938 -2.194*

AGE 0.001 -0.002 0.0002 -0.013

0.445 -0.401 0.161 -1.036

Log(MCAP2) 0.055 0.139 0.109 0.350

1.809 1.691 8.346** 1.969

GEAR2 -0.020 -0.705 -0.016 -0.015

-1.093 -14.625** -2.117* -0.147

EQED -0.359 0.086 -0.128 3.535

-1.615 0.144 -1.336 2.724**

RISK2 -0.001 0.049 0.578 -0.059

-0.056 0.814 60.353** -0.451

2R 0.098 0.501 0.944 0.097

Adjusted 2R 0.059 0.480 0.942 0.058


F-Statistic 2.510 23.307 394.693 2.503

135


Durbin-Watson 2.036 2.046 2.020 1.934


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.

136

Table 7.7

OLS Regressions:

Nomination Committee Independence and Subsequent Performance



Coefficient


Intercept -0.392 -0.109 -0.588 3.112

-2.067* -0.211 -7.176** 2.798**

NCIND -0.229 -0.361 -0.046 0.795

-1.897 -1.094 -0.872 1.122

SIZE 0.003 -0.061 -0.016 -0.372

0.112 -0.928 -1.573 -2.651**

BLOCK -0.038 -0.969 0.102 0.510

-0.178 -1.668 1.108 0.409

SEGMT 3.80E-05 0.104 -0.013 -0.103

0.002 1.937 -1.524 -0.892

DIVR2 0.195 0.523 0.069 -1.021

2.389* 2.340* 1.963 -2.129*

AGE 0.0009 -0.003 0.0002 -0.013

0.394 -0.504 0.190 -1.006

Log(MCAP2) 0.065 0.149 0.112 0.317

2.099* 1.769 8.399** 1.756

GEAR2 -0.017 -0.700 -0.016 -0.023

-0.974 -14.382** -2.094* -0.221

EQED -0.363 0.081 -0.129 3.551

-1.644 0.135 -1.349 2.740**

RISK2 -0.002 0.048 0.578 -0.055

-0.111 0.801 60.326** -0.420

2R 0.107 0.493 0.945 0.100

Adjusted 2R 0.068 0.471 0.942 0.062


F-Statistic 2.773 22.577 395.414 2.587

137


Durbin-Watson 2.044 2.038 2.015 1.947


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.

138

Table 7.8

OLS Regressions:

Remuneration Committee Independence and Subsequent Performance



Coefficient


Intercept -0.317 0.066 -0.573 2.858

-1.668 0.128 -6.955** 2.559*

RCIND -0.221 -0.617 -0.048 0.740

-2.032* -2.090* -1.030 1.159

SIZE 0.005 -0.048 -0.016 -0.380

0.210 -0.734 -1.505 -2.689**

BLOCK -0.094 -1.168 0.089 0.694

0.665 -1.988* 0.850 0.546

SEGMT -0.003 0.099 -0.013 -0.093

-0.138 1.865 -1.593 -0.812

DIVR2 0.207 0.551 0.072 -1.061

2.534* 2.483* 2.034* -2.211*

AGE 0.0008 -0.003 0.0002 -0.013

0.361 -0.541 0.173 -0.986

Log(MCAP2) 0.063 0.157 0.112 0.324

2.055* 1.891 8.450** 1.811

GEAR2 -0.021 -0.707 -0.017 -0.012

-1.156 -14.626** -2.183* -0.117

EQED -0.340 0.141 -0.124 3.471

-1.538 0.235 -1.296 2.677**

RISK2 3.76E-05 0.053 0.578 -0.063

0.002 0.890 60.451** -0.486

2R 0.109 0.500 0.945 0.101

Adjusted 2R 0.070 0.478 0.942 0.062


F-Statistic 2.831 23.200 395.952 2.596

139


Durbin-Watson 2.033 2.073 1.993 1.938


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.

140

Table 7.9

OLS Regressions:

Chairman Independence and Subsequent Performance



Coefficient


Intercept -0.287 0.081 -0.585 2.584

-1.477 0.154 -6.956** 2.276*

CMIND -0.127 -0.242 0.004 0.710

-1.743 -1.216 0.114 1.664

SIZE -0.004 -0.072 -0.017 -0.344

-0.177 -1.110 -1.669 -2.471*

BLOCK -0.043 -0.991 0.110 0.615

-0.203 -1.703 1.192 0.493

SEGMT -0.004 0.097 -0.013 -0.085

-0.201 1.813 -1.574 -0.746

DIVR2 0.207 0.544 0.070 -1.079

2.527* 2.434* 1.971* -2.254*

AGE 0.0008 -0.003 0.0002 -0.012

0.348 -0.535 0.193 -0.965

Log(MCAP2) 0.058 0.140 0.109 0.329

1.920 1.694 8.328** 1.854

GEAR2 -0.018 -0.701 -0.016 -0.022

-1.018 -14.421** -2.137* -0.213

EQED -0.370 0.068 -0.128 3.597

-1.670 0.112 -1.332 2.784**

RISK2 -0.0004 0.052 0.578 -0.063

-0.018 0.859 60.301** -0.485

2R 0.105 0.494 0.944 0.106

Adjusted 2R 0.066 0.472 0.942 0.068


F-Statistic 2.711 22.633 394.069 2.754

141


Durbin-Watson 2.047 2.033 2.013 1.933


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.

iiii

iiii

iiii

ePerformancOwnershipManagerialLeverageFirmSizeFirmAgeyoutDividendPaationDiversific


)()()()()()()(

)()()(

1098

7654

321


Y = RISK2



Independence = FIND, ACIND, NCIND, RCIND or CMIND

Board Size = SIZE




Firm Age = AGE

142


Leverage = GEAR2


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.

143

Table 7.10

OLS Regressions:

Board Independence and Firm Risk



Coefficient

t-Statistic RISK2

Intercept 1.072 1.027 1.007 0.981 1.001

7.327** 7.172** 7.354** 7.140** 7.131**

FIND -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 0.026 0.027 0.025 0.023 0.026

1.486 1.572 1.413 1.322 1.491

BLOCK -0.123 -0.098 -0.068 -0.043 -0.079

-0.783 -0.623 -0.442 -0.274 -0.507

SEGMT 0.021 0.020 0.019 0.020 0.020

1.476 1.401 1.369 1.428 1.410

DIVR2 -0.146 -0.144 -0.146 -0.150 -0.147

-2.482* -2.438* -2.471* -2.540* -2.478*

AGE -3.23E-05 -7.21E-05 -0.0001 -9.35E-05 -0.0001

-0.020 -0.045 -0.077 -0.059 -0.078

Log(MCAP2) -0.180 -0.184 -0.187 -0.188 -0.184

-8.182** -8.386** -8.398** -8.499** -8.375**

GEAR2 0.029 0.028 0.028 0.029 0.029

2.216* 2.203* 2.189* 2.271* 2.223*

EQED 0.117 0.120 0.122 0.114 0.120

0.728 0.746 0.758 0.707 0.744

144

SHERT2 1.626 1.626 1.627 1.626 1.626

60.540** 60.353** 60.326** 60.451** 60.301**

2R 0.945 0.945 0.945 0.945 0.945

Adjusted 2R 0.943 0.943 0.943 0.943 0.943


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


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.

145

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.

146

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


Does firm performance have any influence on board independence among


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.

147

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 H1

(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

148

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

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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).

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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,

151

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.

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Table 8.3

Results: Board Independence, Firm Performance and Firm Risk



Relation FIND ACIND NCIND RCIND CMIND

Past Performance

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

Subsequent Performance

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

Subsequent Risk

Standard Deviation of Return Insignificant Insignificant Insignificant Insignificant 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 independence-

financial 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

153

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.

154

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

155

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

156

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

157

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

158

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

159

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

160

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.

161

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Appendix 1

Summary of Australian Research

Variable* Author Sample

Board Characteristics Firm Performance Control Test Relevant Findings

Muth and

Donaldson (1998)

145 Australian

firms

Board independence

factor composed of board

size, CEO duality,

percentage of NEDs and

interest alignment with

owners

Shareholder wealth, sales

growth, and profit

performance factor

composed of profit

margin, ROA and ROE

Firm size, firm

risk, leverage and

industry rate of

return

Correlations,

rotated factor

analysis, ANOVA

and multivariate

regressions

A higher board independence

factor leads to lower subsequent

shareholder wealth and sales

growth

Calleja (1999) 83 Australian

firms

Board size, percentage of

NEDs and number of

board committees

Shareholder return None Descriptive

statistics and OLS

regressions

No significant relation is found

Lawrence and

Stapledon (1999)

100 Australian

firms

The percentage of

independent directors or

executive directors

Share price performance,

total assets, revenue, net

profit, EBIT, number of

employees, cash flow,

revenue to assets, net

profit to revenue, revenue

to employees, cash flow

to revenue, and

Board size and firm

size

OLS regressions The proportion of independent

directors is negatively related to

the revenue to assets ratio

191

percentage growth in

assets, revenue, net profit,

EBIT and cash flow

Cotter and

Silverster (2003)

109 Australian

firms

The percentage of

independent directors on

the board, on the audit or

compensation committee,

and absence of the CEO

from the committee

Market value of equity Firm size Descriptive

statistics,

correlations and

OLS regressions

Neither board nor committee

independence is significantly

associated with firm value

Kiel and Nicholson

(2003)

348 Australian

firms


outside directors and CEO

duality

Tobin’s q and ROA None Descriptive

statistics,

correlations,

ANOVA and

multivariate

regressions

Tobin’s q is negatively related to

the proportion of outside

directors, and positively related

to board size

Bonn et al (2004) 104 Australian

firms and 160

Japanese firms

Board size, and

percentage of outside

directors or female

directors

ROA and MBT Firm age and

average age of

directors

Correlations and

multivariate

regressions

For Australian firms, the

proportion of outside directors is

positively related to ROA, and

the female ratio is positively

associated with MBT; for

Japanese firms, board size and

the average age of directors are

negatively associated with MBT

192

Balatbat et al

(2004)

1,316 firm-year

observations of

Australian 313

IPOs

The percentage of

independent directors and

CEO duality

Operating return Firm age, leverage,

retained ownership,

and the extent to

which firm is

comprised of asset-

in-place rather than

options

Descriptive

statistics, and OLS

and 2SLS

regressions

There is no evidence that board

composition is associated with

variation in performance; firms

with dual leadership are found to

perform better

Hutchinson and

Gul (2004)

310 Australian

firms

The ratio of non-

executive to executive

directors

ROE Firm size, leverage,

prior performance,

executive director

shareholdings,

managers’

remuneration and

interaction terms

Descriptive

statistics,

correlations and

OLS regressions

No significant relation is found

* 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

193

Appendix 2

Summary of Overseas Research

Variable* Author Sample

Board Characteristics Firm Performance Control Test Relevant Findings

Pfeffer (1972) 80 U.S. firms Board size and percentage

of inside directors

Net income to sales

and net income to

stockholders’

investment

None Correlations and

multivariate

regressions

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

Baysinger and

Butler (1985)

266 U.S. firms The percentage of

independent directors

Industry-adjusted

ROE

None Descriptive

statistics,

correlations and

cross-lagged

regressions

Firms that had invited relatively

more independent directors onto their

boards in 1970 enjoyed relatively

better records of financial

performance in 1980

Kenser (1987) 250 U.S. firms The percentage of inside

directors

ROA, ROE, EPS,

profit margin, stock

market performance

and total return to

investors

None Descriptive

statistics and

correlations

The proportion of inside directors is

positively related to current

performance in terms of ROA and

profit margin, and future

performance measured by total return

to investors

Hermalin and 1,521 firm-year The departures or Stock return and Firm size, number and Descriptive Poor stock return leads to the

194

Weisbach (1988) observations of

142 U.S. firms

additions of inside or

outside directors

earnings change median tenure of inside

or outside directors,

CEO retirement and

tenure, current board

composition and

possible vacancies, and

change in the number of

industries

statistics,

correlations and

Poisson models

resignations of inside directors;

outside directors are added after poor

performance measured by both stock

return and earnings change

Molz (1988) 50 U.S. firms Managerial control factor

consisting of joint

chairman/CEO,

chairman/CEO tenure,

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, inside and

outside director

stockholdings, and

woman and minority

group representation

ROA, ROE and total

return to shareholders

None Correlations,

confirmatory factor

analysis,

discriminant

analysis, ANOVA

and MANOVA

There was no significant relationship

between the degree of managerial

control on the board and financial

performance

195

Fosberg (1989) 127 pairs of U.S.

firms

The percentage of outside

directors

ROE, sales, expenses,

number of

employees, sales to

total assets, expenses

to total assets and

number of employees

to total assets

None Paired sample

analysis

There is no relationship between the

proportion of outside directors and

managerial performance

Schellenger et al

(1989)

526 U.S. firms The percentage of outside

directors

ROA, ROE,

shareholder return,

and risk-adjusted

shareholder return

None Descriptive

statistics and

correlations

ROA and risk-adjusted shareholder

return correlate positively with the

percentage of outside directors

Rosenstein and

Wyatt (1990)

1,251 outside

director

announcements

The appointments of only

one outside director and

no inside directors

Stock abnormal

returns

None

Descriptive

statistics,

frequency

distribution, and

parametric and

nonparametric tests

The appointments of an outside

director are accompanied by positive

excess returns, even though most

boards are dominated by outsiders

before the appointments

Hermalin and

Weisbach (1991)

1,521 firm-year

observations of

142 U.S. firms

The percentage of inside

or outside directors

Tobin’s q and EBIT Firm size, R&D and

advertising expenses,

CEO tenure, median

tenures of insiders and

outsiders, and family

company control

OLS regressions There does not appear to be a relation

between board composition and firm

performance, although firms with

longer median tenures of outsiders

tend to have higher performance

measured as q

196

Pearce II and

Zahra (1992)


affiliated or independent

directors

ROA, ROE, EPS and

net profit margin

Firm size Canonical analysis,

ANOVA, and

MANOVA

Effective past performance is

associated with larger boards and

lower outsiders’ representation; large

boards and high representation of

outsiders are associated positively

with future performance

Daily and Dalton

(1992)

100 U.S. firms The number and


directors, and CEO

duality

ROA, ROE and

price/earnings ratio

None Descriptive

statistics,

correlations,

contingency

analysis and

MANOVA

There is a positive relation between

total numbers and proportion of

outside directors and firm

performance measured by


Daily and Dalton

(1993)

186 U.S. firms The number and


directors, and CEO

duality

ROA, ROE and


Firm age and industry

control

Descriptive

statistics,

correlations,

contingency

analysis and

MANOVA

The results demonstrate a positive

relationship between total numbers

and proportion of outside directors

and financial performance

Yermack (1996) 3,438 firm-year

observations of

452 U.S. firms

Board size and percentage

of outside directors

Tobin’s q, ROA,

sales to assets and

return on sales

Firm size, profitability,

investment and growth

opportunities,

diversification, insider

ownership, stockholder-

Descriptive

statistics, OLS

regressions, and

fixed-effect, Probit

and Poisson

In the OLS model there is a negative

association between the percentage

of outside directors and q; in the

fixed-effect model a positive relation

is found. Firms are valued more

197

directors, CEO duality,

and industry and

individual year controls

models highly when the CEO and chairman

positions are separated

Agrawal and

Knoeber (1996)

383 U.S. firms The percentage of outside

directors

Tobin’s q Firm size,

diversification,

regulated firms and

founding CEOs

OLS and 2SLS

regressions

Fewer outside directors lead to

improved firm performance or, better

performance may lead to fewer

outsiders on the board

Rosenstein and

Wyatt (1997)

170 inside

director

announcements

The appointments of one

or more inside directors

and not outside directors

Stock abnormal

returns

None

Descriptive

statistics,

frequency

distribution, and

parametric and

nonparametric tests

The market reaction to the

announcements is negative when

inside directors own less than 5% of

the firm’s stock, and positive when

their ownership level is between 5%

and 25%

Klein (1998) 485 U.S. firms The percentage of inside

directors

ROA, stock abnormal

returns, Jensen

Productivity and

market returns

Firm risk, director

shareholdings, director

quality, R&D,

relationship investing,

capital expenditures,

and CEO influence

Descriptive

statistics and OLS

regressions

There are positive linkages between

the percentages of inside directors on

finance and investment committees

and performance measures; firms

increasing inside director

representation on these committees

experience higher abnormal returns

than firms decreasing the percentage

of inside directors on these two

committees

198

Barnhart and

Rosenstein

(1998)

321 U.S. firms Board size and percentage

of independent directors

Tobin’s q Firm size, leverage,

R&D and advertising

expenses, institutional

ownership and industry

control

Descriptive

statistics,

correlations, and

OLS and 3SLS

regressions

There may be a curvilinear relation

between the proportion of

independent directors and firm

performance

Dalton et al

(1998)

228 samples of

U.S. firms

The percentage of inside,

outside, affiliate,

independent or

interdependent directors,

and chairman leadership

Accounting and

market performance

indicators

None Meta-analyses Board composition has virtually no

effect on accounting and market

performance indicators; there is no

relationship between board

leadership structure and firm

performance

Vafeas and

Theodorou

(1998)

250 U.K. firms The percentage of

independent or “grey”

directors on the board,

percentage of NEDs on

the audit, nomination or

remuneration committee,

and chairman

independence

ROA, MBT, market

to book value of

equity, and stock

return

ROA, sales, leverage,

R&D expenses,

dividend yield and

industry control

Descriptive

statistics and OLS

regressions

There is no significant link between

board characteristics and firm

performance

Denis and Sarin

(1999)

4,563 firm-year

observations of

583 U.S. firms



Market-adjusted

stock return

Firm size, firm age,

firm risk, leverage,

growth opportunities,

new CEOs, control

Descriptive

statistics,

correlations,

frequency

Large changes in outside

representation and board size are

associated with CEO replacements

and corporate control threats, and

199

threats, and firms in

which founders left

distribution, and

OLS regressions

stock return appears to be higher

among firms that subsequently

increase the proportion of

independent directors

Bhagat and

Black (2000)

934 U.S. firms Board size, and board

independence level

proxied by the percentage


minus percentage of

inside directors

Tobin’s q, ROA,

market-adjusted stock

price return and sales

to assets

Firm size, CEO

ownership, outside

director ownership,

blockholder ownership,

firm and industry sales

growth, and industry

control

Descriptive

statistics, and OLS

and 3SLS

regressions

There is a correlation between poor

performance and subsequent increase

in board independence

Coles et al

(2001)



CEO duality

EVA and MVA Firm size, blockholder

ownership, and industry

Descriptive

statistics,

correlations and

multivariate

regressions

There is a positive contribution of

CEO duality to EVA, and a negative

influence of independent directors

and CEO salary sensitivity on MVA

Dehaene et al

(2001)

122 Belgian

firms



duality

Industry-adjusted

ROA and ROE

None Descriptive

statistics and

multivariate

regressions

There is a positive relation between

the number of outside directors and

ROE; however, where the functions

of CEO and chairman are combined,

ROA appears higher

Hossain et al

(2001)

633 firm-year

observations of



Tobin’s q Firm size, leverage,

diversification and

Descriptive

statistics,

The proportion of independent

directors has a positive influence on

200

New Zealand

firms

CEO duality

growth opportunities correlations and

OLS regressions

firm performance

Singh and

Davidson III

(2003)

236 firm-year

observations of

U.S. firms

Board size, and

percentage of inside,

affiliated or independent

directors

Asset turnover and

SG&A expenses to

sales

Firm size, leverage,

managerial ownership,

blockholder ownership

and industry

Descriptive

statistics and

multivariate

regressions

Boar composition does not seem to

significantly influence agency costs;

boar size is negatively related to asset

turnover, but unrelated to

discretionary expenses

Panasian et al

(2003)

274 Canadian

firms


unrelated directors and

CEO duality

Tobin’s q Firm size, ROA, capital

structure, blockholder

ownership, intangibles

to total assets, and

investment

opportunities

Descriptive

statistics and fixed-

effect models

For firms with prior average q less

than one, there is a positive

correlation between the proportion of

unrelated directors and performance

Anderson and

Reeb (2004)

2,686 firm-year

observations of

403 U.S. firms

The percentage of

independent, affiliated or

family directors

Tobin’s q Firm size, firm age,

firm risk, ROA and

investment

opportunities

Descriptive

statistics, fixed-

effect models and

2SLS regressions

Among firms with founding-family

ownership, there is a positive relation

between the proportion of

independent directors and q

Peng (2004) 1,211 firm-year

observations of

405 Chinese

firms

The percentage of

affiliated or non-affiliated


duality

ROE and sales

growth

Firm size, firm age,

prior performance,

inside or outside

director ownership, and

state ownership and

Descriptive

statistics,

correlations, and

weighted

generalized least-

Outside directors do make a

difference in firm performance, if

such performance is measured by

sales growth; they have little impact

on financial performance such as

201

state directors squares and

proportional

hazards regressions

ROE

Dulewicz and

Herbert (2004)

86 U.K. firms Board size, NED presence

factor consisting of the

number and percentage of

NEDs in relation to board

size or executive

directors, and chairman

independence factor

consisting of non-

executive chairman versus

executive chairman

CFROTA and sales

turnover

None Descriptive

statistics,

correlations and

rotated factor

analysis

The number of executive directors is

positively associated with CFROTA,

and the number and proportion of

NEDs are negatively related to sales;

companies with a chairman who is

not the CEO or is a NED tend to

perform better in terms of CFROTA

Randoy and

Jenssen (2004)

294 firm-year

observations of

98 Swedish firms


of outside directors

Tobin’s q and ROE Firm size, firm age,

leverage, blockholder

ownership and foreign

exchange listings

Correlations and

OLS regressions

Among firms facing high levels of

product market competition, there is

a negative relation between the

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 Descriptive No significant relation is found

202

observations of

New Zealand

firms

of outside directors statistics,

correlations and

OLS regressions

Chang and Leng

(2004)

231 firm-year

observations of

77 Malaysia

firms

The percentage of NEDs,

NED chairman on the

audit committee and CEO

duality

ROE and dividend

payout

None Fixed-effect

models

Board characteristics do not have any

influence on firm performance

Chen et al (2005) 1,648 firm-year

observations of

412 Hong Kong

firms


independent NEDs,

presence of audit

committee, outsider-

dominated board and

CEO duality

ROA, ROE, and

MBT

Firm size, leverage and

sales growth

Descriptive

statistics,

frequency

distribution and

fixed-effect models

Board composition has little impact

on firm performance; there is a

negative association between CEO

duality and MBT

Krivogorsky

(2006)

87 continental

European firms

The percentage of inside

directors, independent

directors, or scholars and

CEO duality

ROA, ROE and MBT Firm size, firm age,

leverage and growth

Descriptive

statistics,

correlations and

OLS regressions

The percentage of independent

directors has a positive correlation

with ROA and ROE

Luan and Tang

(2007)

259 Taiwanese

firms

Independent director

assignment

ROE Firm size, prior

performance and

absorptive capacity,

Descriptive

statistics,

correlations and

OLS regressions

After controlling for a firm’s past

performance, independent director

appointments have a positive impact

on a firm’s performance

Choi et al (2007) 1,834 firm-year Board size, percentage of Tobin’s q Firm size, firm age, Descriptive The results indicate that outside

203

observations of

South Korea

firms

outside, independent or

affiliated directors, and

foreign outside directors

leverage, chaebol

affiliation, depository

receipt, exports to sales,

R&D expenditure to

sales, ROA, beta, and

industry and individual

year controls

statistics,

correlations and

random-effect

models

directors have significant and

positive effects on firm performance;

the effects are stronger for

independent directors than for “grey”

directors who may have professional

ties with the firm

Chan and Li

(2008)

200 U.S. firms Board size, committee

size, percentage of

independent or expert-

independent directors on

the board or audit

committee, and CEO

duality

Tobin’s q Firm size, number of

employees, director’s

age and tenure, number

of other directorships,

Fortune 500 rank, ROA

and holding period

return

Descriptive

statistics and

simultaneous

equation models

The independence of audit committee

results in higher firm value when a

majority of expert-independent

directors serve on the board; the

presence of CEO duality is related to

negative q

* 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

204

Appendix 3

Theories and Hypotheses in Prior Research

Author Theory Hypothesis* Conclusion

Pfeffer (1972) Organizational theories 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

The hypothesis is supported

Baysinger and Butler

(1985)

Legalistic view, agency theory and

transaction costs, and strategy

formulation and implementation

None A public policy prescription in favour of any particular

board composition would be inappropriate in an economy

where firms are different and are continually changing

Kenser (1987) Financial dependence perspective The proportion of inside directors serving on a firm’s

board is positively related to organizational performance

Higher inside representation is associated with greater

profitability and higher asset utilization

Hermalin and

Weisbach (1988)

None The CEO succession process and firm performance will

affect board composition

The findings are consistent with both hypotheses

Molz (1988) None Firms with managerial dominated boards will have

superior financial performance

The hypothesis is not supported

Fosberg (1989) Agency theory Increasing the percentage of outside directors on the

board enhances management performance

Agency theory could not be confirmed by the analysis in

this study

Schellenger et al

(1989)

Agency theory None The findings provides support for advocates of outsider

representation on the boards of corporations

205

Rosenstein and Wyatt

(1990)

None None The addition of an outside director increases firm value;

outside directors are selected, on average, in the interests

of shareholders

Hermalin and

Weisbach (1991)

Agency theory None There appears to be no relation between board

composition and firm performance

Pearce II and Zahra

(1992)

Strategic contingency model (i.e.,

resource dependence theory)

Poor past performance is associated positively with

small board size and low outsider’ representation;

and

Large board size and higher representation of outside

directors on the board are associated positively with

future corporate financial performance

The strategic contingency approach is a viable means of

studying board of directors’ composition

Daily and Dalton

(1992)

None CEO duality will be associated with lower firm

performance;

Fewer total outside directors will be associated with

lower firm performance; and

The proportion of outside directors will be associated

with higher firm performance

There is modest support for the proposition that firms

with greater numbers of outside directors outperform

those with fewer outside directors

Daily and Dalton

(1993)

None CEO duality will be associated with lower firm

performance;

Fewer total outside directors will be associated with

lower firm performance; and

Proportion of outside directors will be associated

It seems that firms adhering to suggested board reforms

realize performance advantages

206

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

Knoeber (1996)

Agency theory None The negative effect of outsiders on the board on firm

performance suggests that firms tend to have too many

outside directors

Rosenstein and Wyatt

(1997)

Agency theory None The expected benefits of an inside director’s expert

knowledge outweigh the expected costs of managerial

entrenchment only when managerial and outside

shareholder interests are closely aligned

Muth and Donaldson

(1998)

Agency theory, stewardship theory

and resource dependence theory

Where board members are more independent of

management, company performance will be higher

(agency theory); and

Boards with a lower level of board independence

lead to higher company performance (stewardship

theory)

Agency theory predictions relating to board independence

and firm performance are not upheld while those of

stewardship theory are supported

Klein (1998) Agency theory None Inside directors provide valuable information to boards

about the firms’ long-term investment decisions

Barnhart and

Rosenstein (1998)

None None There may be a curvilinear relation between the

proportion of independent directors and firm

performance; board composition, managerial ownership

207

and performance may be jointly determined

Dalton et al (1998) Agency theory, stewardship theory


None The findings provide support for neither agency theory

nor stewardship theory

Vafeas and

Theodorou (1998)

Agency theory There is a positive association between the fraction

of non-executive directors on the board and firm

value;

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

The results are consistent with governance needs varying

across firms, and contrast the notion that uniform board

structures should be mandated

Calleja (1999) None None The small sample size made it difficult to reach any firm

conclusions

Lawrence and

Stapledon (1999)

Agency theory None Independent directors did not appear to have added value

to Australian largest listed companies

Denis and Sarin

(1999)

None None The predominant factors associated with ownership and

control changes appear to be top executive changes, prior

stock price performance and corporate control threats

Bhagat and Black

(2000)

None None There is a reasonably strong correlation between poor

performance and subsequent increase in board

independence; there is no evidence that greater board

208

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

the board will have better performance than will

firms that join the two positions; and

Firms that select higher proportions of independent

outsiders to serve on their board of directors will

have better performance than will firms with a higher

proportion of insides on the board

While there is evidence to support that firms may use

governance packages to deal with agency issues, further

research could provide important evidence on these

issues by focusing on examining a more refined,

industry-level context

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

(2003)

Agency theory There is a positive relationship between the independence

of boards of directors (and their monitoring committees)

and firm value

There is no evidence that firm value is enhanced through

stronger monitoring committee or full board

independence

Kiel and Nicholson

(2003)



Board size is positively correlated with firm

performance;

The proportion of outside directors is uncorrelated

The arguments put forward by stewardship theory are

supported

209

with firm performance; and

Separation of chairman and CEO is uncorrelated

with firm performance

Singh and Davidson

III (2003)

Agency theory None Independent outsiders on a board do not appear to protect

the firm from agency costs

Panasian et al (2003) 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

performance in Australian firms;

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

There may be different agency relationships in different

countries

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

210

Hutchinson and Gul

(2004)

Agency theory None The results demonstrate the importance of corporate

governance for firms with more growth opportunities

Anderson and Reeb

(2004)

Agency theory and stewardship

theory

The greater the fraction of independent directors in

public firms with founding-family ownership, the

better the performance of the firm;

At low (high) levels of family board representation

relative to independent directors, the higher the ratio

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

The 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

Peng (2004) Agency theory, resource

dependence theory and

institutional theory

Greater representation on the board by outside

directors has a positive effect on firm performance;

Greater representation on the board by outside

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

While agency theory hypotheses typically fail to be

supported in emerging economies, resource dependence

and institutional claims tend to be substantiated

211

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

Herbert (2004)


and stakeholder theory

Where the roles of chairman and CEO are separated

(agency theory) combined (stewardship theory),

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

The results generally provide scant support for the main

theories of board of directors

Randoy and Jenssen

(2004)

Agency theory and stewardship

theory

Board independence has a negative influence on firm

performance in firms that face a high level of product

market competition, and

Board independence has a positive influence on firm

performance in firms that face a less competitive

product market

Board independence is less relevant or even redundant in

highly competitive industries, where the firm is already

monitored by a competitive product market; board

independence enhances firm performance among

companies facing less competitive product market

212

Chin et al (2004) Agency theory There is a positive correlation between the

percentage of outside directors and firm

performance; and

There is an inverse relationship between board size

and firm performance

There does not seem to be a rise-fall relationship in

performance relating to the percentage of outside

directors, nor to board size

Chang and Leng

(2004)

Agency theory None Several corporate governance variables do not have any

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

on the board has a strong effect on the profitability of

the company;

The proportion of inside directors does not have a

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

The theoretical predictions of agency theory on a positive

relationship between outside (independent) director and

firm performance are also applicable in the European

environment

Luan and Tang

(2007)



Ceteris paribus, appointing independent outside

directors on the board has a positive effect on firm

The findings suggest that firms that chose to appoint

independent outside directors have a higher corporate

213

performance; and

Absorptive capacity of the firms has a positive effect

on firm performance when appointing independent

outside directors on the board

profit

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

value

The presence of expert-independent directors on the

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

214

Appendix 4




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

215

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

216

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

217

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

218

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

219

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 ----- -----

220

Appendix 5




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

221

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

222

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

223

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

224

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

225

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 ----- -----

226

Appendix 6


Board Independence and Past Performance (ROA)



Coefficient


Intercept 0.474 0.557 -0.032 0.269 0.659

6.793** 5.285** -0.316 2.461* 0.327

ROA1 -0.039 0.037 -0.073 -0.138 -0.814

-0.772 0.479 -1.000 -1.731 -1.517

SIZE 0.007 0.033 0.039 0.046 -0.009

0.922 2.742** 3.432** 3.741** -0.124

BLOCK -0.255 -0.383 -0.144 -0.364 -1.066

-3.193** -3.178** -1.258 -2.922** -1.392

SEGMT 0.010 -0.001 0.020 0.007 -0.021

1.426 -0.122 1.887 0.632 -0.300

DIVR1 0.006 0.028 0.048 0.101 0.381

0.172 0.579 1.041 1.989* 1.192

AGE 0.0009 0.001 0.0005 0.0002 -0.001

1.063 0.812 0.418 0.149 -0.137

GEAR1 0.015 0.016 0.014 0.021 0.145

1.548 1.131 1.039 1.384 1.101

EQED -0.054 -0.010 -0.083 0.029 -0.533

-0.667 -0.079 -0.718 0.231 -0.677

RISK1 -0.003 -0.0003 -0.007 -0.013 -0.102

-0.589 -0.040 -0.926 -1.471 -1.034

2R /McFadden 2R 0.106 0.104 0.155 0.166 0.031

Adjusted 2R 0.071 0.070 0.123 0.134


F/LR-Statistic 3.068 3.012 4.761 5.161 10.291


Durbin-Watson 1.702 1.912 2.157 1.7870.658


227

Appendix 7


Board Independence and Past Performance (ROE)



Coefficient


Intercept 0.502 0.561 -0.004 0.308 0.890

7.305** 5.400** -0.040 2.843** 1.346

ROE1 0.033 0.033 0.011 -0.006 0.027

1.403 0.925 0.316 -0.171 0.120

SIZE 0.007 0.033 0.038 0.045 -0.016

0.849 2.751** 3.368** 3.633** -0.210

BLOCK -0.272 -0.388 -0.159 -0.383 -1.200

-3.418** -3.228** -1.385 -3.055** -1.574

SEGMT 0.009 -0.001 0.019 0.006 -0.028

1.296 -0.131 1.788 0.496 -0.404

DIVR1 -0.006 0.029 0.035 0.079 0.248

-0.187 0.622 0.767 1.593 0.811

AGE 0.0008 0.001 0.0004 8.05E-05 -0.002

0.928 0.778 0.339 0.062 -0.235

GEAR1 0.013 0.016 0.013 0.019 0.128

1.403 1.098 0.949 1.275 1.035

EQED -0.078 -0.031 -0.094 0.028 -0.557

-0.955 -0.250 -0.791 0.215 -0.703

RISK1 -0.002 7.16E-05 -0.006 -0.011 -0.072

-0.335 0.009 -0.768 -1.273 -0.831

2R //McFadden 2R 0.111 0.107 0.152 0.156 0.023

Adjusted 2R 0.077 0.072 0.119 0.123


F/LR-Statistic 3.238 3.090 4.643 4.771 7.723


Durbin-Watson 1.627 1.888 2.138 1.787


228

Appendix 8


Board Independence and Past Performance (Shareholder Return)



Coefficient


Intercept 0.489 0.551 0.002 0.327 0.905

7.168** 5.360** 0.016 3.093** 1.381

SHRET1 -0.026 -0.060 -0.129 -0.187 -0.288

-0.567 -0.878 -1.973 -2.648** -0.662

SIZE 0.007 0.033 0.038 0.044 -0.017

0.864 2.747** 3.341** 3.601** -0.230

BLOCK -0.265 -0.387 -0.176 -0.415 -1.239

-3.321** -3.217** -1.545 -3.361** -1.624

SEGMT 0.009 -0.002 0.016 0.001 -0.035

1.268 -0.211 1.511 0.099 -0.492

DIVR1 0.002 0.041 0.050 0.097 0.283

0.056 0.853 1.101 1.987* 0.920

AGE 0.0009 0.001 0.0007 0.0004 -0.001

1.073 0.928 0.566 0.325 -0.159

GEAR1 0.015 0.018 0.017 0.024 0.136

1.560 1.270 1.230 1.617 1.101

EQED -0.056 -0.010 -0.091 0.017 -0.553

-0.699 -0.084 -0.789 0.133 -0.710

RISK1 0.012 0.034 0.068 0.097 0.091

0.452 0.839 1.764 2.328* 0.346

2R /McFadden 2R 0.105 0.106 0.166 0.180 0.024

Adjusted 2R 0.070 0.072 0.133 0.149


F/LR-Statistic 3.034 3.079 5.140 5.690 8.150


Durbin-Watson 1.683 1.913 2.131 1.808


229

Appendix 9


Board Independence and Past Performance (Tobin’s Q)



Coefficient


Intercept 0.455 0.550 -0.017 0.220 0.776

6.201** 4.957** -0.161 1.923 1.100

TOBQ1 0.007 -0.001 0.002 0.020 0.022

1.138 -0.106 0.199 2.103* 0.384

SIZE 0.008 0.033 0.039 0.048 -0.013

0.985 2.749** 3.380** 3.844** -0.171

BLOCK -0.251 -0.378 -0.153 -0.358 -1.161

-3.152** -3.139** -1.331 -2.878** -1.521

SEGMT 0.010 -0.001 0.019 0.007 -0.027

1.417 -0.087 1.814 0.582 -0.383

DIVR1 0.005 0.033 0.038 0.095 0.271

0.161 0.701 0.829 1.927 0.881

AGE 0.0009 0.001 0.0005 0.0004 -0.001

1.144 0.823 0.381 0.289 -0.183

GEAR1 0.015 0.017 0.013 0.020 0.132

1.557 1.157 0.982 1.381 1.049

EQED -0.073 -0.006 -0.091 -0.027 -0.593

-0.891 -0.045 -0.767 -0.214 -0.750

RISK1 -0.003 -0.0008 -0.006 -0.011 -0.073

-0.477 -0.101 -0.805 -1.232 -0.840

2R /McFadden 2R 0.109 0.103 0.152 0.171 0.023

Adjusted 2R 0.074 0.069 0.119 0.139


F/LR-Statistic 3.155 2.985 4.636 5.349 7.856


Durbin-Watson 1.696 1.915 2.147 1.797


230

Appendix 10

OLS Regressions:

Full Board Independence and Subsequent Performance



Coefficient


Intercept -0.120 0.680 -0.439 2.688

-0.606 1.274 -4.575** 2.339*

FIND -0.272 -0.969 0.178 2.220

-1.587 -2.090* 2.141* 2.225*

SIZE 0.021 -0.009 0.025 -0.232

1.009 -0.163 2.442* -1.920

BLOCK -0.049 -1.105 0.202 1.110

-0.227 -1.880 1.912 0.877

SEGMT 0.009 0.130 0.003 -0.055

0.463 2.517* 0.336 -0.496

DIVR2 0.229 0.606 0.121 -0.894

2.827** 2.769** 3.072** -1.897

AGE 0.002 -0.0004 0.002 -0.010

0.842 -0.066 1.444 -0.791

GEAR2 -0.014 -0.691 -0.008 0.009

-0.814 -14.398** -0.916 0.084

EQED -0.485 -0.243 -0.333 2.986

-2.261* -0.419 -3.206** 2.395*

RISK2 -0.005 0.039 0.573 -0.071

-0.227 0.656 53.110** -0.546

2R 0.091 0.495 0.929 0.099

Adjusted 2R 0.055 0.475 0.926 0.064


F-Statistic 2.579 25.328 338.756 2.846


Durbin-Watson 2.019 2.047 1.990 1.917


231

Appendix 11

OLS Regressions:

Audit Committee Independence and Subsequent Performance



Coefficient


Intercept -0.187 0.574 -0.377 3.477

-0.981 1.119 -4.061** 3.119**

ACIND -0.118 -0.660 0.046 0.520

-1.029 -2.142* 0.818 0.777

SIZE 0.023 0.006 0.024 -0.233

1.081 0.101 2.368* -1.878

BLOCK -0.024 -1.108 0.174 0.739

-0.112 -1.888 1.632 0.579

SEGMT 0.006 0.120 0.005 -0.035

0.326 2.335* 0.510 -0.311

DIVR2 0.231 0.628 0.121 -0.889

2.840** 2.861** 3.044** -1.865

AGE 0.002 -0.0005 0.002 -0.009

0.791 -0.087 1.531 -0.678

GEAR2 -0.015 -0.694 -0.008 0.013

-0.851 -14.472** -0.870 0.122

EQED -0.468 -0.190 -0.345 2.839

-2.180* -0.328 -3.296** 2.259*

RISK2 -0.004 0.041 0.572 -0.078

-0.194 0.685 52.636** -0.599

2R 0.085 0.495 0.928 0.082

Adjusted 2R 0.050 0.475 0.925 0.047


F-Statistic 2.402 25.376 332.748 2.321


Durbin-Watson 2.007 2.023 2.005 1.928


232

Appendix 12

OLS Regressions:

Nomination Committee Independence and Subsequent Performance



Coefficient


Intercept -0.255 0.206 -0.351 3.783

-1.423 0.422 -4.006** 3.607**

NCIND -0.182 -0.252 0.036 1.027

-1.520 -0.773 0.624 1.470

SIZE 0.026 -0.006 0.025 -0.257

1.232 -0.111 2.351* -2.060*

BLOCK -0.004 -0.890 0.161 0.677

-0.017 -1.530 1.540 0.542

SEGMT 0.010 0.126 0.004 -0.055

0.511 2.416* 0.425 -0.487

DIVR2 0.226 0.594 0.123 -0.869

2.794** 2.629** 3.106** -1.834

AGE 0.002 -0.001 0.002 -0.009

0.790 -0.179 1.555 -0.690

GEAR2 -0.013 -0.689 -0.008 -0.0004

-0.715 -14.208** -0.932 -0.004

EQED -0.486 -0.202 -0.342 2.947

-2.267* -0.346 -3.258** 2.348*

RISK2 -0.006 0.041 0.572 -0.070

-0.253 0.679 52.560** -0.539

2R 0.090 0.486 0.928 0.088

Adjusted 2R 0.055 0.467 0.925 0.053


F-Statistic 2.554 24.514 332.318 2.510


Durbin-Watson 2.009 2.008 1.997 1.944


233

Appendix 13

OLS Regressions:

Remuneration Committee Independence and Subsequent Performance



Coefficient


Intercept -0.195 0.372 -0.355 3.491

-1.072 0.753 -3.979** 3.274**

RCIND -0.188 -0.536 0.010 0.909

-1.739 -1.824 0.182 1.432

SIZE 0.028 0.010 0.026 -0.260

1.318 0.170 2.431* -2.073*

BLOCK -0.054 -1.068 0.160 0.900

-0.249 -1.816 1.503 0.708

SEGMT 0.007 0.124 0.005 -0.041

0.392 2.409* 0.493 -0.364

DIVR2 0.236 0.623 0.123 -0.913

2.906** 2.831** 3.087** -1.921

AGE 0.002 -0.001 0.002 -0.008

0.757 -0.187 1.576 -0.654

GEAR2 -0.015 -0.694 -0.008 0.014

-0.870 -14.425** -0.884 0.137

EQED -0.465 -0.172 -0.346 2.825

-2.174* -0.296 -3.304** 2.255*

RISK2 -0.004 0.044 0.572 -0.082

-0.160 0.739 52.555** -0.628

2R 0.093 0.492 0.928 0.088

Adjusted 2R 0.057 0.473 0.925 0.053


F-Statistic 2.640 25.103 331.772 2.496


Durbin-Watson 2.003 2.041 2.002 1.930


234

Appendix 14

OLS Regressions:

Chairman Independence and Subsequent Performance



Coefficient


Intercept -0.173 0.356 -0.370 3.229

-0.928 0.704 -4.068** 2.973**

CMIND -0.115 -0.213 0.027 0.780

-1.572 -1.067 0.746 1.824

SIZE 0.019 -0.017 0.026 -0.214

0.906 -0.297 2.563* -1.771

BLOCK -0.015 -0.921 0.164 0.778

-0.068 -1.581 1.567 0.622

SEGMT 0.006 0.120 0.005 -0.031

0.301 2.318* 0.518 -0.277

DIVR2 0.235 0.610 0.121 -0.925

2.887** 2.759** 3.050** -1.952

AGE 0.002 -0.001 0.002 -0.008

0.721 -0.217 1.587 -0.622

GEAR2 -0.014 -0.690 -0.008 0.003

-0.766 -14.266** -0.918 0.032

EQED -0.484 -0.207 -0.342 2.953

-2.257* -0.355 -3.260** 2.360*

RISK2 -0.004 0.044 0.572 -0.081

-0.167 0.726 52.612** -0.627

2R 0.090 0.485 0.928 0.093

Adjusted 2R 0.055 0.468 0.925 0.058


F-Statistic 2.573 24.631 332.574 2.650


Durbin-Watson 2.015 2.008 2.002 1.926


235

Appendix 15

OLS Regressions:

Board Independence and Firm Risk



Coefficient

t-Statistic RISK2

Intercept 0.766 0.622 0.616 0.621 0.646

4.779** 4.261** 4.197** 4.161** 4.240**

FIND -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 -0.046 -0.045 -0.045 -0.047 -0.048

-2.700** -2.618** -2.562* -2.699** -2.828**

BLOCK -0.207 -0.157 -0.136 -0.130 -0.138

-1.161 -0.874 -0.773 -0.726 -0.783

SEGMT -0.008 -0.011 -0.010 -0.011 -0.011

-0.534 -0.716 -0.606 -0.699 -0.721

DIVR2 -0.240 -0.241 -0.245 -0.245 -0.242

-3.675** -3.648** -3.714** -3.701** -3.663**

AGE -0.002 -0.002 -0.003 -0.003 -0.003

-1.315 -1.402 -1.422 -1.449 -1.460

GEAR2 0.015 0.014 0.015 0.014 0.015

1.009 0.962 1.040 0.979 1.010

EQED 0.440 0.458 0.451 0.460 0.454

2.501* 2.585* 2.536* 2.592* 2.554*

SHERT2 1.612 1.612 1.611 1.612 1.612

53.110** 52.636** 52.560** 52.555** 52.612**

236

2R 0.930 0.929 0.928 0.928 0.928

Adjusted 2R 0.927 0.926 0.926 0.926 0.926


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


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