An analysis of the nature and effectiveness of corporate governance in smaller listed australian companies

An analysis of the nature and effectiveness of
corporate governance in smaller listed
Australian companies

Kevin Plastow
B Comm (Hons)

A thesis submitted in fulfilment of the requirements for the degree of
Doctor of Philosophy
to the
School of Accountancy
Queensland University of Technology

February 2011





Abstract
The objective of this thesis is to investigate the corporate governance attributes of smaller listed
Australian firms. This study is motivated by evidence that these firms are associated with more
regulatory concerns, the introduction of ASX Corporate Governance Recommendations in 2004, and
a paucity of research to guide regulators and stakeholders of smaller firms. While there is an
extensive body of literature examining the effectiveness of corporate governance, the literature
principally focuses on larger companies, resulting in a deficiency in the understanding of the nature
and effectiveness of corporate governance in smaller firms.
Based on a review of agency theory literature, a theoretical model is developed that posits that
agency costs are mitigated by internal governance mechanisms and transparency. The model
includes external governance factors but in many smaller firms these factors are potentially absent,
increasing the reliance on the internal governance mechanisms of the firm. Based on the model, the

observed greater regulatory intervention in smaller companies may be due to sub-optimal internal
governance practices. Accordingly, this study addresses four broad research questions (RQs). First,
what is the extent and nature of the ASX Recommendations that have been adopted by smaller firms
(RQ1)? Second, what firm characteristics explain differences in the recommendations adopted by
smaller listed firms (RQ2), and third, what firm characteristics explain changes in the governance of
smaller firms over time (RQ3)? Fourth, how effective are the corporate governance attributes of
smaller firms (RQ4)?
Six hypotheses are developed to address the RQs. The first two hypotheses explore the extent and
nature of corporate governance, while the remaining hypotheses evaluate its effectiveness. A timeseries, cross-sectional approach is used to evaluate the effectiveness of governance. Three models,
based on individual governance attributes, an index of six items derived from the literature, and an
index based on the full list of ASX Recommendations, are developed and tested using a sample of 298
smaller firms with annual observations over a five-year period (2002-2006) before and after the
introduction of the ASX Recommendations in 2004.
With respect to (RQ1) the results reveal that the overall adoption of the recommendations increased
from 66 per cent in 2004 to 74 per cent in 2006. Interestingly, the adoption rate for
recommendations regarding the structure of the board and formation of committees is significantly
lower than the rates for other categories of recommendations. With respect to (RQ2) the results
reveal that variations in rates of adoption are explained by key firm differences including, firm size,
profitability, board size, audit quality, and ownership dispersion, while the results for (RQ3) were
inconclusive. With respect to (RQ4), the results provide support for the association between better
governance and superior accounting-based performance. In particular, the results highlight the
importance of the independence of both the board and audit committee chairs, and of greater
accounting-based expertise on the audit committee. In contrast, while there is little evidence that a
majority independent board is associated with superior outcomes, there is evidence linking board
independence with adverse audit opinion outcomes. These results suggest that board and chair
independence are substitutes; in the presence of an independent chair a majority independent board
may be an unnecessary and costly investment for smaller firms.
The findings make several important contributions. First, the findings contribute to the literature by
providing evidence on the extent, nature and effectiveness of governance in smaller firms. The
A

governance code. The findings regarding board and chair independence, and audit committee
characteristics, suggest that policy-makers could consider providing additional guidance for smaller
I
?
A“X
rather than a prescriptive rules-based approach.


ii


Table of Contents
Abstract

...................................................................................................................................................... i

Table of Contents ......................................................................................................................................... iii
List of Tables ................................................................................................................................................. ix
List of Figures ............................................................................................................................................... xi
Statement of Original Authorship ............................................................................................................... xii
List of Abbreviations ....................................................................................................................................xiii
Acknowledgements .................................................................................................................................... xvi

Chapter One: Introduction
1.1 Introduction ......................................................................................................................................... 1
1.2 Motivation .............................................................................................................................................. 2
1.3 Corporate governance in smaller firms .................................................................................................. 3
1.3.1 The external governance environment ............................................................................................... 4
1.3.2 The internal governance environment ................................................................................................ 7
1.4 Research objectives and research questions ......................................................................................... 7

1.5 Theoretical framework ........................................................................................................................... 8
1.6 Research design...................................................................................................................................... 9
1.7 Summary of major findings .................................................................................................................. 10
1.8 Contribution of the study ..................................................................................................................... 11
1.9 Organisation of the thesis .................................................................................................................... 12

Chapter Two: Institutional setting
2.1 Introduction ......................................................................................................................................... 15
2.2 Development of corporate governance principles and disclosure in Australia ................................... 15
2.2.1 Voluntary period (1991-1996) ........................................................................................................... 16
2.2.2 Introduction of Listing Rule 3C(3)(j) (1996-2004).............................................................................. 17
2.2.3 Principles of Good Corporate Governance and Best Practice Recommendations ............................ 18
2.2.4 Changes subsequent to the introduction of the ASX recommendations (post 2003) ...................... 20
2.2.5 ASX recommendations in the context of theories of regulation ....................................................... 21
2.3 Overview of governance codes internationally .................................................................................... 22
2.3.1 United States ..................................................................................................................................... 23
2.3.2 United Kingdom ................................................................................................................................ 24
2.3.3 European Union ................................................................................................................................ 26
2.3.4 New Zealand ...................................................................................................................................... 27
2.3.5 Hong Kong ......................................................................................................................................... 27
2.3.6 Singapore .......................................................................................................................................... 28
2.3.7 Summary ........................................................................................................................................... 30
2.4 Corporate governance codes and smaller companies ......................................................................... 34
2.5 Conclusion ............................................................................................................................................ 40

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Chapter Three: Literature review
3.1 Introduction .......................................................................................................................................... 43

3.2 Agency theory ....................................................................................................................................... 43
3.3 Regulation of corporate disclosure ....................................................................................................... 46
3.4 The relevance of corporate governance ............................................................................................... 49
3.5 The effectiveness of corporate governance ......................................................................................... 51
3.5.1 Governance and performance and valuation studies ........................................................................ 51
3.5.2 Governance and disclosure research ................................................................................................. 53
3.5.3 Governance and ASX queries ............................................................................................................. 53
3.5.4 Governance and modified audit opinions ......................................................................................... 54
3.6 Internal governance factors .................................................................................................................. 55
3.6.1 Board characteristics ......................................................................................................................... 56
3.6.2 Board committees ............................................................................................................................. 61
3.6.3 Internal control systems .................................................................................................................... 64
3.7 External governance influences ............................................................................................................ 65
3.7.1 Debt ................................................................................................................................................... 65
3.7.2 External Audit .................................................................................................................................... 65
3.8 The relevance of corporate governance in smaller companies ............................................................ 66
3.9 Conclusion............................................................................................................................................. 68

Chapter Four: Theoretical framework and hypothesis development
4.1 Introduction .......................................................................................................................................... 71
4.2 A framework for corporate governance ............................................................................................... 72
4.3 Introduction of the ASX Best Practice Recommendations.................................................................... 77
4.3.1 Adoption of recommendations (RQ1) ............................................................................................... 77
4.3.2 Factors influencing the adoption of corporate governance recommendations (RQ2) ...................... 80
4.3.3 Factors associated with changes in corporate governance (RQ3) ..................................................... 84
4.4 Corporate governance and firm outcomes (RQ4) ................................................................................ 85
4.4.1 Performance ...................................................................................................................................... 86
4.4.2 Disclosure........................................................................................................................................... 87
4.4.3 ASX price movement queries ............................................................................................................. 88
4.4.4 Modified audit opinions..................................................................................................................... 89

4.5 Summary ............................................................................................................................................... 90

Chapter Five: Research method
5.1 Introduction .......................................................................................................................................... 91
5.2 Study period.......................................................................................................................................... 91
5.3 Sample selection ................................................................................................................................... 92
5.4 Data sources ......................................................................................................................................... 94
5.5 Research method .................................................................................................................................. 94
5.5.1 Internal corporate governance environment .................................................................................... 94

iv


5.5.2 Development of governance index ................................................................................................... 95
5.5.3 Research method H1, H2A and H2B .................................................................................................. 97
5.5.4 Change in levels of governance ......................................................................................................... 99
5.5.5 Outcome-related research models (H3 H6) ................................................................................... 99
5.5.6 The relationship between ASX recommendations and outcome variables .................................... 100
5.5.7 Internal governance variables ......................................................................................................... 101
5.6 Outcome (dependent) variables ........................................................................................................ 101
5.6.1 Performance .................................................................................................................................... 101
5.6.2 Disclosure ........................................................................................................................................ 102
5.6.3 ASX price movement queries .......................................................................................................... 104
5.6.4 Modified audit opinions .................................................................................................................. 104
5.7 Definition of independent variables ................................................................................................... 105
5.7.1 Board size (BRDSZE) ........................................................................................................................ 105
5.7.2 Board independence (BDIND) ......................................................................................................... 105
5.7.3 Independence of board chair (CHIND) ............................................................................................ 105
5.7.4 Board expertise (BDEXP) ................................................................................................................. 106
5.7.5 Board meetings ............................................................................................................................... 106

5.7.6 Audit committee (AC) ...................................................................................................................... 106
5.7.7 Remuneration committee and nomination committee (RC and NC) .............................................. 106
5.8 Control variables ................................................................................................................................ 107
5.8.1 Firm size (SIZE) ................................................................................................................................ 107
5.8.2 Industry (IND) .................................................................................................................................. 107
5.8.3 Audit firm (AUDIT) ........................................................................................................................... 108
5.8.4 Leverage (LEV) ................................................................................................................................. 108
5.8.5 Growth (GROWTH) .......................................................................................................................... 108
5.8.6 Ownership dispersion (SHLDRS) ...................................................................................................... 109
5.8.7 Age (AGE) ........................................................................................................................................ 109
5.8.8 Commitment test entities (CTE) ...................................................................................................... 109
5.8.9 Pre-post (PREPOST) ......................................................................................................................... 110
5.9 Regression models ............................................................................................................................. 110
5.9.1 Regression models for the effectiveness of corporate governance 2002-2006 ............................. 111
5.9.2 Regression model for indices based on ASX recommendations ..................................................... 113
5.10 Summary .......................................................................................................................................... 113
5.11 Conclusion ........................................................................................................................................ 115

Chapter Six: Results of the extent and nature of corporate governance
6.1 Introduction ....................................................................................................................................... 117
6.2 Observation and analysis of corporate governance reporting ........................................................... 117
6.3 Commencement of the Best Practice Recommendations ................................................................. 119
6.4 Change in ASX governance recommendations 2004-2006 ................................................................ 122
6.5 Categories of governance recommendations .................................................................................... 126

v


6.6 Factors influencing adoption of recommendations ............................................................................ 130
6.6.1 Descriptive statistics ........................................................................................................................ 131

6.6.2 Correlations ..................................................................................................................................... 134
6.7 Regression analysis of factors associated with conformance with ASX recommendations
(H2A) ................................................................................................................................................ 137
6.7.1 Factors associated with overall governance score (GOVSC) ............................................................ 137
6.7.2 Behavioural index ............................................................................................................................ 138
6.7.3 Structural index................................................................................................................................ 139
6.7.4 Disclosure index ............................................................................................................................... 140
6.7.5 Summary of regression analysis ...................................................................................................... 141
6.8 Robustness testing .............................................................................................................................. 142
6.9 Change in governance ........................................................................................................................ 142
6.10 The relationship between committee formation and board size ..................................................... 144
6.11 Conclusion......................................................................................................................................... 147

Chapter Seven: Results of tests on the effectiveness of corporate governance
7.1 Introduction ........................................................................................................................................ 149
7.2 Descriptive statistics for variables in the outcomes models............................................................... 149
7.2.1 Data transformations ....................................................................................................................... 151
7.3 Correlations ........................................................................................................................................ 153
7.4 Results for performance variables 2002- 2006 ................................................................................... 158
7.4.1 Return on assets (H3A) .................................................................................................................... 158
7.4.2 Market performance (H3A) ............................................................................................................. 161
G

-

H A ............................................................................ 162

7.4.4 Governance and market-sensitive disclosure (H4A) ........................................................................ 165
7.4.5 Governance and ASX queries (H5A) ................................................................................................. 166
7.4.6 Governance and modified audit opinions (H6A) ............................................................................. 168

7.4.7 Summary of results .......................................................................................................................... 170
7.5 Additional analysis .............................................................................................................................. 172
7.5.1 Non-contemporaneous association between governance and return on assets (ROA)
(2002-2006) ...................................................................................................................................... 172
7.5.2 Board independence ........................................................................................................................ 174
7.5.3 Audit committee characteristics ...................................................................................................... 176
7.5.4 Audit committee characteristics and performance outcomes (H3A) .............................................. 178
7.5.5 Audit committee characteristics and disclosure (H4A).................................................................... 179
7.5.6 Audit committee characteristics and ASX queries (H5A) ................................................................. 181
7.5.7 Audit committee characteristics and modified audit opinions (H6A) ............................................. 181
7.5.8 Summary of associations between audit committee characteristics and dependent
variables ........................................................................................................................................... 182
7.5.9 Robustness testing ........................................................................................................................... 183
7.5.10 Summary of additional analysis ..................................................................................................... 184
7.6 Governance indices created from the ASX recommendations 2004-2006 ......................................... 184

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7.6.1 Governance indices and ROA .......................................................................................................... 185
7.6.2 Governance indices and market returns ......................................................................................... 188
7.6.3 Governance indices and voluntary disclosure ................................................................................. 189
7.6.4 Governance indices and market-sensitive disclosures .................................................................... 191
7.6.5 Governance indices and ASX queries .............................................................................................. 193
7.6.6 Governance indices and modified audit opinions ........................................................................... 193
7.6.7 Summary of results for ASX recommendations-based indices ....................................................... 195
7.7 Principal components analysis of the ASX recommendations ........................................................... 196
7.7.1 Description of the components ....................................................................................................... 199
7.7.2 Association between governance components and performance variables 2004-2006 ................ 202
7.7.3 Association between governance components and disclosure variables 2004-2006 ..................... 203

7.7.4 Association between governance components and ASX queries 2004-2006 ................................. 205
7.7.5 Association between governance components and modified audit opinions 2004-2006 .............. 205
7.7.6 Summary of PCA analysis of ASX recommendations. ...................................................................... 205
7.8. Review of results ............................................................................................................................... 207
7.8.1 Accounting-based performance ...................................................................................................... 207
7.8.2 Disclosure ........................................................................................................................................ 208
7.8.3 Modified audit opinions .................................................................................................................. 209
7.9 Conclusions ........................................................................................................................................ 209

Chapter Eight: Conclusions
8.1 Introduction ....................................................................................................................................... 211
8.2 Summary of thesis .............................................................................................................................. 211
8.2.1 Motivation for the research ............................................................................................................ 211
8.2.2 Theoretical framework and hypotheses ......................................................................................... 212
8.2.3 Research method ............................................................................................................................ 213
8.3. Summary of findings ......................................................................................................................... 213
8.3.1 The nature of corporate governance in smaller firms .................................................................... 213
8.3.2 The effectiveness of corporate governance .................................................................................... 214
8.4 Discussion of key findings .................................................................................................................. 216
8.5 Limitations and opportunities for further research ........................................................................... 217
8.6 Contribution ....................................................................................................................................... 219

References................................................................................................................................................ 223
Appendix A:Members of the ASX Corporate Governance Council and Members of the Working
G
C
P
C
.................................................................. 233
Appendix B: The ASX Best Practice Recommendations ........................................................................... 235

Appendix C: Australian Stock Exchange Listing Rules Appendix 4A ......................................................... 237

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viii


List of Tables
Table 1.1 Differences in the information environment for listed Australian firms ....................................... 5
Table 2.1 Review of international corporate governance codes ................................................................ 31
Table 2.2 Comparison of different approaches to governance in smaller listed companies ...................... 40
Table 5.1 Summary of sample selection process ........................................................................................ 93
Table 5.2 Sample distribution and size comparison .................................................................................... 94
Table 5.3 Components of governance index based on ASX Recommendations ......................................... 97
Table 5.4 Summary of regression techniques ........................................................................................... 111
Table 5.5 Summary of predicted relationships between independent and control variables
and dependent variables .......................................................................................................... 114
Table 5.6 Summary description of independent variables........................................................................ 115
Table 6.1 Changes in governance practices 2002-2006 ............................................................................ 120
Table 6.2 Significance of changes in governance practices 2002-2006 .................................................... 122
Table 6.3 Conformance with ASX recommendations 2004-2006 ............................................................. 123
Table 6.4 Adoption of ASX recommendations by category ....................................................................... 126
Table 6.5 Tests of changes in adoption of governance recommendations ............................................... 130
Table 6.6 Descriptive statistics raw data ................................................................................................ 132
Table 6.7 Descriptive statistics transformed data .................................................................................. 133
Table 6.8 Frequencies of dichotomous variables ...................................................................................... 134
Table 6.9 Pearson and Spearman correlation coefficients........................................................................ 135
Table 6.10 Results of regression analysis on governance score (GOVSC) ................................................. 138
Table 6.11 Results of regression analysis on behavioural governance score (GOV_B) ............................. 139

Table 6.12 Results of regression analysis on structural governance score (GOV_S)................................. 140
Table 6.13 Results of regression analysis on disclosure governance score (GOV_D) ............................... 141
Table 6.14 Summary of relationships between governance indices and independent variables in 2004 142
Table 6.15 Results of regression analysis on change of structural governance ........................................ 144
Table 6.16 Cross Tabulations of board size and committees .................................................................... 146
Table 7.1 Descriptive statistics of panel data 2002-2006.......................................................................... 152
Table 7.2 Pearson and Spearman correlation coefficients........................................................................ 156
Table 7.3 Results of OLS regression of governance measures on return on assets (ROA) 2002-2006 ..... 160
Table 7.4 Results of OLS regression of governance measures on market adjusted returns
(CAR) 2002-2006...................................................................................................................... 162
Table 7.5 Results of ZINB regression of governance measures on non-routine disclosure
(ASX code '14") 2002-2006 ....................................................................................................... 164
Table 7.6 Results of ZTNB regression of governance measures on market-sensitive disclosure .............. 166
2002-2006 ................................................................................................................................ 166
Table 7.7 Results of logistic regression of governance measures on ASX queries 2002-2006 .................. 168

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Table 7.8 Results of logit regression of governance measures on modified audit opinion (MAO) .......... 170
2002-2006 ................................................................................................................................ 170
Table 7.9 Summary of results ................................................................................................................... 171
Table 7.10 Results of OLS regression of governance measures on one- and two-year lags of return on
assets (ROA) 2002-2006 ........................................................................................................ 173
Table 7.11 Descriptive statistics for audit committee characteristics ...................................................... 177
Table 7.12 Results of regression analysis of audit committee characteristics on performance
2002-2006 ................................................................................................................................ 179
Table 7.13 Results of regression of governance measures on disclosure variables ................................. 180
Table 7.14 Results of regression of audit committee characteristics on modified audit opinions
(MAO) 2002-2006 ................................................................................................................. 182

Table 7.15 Summary of significant associations between audit committee characteristics and
dependent variables ................................................................................................................ 183
Table 7.16 Results of test of OLS regression of governance indices on return on assets (ROA)
2004-2006 (RM 5) ................................................................................................................. 186
Table 7.17 Results of OLS regression of governance indices on one-year lagged return on assets
(ROA) 2004-2006 (RM 5) .......................................................................................................... 187
Table 7.18 Results of OLS regression of governance indices on two-year lagged return on assets
(ROA) 2004-2006 (RM 5) .......................................................................................................... 188
Table 7.19 Results of OLS regression of governance indices on CAR 2004-2006 (RM 5) ......................... 189
Table 7.20 Results of ZINB regression on voluntary disclosure ................................................................ 190
Table 7.21 Results of ZTNB regression of governance indices on market-sensitive disclosure
2004-2006 (RM5) ..................................................................................................................... 192
Table 7.22 Results of logistic regression on receipt of modified audit opinion ........................................ 194
Table 7.23 Summary of results for governance indices based on ASX recommendations ....................... 195
Table 7.24 Comparison of component and randomly generated eigenvalues, and reliability
coefficients for components derived from ASX recommendations ......................................... 198
Table 7.25 Identification of components and the relevant variables ....................................................... 200
Table 7.26 Summary of predicted relationships between governance components and
dependent variables 2004-2006 .............................................................................................. 201
Table 7.27 Results of OLS regression of governance components on temporal measures of
return on assets (ROA) 2004-2006 .......................................................................................... 203
Table 7.28 Results of regression of governance components on disclosure variables ............................ 204
Table 7.29 Results of logistic regression of governance components on modified audit opinions
2002-2006 ............................................................................................................................. 206
Table 7.30 Summary of associations between components and dependent variables ........................... 206

x


List of Figures

Figure 1.1 Financial and information flows in a capital markets economy ................................................... 6
Figure 1.2 Financial and information flows for smaller firms........................................................................ 6
Figure 2.1 Flowchart of changes in corporate governance reporting in Australia ...................................... 16
F

I

.................................................... 74

Figure 4.2 Corporate governance framework ............................................................................................. 75
Figure 6.1 Changes in selected governance mechanisms 2002-2006 ....................................................... 121
Figure 6.2 Change in total conformance by level and by category 2004-2006 ......................................... 127
Figure 7.1 Scree plot of eigenvalues of components based on ASX Recommendations .......................... 198

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xii


xiii


List of Abbreviations
AIM

Alternative Investment Market

AIMA

A

AMEX

American Stock Exchange

ASIC

Australian Securities and Investments Commission

ASA

A

ASX

Australian Securities Exchange (formerly Australian Stock Exchange)

ASXCGC

ASX Corporate Governance Council

ASXMS

ASX Markets Supervision

CCDG

Council of Corporate Disclosure and Governance

CGC

Corporate Governance Committee

CISCO

City Group for Smaller Companies (now Quoted Companies Alliance)

CLERP

Corporate Law Economic Reform Program

CTE

Commitments Test Entity

ECGF

European Corporate Governance Forum

FRC

Financial Reporting Council

GEM

Growth Enterprise Market

HKEx

Stock Exchange of Hong Kong

ICAA

Institute of Chartered Accountants in Australia

IFRS

International Financial Reporting Standards

LSE

London Stock Exchange

MAS

Monetary Authority of Singapore

NASDAQ

National Association of Securities Dealers Automatic Quotation

NYSE

New York Stock Exchange

NZSC

New Zealand Securities Commission

NZX

New Zealand Exchange

OECD

Organisation for Economic Co-operation and Development

PCA

Principal Components Analysis

PCAOB

Public Accounting Oversight Board

SEC

Securities and Exchange Commission

SGX

Singapore Exchange

I

M

“

A

A

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Acknowledgements

This thesis would not have been possible without the support, encouragement and
contributions of many people.

I am grateful to my supervisors, Professor Gerry Gallery and Professor Natalie Gallery for their
continual guidance and support throughout the duration of the project. I am also deeply
indebted to Dr Stephen Cox for his assistance and advice. I would also like to thank the staff in
the School of Accountancy and my fellow research students for their helpful comments,
friendship and encouragement.

I would also like to thank Kim for her patience during the long journey and everyone else who
has been neglected.

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xvii

Chapter One
Introduction
1.1 Introduction
There has been considerable public, investor and regulatory interest in corporate governance
issues over the past 20 years. This interest has been created by a number of stimuli, including
increased fluidity of global capital, corporate failures, the need to improve investor confidence,
and recent poor public perception of corporate accountability. In response to these stimuli,
market regulators across the globe have undertaken reforms of corporate governance
requirements, usually taking the form of development of codes of conduct or best practice
guidelines.

A spate of corporate failures in 2001, both in Australia and overseas, led the Australian Stock
Exchange1 (ASX) to form the ASX Corporate Governance Council (ASXCGC)
develop and deliver an industry-wide, supportable and supported framework for corporate
A“XCGC

Foreword)2. In 2003, t

C

P

Good Corporate Governance and Best Practice Recomme
which became effective for listed companies from reporting dates after 1 January 2004.

The ASX first required companies to disclose their corporate governance practices when Listing
Rule 3C(3)(j) became effective for reporting periods ending on or after 30 June 1996. This rule
required listed companies to disclose their main corporate governance practices in place

during the reporting period.

The ASX opted for a non-prescriptive approach with the

subsequent introduction of recommendations owing to concerns that smaller companies
might be overwhelmed by the burden of compliance (Ramsay and Hoad, 1997). Concerns
about the cost of compliance with corporate governance codes for smaller companies have
been a feature of debates in other jurisdictions. In the context of the UK market, Peter (2005,
p. 154) observes that:

1

Now Australian Securities Exchange
Ironically, the first corporate governance code in Australia, developed by a working group chaired by
Henry Bosch, was in response to a loss of investor and public confidence following the corporate

2

1


While the major principles of good corporate governance are of relevance to all
companies, it would be a mistake to believe that every aspect of the detail of what is
promulgated for large listed companies is relevant across the spectrum. In order to
achieve acceptance and eventually enthusiasm for corporate governance the principle
must be relevant to the size, structure and nature of the business entity.

P

A

he Australian market is characterised by a large

number of smaller companies (Ramsay and Hoad, 1997), and the debate regarding how
corporate governance requirements should apply to these companies has been robust. The
objective of this thesis is to investigate the nature and effectiveness of corporate governance
in smaller listed Australian companies.

1.2 Motivation
This thesis is motivated by several factors. First, despite the debate over how corporate
governance codes should apply to smaller companies, there is comparatively little empirical
evidence related to the corporate governance environment of smaller companies, and the
efficacy of governance mechanisms in these firms. Reasons for the lack of empirical evidence
include the economic significance of the largest companies and the availability of data for
these firms. This thesis addresses this gap by examining the governance structures of smaller
Australian firms.

Second, despite the lack of research focus on smaller companies, there is evidence that smaller
companies create more regulatory concerns. Smaller listed Australian companies receive a
disproportionately high number of ASX queries regarding large, unexplained share price
movements (Neagle and Tsykin, 2001). Smaller companies in the US are also associated with a
higher number of regulatory interventions for breaches of accounting standards (Dechow,
Sloan and Sweeney, 1996). This evidence of adverse outcomes for smaller firms provides the
second motivation for exploring the governance environment of smaller firms.

Third, the introduction of the ASX Recommendations in 2004 provides an opportunity to
examine how smaller companies have approached the commencement of a new governance
code and to determine if the new code has caused smaller firms to review and amend their
corporate governance policies and mechanisms. More specifically, this thesis investigates the
extent of adoption of individual recommendations and examines the principal factors

associated with the governance choices of smaller firms.
2

Where changes in corporate


governance policies have occurred, this thesis explores whether the desired outcomes have
been achieved.

Fourth, the ASX is considering further relaxation of its listing and compliance rules to
encourage further listings of companies with market capitalisation under $100M (Molina,
2006; Wilson, 2008). The listing of large numbers of small and potentially unprofitable firms
raises concerns regarding the corporate governance of these firms. Many of these firms will
lack market visibility, resulting in insufficient external monitoring and governance. More
reliance will therefore be placed on the internal corporate governance structures which, for
new listings, may not be sufficiently developed to best guide these companies.

1.3 Corporate governance in smaller firms
Effective corporate governance measures act to reduce the agency costs that arise from the
information asymmetries caused by the separation of ownership and management. The
agency conflict is central to Shleifer and Vishny (1997) description of corporate governance

C

governance is a broad term given to the disparate forces and

mechanisms that direct and influence the operations and management of a company. A
commonly cited definition is
originating in the Cadbury Committee report (1992: para 2.5). Yet, these definitions and
others seemingly overlook the complexity of corporate governance and its influences and

mechanisms. The Organisation for Economic Co-operation and Development (OECD) takes a
more holistic approach and describes corporate governance as a set of relationships between
I
structure through which the objectives of the company are set, and the means of attaining
OECD

T

OECD

definition takes a broader view of governance, in contrast to the narrower definitions focused
on control or suppliers of finance.

The ASXCGC (2003, p. 3) also uses a broad approach that incorporates the notion of
accountability by defining corporate governance as:
I
objectives of the company are set and achieved, how risk is monitored and assessed,
and how performance is optimised. Good corporate governance structures encourage
3