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What makes a board independent? Australian evidence

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  • Liyu He
  • Sue Wright
  • Elaine Evans
  • Susan Crowe

Abstract

Purpose - The purpose of this paper is to determine what aspects of board independence, in terms of board structure and characteristics of non‐executive directors (NEDs), are associated with effective monitoring of management, as evidenced through lower levels of earnings management. Design/methodology/approach - This paper examines the effectiveness of board independence requirements under the 2003 Australian Stock Exchange (ASX)Principles of Good Corporate Governance and Best Practice Recommendations(POGCG) for a sample of 231 firms listed on the ASX in the financial year 2005. The associations of board composition, share ownership and compensation of NEDs with the level of earnings management are estimated. To explore the characteristics of NEDs that are important for effective monitoring, NEDs are separated into “grey” (affiliated) directors and independent directors and compensation is separated into variable and fixed components. Findings - The results of the paper indicate a positive relation between earnings management and share ownership of NEDs, particularly that of grey directors. There is a negative relation between NED compensation and the level of earnings management, particularly the fixed compensation component for independent directors. Practical implications - This paper is important to shareholders, academics and policy makers because it shows the type of remuneration and ownership levels for NEDs that are consistent with good corporate governance. NEDs are more effective monitors when independent directors are compensated more as a fixed amount that is not related to the firm's performance. The compensation of grey directors is not associated with the level of earnings management. On the other hand, NEDs are less effective monitors as share ownership by grey directors increases. The share ownership of independent directors is not associated with the level of earnings management. To ensure the independence of the board and enhance its ability and incentives to effectively monitor management, the paper recommends that remuneration of NEDs should be a fixed amount, and the share ownership of NEDs should be limited. Originality/value - The findings provide guidance as to the meaning of board independence, in terms of the payments and returns that NEDs receive from a company. The results provide support for recommendation 2.1 in the ASX'sPOGCGthat requires the majority of the board to be independent directors. The paper highlights the need for boards to be careful when choosing and rewarding NEDs.

Suggested Citation

  • Liyu He & Sue Wright & Elaine Evans & Susan Crowe, 2009. "What makes a board independent? Australian evidence," Accounting Research Journal, Emerald Group Publishing Limited, vol. 22(2), pages 144-166, September.
    • Handle: RePEc:eme:arjpps:v:22:y:2009:i:2:p:144-166
    DOI: 10.1108/10309610910987493
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    Cited by:

    1. Santiago Lago-Peñas & Elena Rivo-López & Mónica Villanueva-Villar, 2016. "On the relationship between corporate governance and value creation in an economic crisis: Empirical evidence for the Spanish case," Working Papers. Collection C: Family business 1602, Universidade de Vigo, GEN - Governance and Economics research Network.
    2. Devika Sharma, 2010. "Uranium Trade and its Security Implications for India," South Asian Survey, , vol. 17(1), pages 91-110, March.

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