Studi Kelayakan Bisnis

Accounting and Finance
Do corporate governance recommendations improve the

performance and accountability of small listed
companies?
Jacqueline Christensena, Pamela Kenta, James Routledgea,

Jenny Stewartb
a
Bond Business School, Bond University, Gold Coast,
b
Griffith Business School, Griffith University, Nathan, QLD, Australia
Abstract
This study examines whether the implementation of the 2003 Australian

Securities Exchange Limited governance recommendations influenced the
governance choices of small companies and whether compliance improves their
accounting and market performance and earnings quality. Our analysis
examines small and large companies because we are interested in the different
effects of the governance recommendations on the two groups. The analysis
shows a significant shift by small and large companies to comply with the
recommendations around the time of their introduction. We find that
formation of an audit committee surrounding the reform period is significantly
associated with improved earnings quality for small and large companies.
However, compliance with other governance recommendations is not system-
atically associated with improved performance or earnings quality.
Key words: Small companies; Governance; Performance; Accountability
JEL classification: M40, M41
doi: 10.1111/acfi.12055
1. Introduction
This study examines whether comply or explain governance regulation

implemented by the Australian Securities Exchange Limited (ASX) improves
The authors would like to acknowledge the valuable suggestions made by Jere Francis,
Stephen Lin, Gulasekaran Rajaguru, Tom Smith, participants at the Journal of
International Accounting Research Conference and two anonymous referees.
Received 2 May 2013; accepted 30 September 2013 by Gary Monroe (Editor).
© 2013 AFAANZ
2 J. Christensen et al./Accounting and Finance
the performance and accountability of small listed companies. Significant

corporate failures of the last decade or so prompted a revision of corporate
governance regulation in many jurisdictions. In Australia, the ASX Corporate
Governance Council released The Principles of Good Corporate Governance
and Best Practice Recommendations in 2003 (ASX Corporate Governance
Council, 2003). The recommendations adopted the comply or explain principle,
which allows companies to choose whether they comply with the recommen-
dations, but requires that noncompliance is disclosed and explained in
company annual reports (ASX Listing Rule 4.10.3). The comply or explain
principle is aimed at overcoming the inflexibility of one size fits all regulation.
Preserving flexibility is important because effective governance practice is likely
to differ substantially between small and large companies. In Australia, and in
most other jurisdictions, small companies are a substantial proportion of all
listed companies. Therefore, how governance regulation affects small compa-
nies is an important regulatory efficiency issue.
The primary objectives of our study are to examine whether (i) the ASX
comply or explain regulation has resulted in small and large companies
systematically adopting the ASX recommended governance practices and (ii)
whether adoption improves company performance and accountability. The
ASX claims that the aim of its recommendations is to promote company
value and accountability (ASX Corporate Governance Council, 2003).
Accordingly, we test the association between compliance and financial
performance as a proxy for value, and earnings quality as a proxy for
accountability. Our analysis examines small and large companies because we
are interested in the different effects of the governance recommendations on
the two groups.
Studies show that companies tend to adopt efficient bundles of governance
mechanisms by estimating the costs and benefits of their implementation
(Beatty and Zajac, 1994; Zajac and Westphal, 1994; Rediker and Seth, 1995;
Ward et al., 2009). Comply or explain regulation is intended to allow
companies to continue to make efficient governance choices on a cost–benefit
basis. However, it is an open question as to whether comply or explain
regulation preserves this flexibility. While small companies may achieve
optimal or efficient governance with less sophisticated structures, they are
likely to experience pressure to comply with the recommendations. Signalling
theory suggests that directors view the disclosure of explanations for
noncompliance with the ASX recommendations as an adverse signal (Gennotte
and Trueman, 1996; Campbell et al., 2001; Oliveira et al., 2006). Furthermore,
small companies are likely to be particularly sensitive to a negative signal from
noncompliance because they tend to be younger, are less well known, have
higher idiosyncratic risk and less collateral (Fama and French, 1993; Gertler
and Gilchrist, 1994). Signalling theory therefore provides an explanation as to
why some smaller companies are compelled to adopt the recommendations
rather than disclose their noncompliance.
© 2013 AFAANZ
J. Christensen et al./Accounting and Finance 3
Compounding these signalling considerations is a misunderstanding about

the voluntary nature of the recommendations that was documented after their
initial release. The ASX Corporate Governance Council Implementation
Review Group (2004, 2004a, 2005, 2006) found that smaller companies and
their advisers interpreted the recommendations to be prescriptive rather than
guidelines. Further, the wider community understood the phrase best practice
as implying that all other practices are below standard (ASX Corporate
Governance Council Implementation Review Group, 2004).1
We develop hypotheses to explore whether the ASX governance recommen-
dations improve the performance and accountability of small companies
compared with large companies. We test our hypotheses by conducting
analyses using independent samples of small and large companies that were
listed on the ASX for the period from 2000 to 2005.2 The samples therefore
comprise companies that operated during the period of the 2003 implemen-
tation of the ASX governance recommendations. First, we examine whether
small and large companies changed their governance arrangements to adopt the
ASX recommendations by comparing their governance structures in the pre-
and postregulation periods (2001 and 2004). Having considered the influence of
regulation on governance choice, we investigate the association between
adoption of the recommendations and measures of performance and earnings
quality. We first perform preliminary analysis to examine this association in the
prereform year of 2001 and the postreform year of 2004. We then test whether a
change in governance structure to adoption of the recommendations is
associated with changes in performance and earnings quality over the pre- and
postregulation period.
We identify small companies based on the criteria that they have 20 or fewer
employees and have <$12.5 million in reported assets. The governance
variables included in our analysis are determined from the principles presented
in the ASX corporate governance guidelines (ASX Corporate Governance
Council, 2003). From the ten principles, we select recommendations that can be
readily operationalized from publicly available information, which include a
majority of independent directors on the board, separation of the roles of
board chair and chief executive officer (CEO), board commitment (measured
by the frequency of board meetings) and the presence of an audit committee.
1
The ASX Corporate Governance Council released the second edition of the Corporate
Governance Principles and Recommendations on 2 August 2007 (ASX Corporate
Governance Council, 2007), with further amendments issued in 2010 (ASX
Corporate Governance Council, 2010). Of note, the term ‘best practice’ was dropped
from the second edition in an attempt to remove the implication that any deviation
from these practices results in lower quality corporate governance.
2
Our measure of earnings quality requires a lead and lag year. Therfore, while we
examine companies in 2001 and 2004, it is necessary to have some data for 2000 and
2005. Thus, our sample companies were listed in both 2000 and 2005.
© 2013 AFAANZ
The study contributes to the existing literature in a number of ways. First, to

our knowledge, it is the only study to examine the extent to which the ASX
corporate governance guidelines (ASX Corporate Governance Council, 2003)
led to changes in the governance practices of small and large listed companies.
Second, while prior studies have questioned the optimality of a single board
structure for all companies (Hermalin and Weisbach, 2003; Coles et al., 2008;
Linck et al., 2008), our study is the first to specifically examine whether small
companies should adopt the same governance structures as large companies.
Third, the majority of Australian studies have used either samples of large
companies or heterogeneous samples with company size included as a control
variable (Lawrence and Stapledon, 1999; Bonn et al., 2004; Setia-Atmaja, 2009;
Lim, 2011; Pham et al., 2011; Ahmed and Henry, 2012). Our comparison of
small and large companies provides new and important insights that are not
evident from the existing literature.
Fourth, the Australian studies that have examined the governance practices
of small listed companies focus on the extent and determinants of compliance
(Da Silva Rosa et al., 2004, 2007; Da Silva Rosa and Izan, 2011; Plastow
et al., 2012). Da Silva Rosa et al. (2004, 2007) and Da Silva Rosa and Izan
(2011) investigate the relation between compliance with governance recom-
mendations and market performance in the context of initial public share
offerings, with the latter study focusing only on mining companies. Our study
examines these relationships across a range of industry sectors in a pre- and
postreform setting.
Fifth, the sample periods of 2001 and 2004 enable us to examine the direct
impact of best practice recommendations in a regime that, while not mandatory
like the U.S. Sarbanes-Oxley Act of 2002 (2002) legislation, was widely
interpreted as being more prescriptive than intended by the regulators.
The results indicate that the implementation of the ASX recommendations
did influence the governance choice of small and large companies. The
companies in our sample altered their governance arrangements towards
compliance between 2001 and 2004. However, our preliminary analysis
indicates that, for small companies, adoption of the ASX recommendations
is generally not associated with improved performance and accountability in
either the pre- or postreform periods. The exception is that compliance with the
ASX recommendation for a majority independent board is positively associ-
ated with Tobin’s Q in the 2004 postreform year. In contrast, for large
companies, we find that board independence, CEO duality, and audit
committee formation are to some extent related to performance and account-
ability measures. However, the results are mixed, suggesting the relationships
are not as strong as anticipated by the regulators. For our primary analysis of
change in governance structure, we find that, for both small and large
companies, the formation of an audit committee is positively related to
earnings quality. For large companies only, a change to separate board chair
and CEO roles is significantly associated with an increase in return on assets
© 2013 AFAANZ
(ROA). Finally, an increase in board meetings is marginally associated with an

increase in Tobin’s Q for small companies.
The article is organized as follows. The next section discusses relevant theory
and develops our hypotheses, while Section 3 outlines the research method. The
results are reported and discussed in Section 4, and conclusions are drawn in
the final section.
2. Theory and hypothesis development
We develop our hypotheses by reference to four theoretical perspectives that

explain how governance practice might assist small companies. These are as
follows: agency theory, stewardship theory, the scope of operations hypothesis
and the model of governance bundles.
Agency theory is often applied to make predictions about the benefit of
governance mechanisms. From an agency perspective, effective governance
provides monitoring of managers to protect shareholders by mitigating
opportunistic behaviour and related agency costs (Fama and Jensen, 1983;
Shleifer and Vishny, 1997). A key focus of the ASX recommendations is
enhancement of the independent monitoring role of the board of directors.
Stewardship theory in contrast proposes that managers are trustworthy and
effective stewards of company resources (Donaldson, 1990; Donaldson and
Davis, 1991, 1994; Nicholson and Kiel, 2007; Kent et al., 2010). Excessive
monitoring is likely to detract from the effectiveness of governance from the
stewardship perspective. Prior studies indicate that governance mechanisms
should balance the need for monitoring with the stewardship role and that
the appropriate balance varies with company size (Dedman, 2000; Ward
et al., 2009). Given that small firms have less need for monitoring, we
suggest that the appropriate balance tends towards a greater stewardship
role.
Large companies generally have more complex operations and more
dispersed shareholding compared with smaller companies. As a result, larger
companies have a greater need for board monitoring and access to expert
advice and resources (Coles et al., 2008; Linck et al., 2008). This relation
between business complexity and governance is referred to by Boone et al.
(2007, p. 68) as the ‘scope of operations’ hypothesis. The implication of the
hypothesis for this study is that optimal governance for small firms is not likely
to require majority adoption of the ASX recommendations.
We also refer to the model developed by Ward et al. (2009) in considering
whether compliance with the ASX recommendations assists small firms. The
model suggests that frequently the implementation of additional governance
mechanisms can be detrimental. The Ward et al. (2009) model of ‘gover-
nance bundles’ is an indifference curve analysis of corporate governance
choice and shows that companies adopt an efficient bundle of governance
mechanisms based on a cost–benefit trade-off (Beatty and Zajac, 1994; Zajac
© 2013 AFAANZ
and Westphal, 1994; Rediker and Seth, 1995). Of particular relevance to the
current study is the notion of ‘boundary conditions’ for governance bundles
(Ward et al., 2009: p. 650). The model acknowledges that companies may
choose to allocate resources to implement additional governance and shift to
a higher indifference curve. However, Ward et al. (2009) demonstrate that
additional governance does not always complement existing governance
mechanisms. They propose that there is a limit ‘beyond which the addition
of further governance mechanisms does not add to, and indeed may detract
from, overall governance effectiveness’ (Ward et al., 2009, p. 650). It is
therefore possible that smaller companies that adopt the ASX recommen-
dations for signalling or other reasons could experience adverse conse-
quences.
2.1. Board independence
The functions of the board of directors can be divided into the two major roles
of monitoring and advising (Raheja, 2005; Adams and Ferreira, 2007; Coles
et al., 2008; Linck et al., 2008). The monitoring role is intended to mitigate
agency costs arising from the adverse behaviour of management including
shirking, earnings management and fraud, risk aversion and suboptimal
decision-making (Kroll et al., 2007; Linck et al., 2008). A key aspect of the
board’s advising role is to assist senior management to make sound strategic
and operational decisions (Kroll et al., 2007). To carry out these functions,
boards are traditionally structured with a mix of executive or inside directors
and independent or outside directors. Inside directors have more specific
knowledge about the company through their role as internal managers, while
outside directors are more likely to exercise independent judgment (Fama and
Jensen, 1983; Kiel and Nicholson, 2003; Nicholson and Kiel, 2007; Gray and
Nowland, 2012). ASX Recommendation 2.1 asserts that a majority of the board
should consist of independent directors. However, a company’s optimal board
structure involves balancing the costs and benefits of monitoring and advising
and depends on the company’s individual characteristics and its overall bundle
of governance mechanisms (Linck et al., 2008; Ward et al., 2009).
We argue that optimal board structure is likely to vary with company size for
a number of key reasons. First, large companies have more complex operating
and financial structures, engage in a greater range of business activities and
have more dispersed shareholding compared with smaller companies. There-
fore, larger companies have a greater need for board monitoring and access to
expert advice and resources (Coles et al., 2008; Linck et al., 2008). The ‘scope
of operations’ hypothesis (Boone et al., 2007; p. 68) predicts that large
companies with more complex operations engage outside directors with a range
of expertise, thereby resulting in more independent boards. Boone et al. (2007)
find support for the hypothesis for a sample of U.S. companies. In the
Australian setting, support for the scope of operations effect is found by Kiel
© 2013 AFAANZ
and Nicholson (2003), who report a strong relation between company size and
board composition.
Second, Lehn et al. (2009) argue that larger companies have a greater
potential for agency conflicts between managers and shareholders because
managers in larger companies tend to hold a smaller percentage of
company equity. They also suggest that larger companies have greater
agency costs associated with free cash flow and less transparency relating to
individual units within the company. Lehn et al. (2009) predict that larger
companies have more independent boards because of these additional
agency costs.
Third, we suggest that stewardship theory arguments are more relevant to
small companies compared with large companies because small companies
generally have higher levels of management ownership (Lehn et al., 2009).
From this perspective, the effective operation of the board depends on an
understanding of the company’s business and the quality of decision-making
rather than independent monitoring. Thus, stewardship theory favours the
employment of inside, nonindependent directors as they are likely to have a
greater depth of knowledge, technical expertise and access to current
information about the company’s operations (Muth and Donaldson, 1998).
Kroll et al. (2007) argue that the benefits of inside directors are particularly
strong for younger newly listed companies that tend to be smaller.
Our arguments are supported by a U.K. study by Dedman (2000) who
reports that decisions about board independence are made mostly on the basis
of company size. Similarly, Talaulicar and van Werder (2008) find that the level
of compliance with the governance code in Germany is positively associated
with company size. These studies conclude that this association is due to the
smaller direct compliance costs and greater political costs or visibility of large
companies.
Overall, prior research evidence suggests there is little need for small
companies to install a majority independent board for effective governance. In
contrast to large companies, we do not expect small companies to gain from
complying with board independence recommendations. This leads to the
following four hypotheses.
H1a: For large companies, the change to a majority independent board of

directors surrounding the reform period is associated with an improvement in
company performance.
H1b: For small companies, the change to a majority independent board of
directors surrounding the reform period is not associated with an improvement in
H1c: For large companies, the change to a majority independent board of
directors surrounding the reform period is associated with an improvement in the
quality of reported earnings.
© 2013 AFAANZ
H1d: For small companies, the change to a majority independent board of

directors surrounding the reform period is not associated with an improvement in
the quality of reported earnings.
2.2. Separation of CEO and board chair
ASX Recommendation 2.3 relates to the separation of the roles of board

chair and CEO. The rationale for this recommendation is to enhance the
board’s independence through a clear division of responsibility at the head of
the company. From an agency perspective, having a separate and independent
board chair decreases the power of the CEO and strengthens the ability of the
board to exercise its oversight role (Muth and Donaldson, 1998; Palmon and
Wald, 2002; Kiel and Nicholson, 2003). In contrast, stewardship theory argues
that CEO duality, where the roles are combined, empowers the CEO and
motivates achievement (Muth and Donaldson, 1998). It also removes ambi-
guity with respect to who is responsible for achieving outcomes and reduces
potential confusion and conflict between the CEO and chair, facilitating more
effective and efficient implementation of strategic decisions (Kiel and Nichol-
son, 2003; Chahine and Tohme, 2009).
Palmon and Wald (2002) argue that larger, more complex companies have
greater agency problems than small companies and benefit from the checks and
balances arising from a separation of the roles of CEO and board chair. In
contrast, small companies benefit more from the stronger, clearer and more
decisive leadership generated by CEO duality. They found that small U.S.
companies with a separate CEO and board chair had negative abnormal
returns and lower accounting profitability, while large companies with a
separate CEO and board chair had positive abnormal returns and higher
accounting profitability. These results are consistent with the Ward et al. (2009)
model that demonstrates that adoption of best practice recommendations does
not always increase governance effectiveness. We therefore expect that small
companies do not benefit as much as large companies from separating the roles
of CEO and chair, leading to the following hypotheses.
H2a: For large companies, the change to a separation of the roles of CEO and
board chair surrounding the reform period is associated with an improvement in
H2b: For small companies, the change to a separation of the roles of CEO and
board chair surrounding the reform period is not associated with an improvement
in company performance.
H2c: For large companies, the change to a separation of the roles of CEO and
board chair surrounding the reform period is associated with an improvement in
the quality of reported earnings.
© 2013 AFAANZ
H2d: For small companies, the change to a separation of the roles of CEO and
board chair surrounding the reform period is not associated with an improvement
in the quality of reported earnings.
2.3. Board commitment
Principle 2 of the ASX recommendations states that companies should have a

board that is sufficiently committed to adequately discharge its responsibilities.
The concept of board commitment is not directly observable, so, consistent with
prior studies, we rely on the number of board meetings at main board as an
estimate of board commitment or diligence (Lipton and Lorsch, 1992; Conger
et al., 1998; Vafeas, 1999; Yatim et al., 2006; Kent and Stewart, 2008). One of the
advantages of more frequent board meetings is that the board is likely to have
richer information about the company’s operations, which enhances its ability to
carry out its monitoring role (Eisenhardt, 1989; Rutherford et al., 2007).
However, smaller companies have lower requirements for monitoring than larger
companies (Coles et al., 2008; Linck et al., 2008) and smaller companies are
expected to have more inside directors on the board compared with larger
companies (Dedman, 2000; Talaulicar and van Werder, 2008). Inside directors
have superior knowledge of the company’s business and access to specific
information about the company, leading to better decision-making (Fama and
Jensen, 1983; Donaldson and Davis, 1991). It is therefore unlikely that substantial
information asymmetry exists between the board and senior managers that could
be detrimental to organisational performance (Rutherford et al., 2007). Thus, it is
expected that greater levels of board interaction through frequency of meetings
are less beneficial for small companies. This leads to hypotheses 3a to 3d.
H3a: For large companies, the change to more board meetings surrounding the
reform period is associated with an improvement in company performance.
H3b: For small companies, the change to more board meetings surrounding the
reform period is not associated with an improvement in company performance.
H3c: For large companies, the change to more board meetings surrounding the
reform period is associated with an improvement in the quality of reported earnings.
H3d: For small companies, the change to more board meetings surrounding the
reform period is not associated with an improvement in the quality of reported earnings.
2.4. Presence of an audit committee
ASX Recommendation 4.2 proposes that the board of directors should

establish an audit committee as a key mechanism for safeguarding the integrity
of the company’s financial reporting. However, the recommendations acknowl-
edge that companies with fewer directors may not benefit from structuring the
© 2013 AFAANZ
board into committees, implying audit committees are likely to be more

efficient for larger companies. Hence, companies in the S&P/ASX All
Ordinaries Index (the top 500 listed companies in Australia) are required to
have an audit committee. For the remaining companies, use of an audit
committee is not mandatory.
In the absence of an audit committee, the ASX Corporate Governance
Council (2003) recommendations particularly emphasize the importance of
comply or explain disclosure requirements, stressing that companies must
disclose how the integrity of the financial statements and the independence of
the external auditor are assured. Given the tendency for small companies to
adopt the recommendations to avoid providing additional disclosures, it is
likely that some companies establish audit committees when it is not optimal to
do so (Ward et al., 2009).
Prior research indicates the benefits of audit committees in terms of
strengthening financial reporting quality (Davidson et al., 2005; Kent and
Stewart, 2008; Rainsbury et al., 2008). However, this research does not
differentiate between small and large companies. We suggest that these benefits
are more likely to be associated with large companies given that larger
companies have a greater need for access to expert advice (Coles et al., 2008;
Linck et al., 2008). We expect that audit committees are less likely to benefit
small companies, leading to the following two hypotheses.
H4a: For large companies, the change to the adoption of an audit committee
surrounding the reform period is associated with an improvement in the quality of
reported earnings.
H4b: For small companies, the change to the adoption of an audit committee
surrounding the reform period is not associated with an improvement in the
quality of reported earnings.
3. Research method
3.1. Sample
The sample for this study consists of Australian listed companies that
operated during the period from 2000 to 2005.3 We identified 667 companies
that existed during this period for which the required corporate governance and
financial data were available. Real Estate Investment Trusts (REITs – GICS
Industry 404020) and Asset Management and Custody Banks (GICS Subin-
3
The analysis uses average ROA for 2004 and 2005; therefore, ROA data for 2005 were
required. The measure of earnings quality is calculated using a lead and lag year.
Therefore, the earnings quality measure for 2001 requires data from 2000, and for the
2004 earnings quality measure, it was necessary to have financial data for 2005.
© 2013 AFAANZ
dustry 40203010) were excluded from the sample due to their unique operating
environment. We excluded four companies with a debt to asset ratio greater
than one in 2001 and 2004 due to the specialist governance issues associated
with insolvency. The final sample comprised 660 companies, of which 99 were
classified as small and 561 as large. Corporate governance and financial data
for analyses were collected from three databases (SIRCA, Aspect FinAnalysis
and Capital IQ) and missing data hand-collected from the company financial
reports.
Small companies are identified using criteria of employee numbers and asset
size. Prior studies support the use of more than one measure of company size
(Hopkins, 1988). The first criterion is that the company has twenty or fewer
employees. Using employee size to determine small companies is supported by
evidence that it is strongly correlated with company complexity (Kaen and
Baumann, 2003), and the Australian Bureau of Statistics (ABS) identifies small
companies as those with twenty or fewer employees (Australian Bureau of
Statistics (ABS), 2000). The second criterion is that the company has reported
assets of <$12.5 million. We use this threshold because it is consistent with the
asset size measure for small companies in the Corporations Act 2001. This
criterion is applied to identify companies that have few employees but could be
considered large because of their economic significance indicated by asset size.
Approximately one quarter of all listed companies in 2004 meet these two
criteria.4
3.2. Dependent variables
3.2.1. Performance measures
Various accounting based measures have been used in prior studies to

measure financial performance. These include sales (Dulewicz and Herbert,
2004), profit (Muth and Donaldson, 1998; Joh, 2003), return on equity (Muth
and Donaldson, 1998), earnings per share (Abdullah, 2004) and growth (Kent,
1994). Core et al. (2006) recommend the use of operating performance
measured by ROA, because it is less likely to be biased by leverage or
extraordinary and other discretionary income items. Consistent with many
prior related studies (Baliga et al., 1996; Klein, 1998; Muth and Donaldson,
1998; Vafeas, 1999; Kiel and Nicholson, 2003; Haniffa and Hudaib, 2006;
Yatim et al., 2006; Doucouliagos et al., 2007; Elsayed, 2007; Bhagat et al.,
2008; Brown and Caylor, 2009), we use ROA as our measure of accounting
performance. We present analyses using 2-year average ROAs for the
4
The Osiris database shows that 19 per cent of U.S. companies and 12 per cent of U.K.
listed companies have 20 or fewer employees. Globally, for the 202 listed companies
included in this database, an average of 15 per cent of companies had less than 20
employees (Bureau van Dijk, 2011).
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prereform years 2000 and 2001, and the postreform period years 2004 and
2005. The average ROA measure is used rather than ROA in 2001 and 2004 as
it provides a measure that is less likely to be subject to short-term fluctuations
(Kiel and Nicholson, 2003).
Tobin’s Q measured in 2001 and 2004 is also used in our analysis as a
measure of performance. It is argued that performance measures related to
market value better reflect use of existing assets and future growth potential
(Bharadwal et al., 1999). Previous studies have used Tobin’s Q as a market-
based measure of financial performance (Lawrence and Stapledon, 1999; Kiel
and Nicholson, 2003; Beiner et al., 2006; Haniffa and Hudaib, 2006; Elsayed,
2007; Christensen et al., 2010; Pham et al., 2011). The method of calculating
Tobin’s Q developed by Chung and Pruitt (1994) is used because of its simple
computation and because it can be calculated from market and accounting data
that are readily available from database sources.
3.2.2. Earnings quality
Our measure of earnings quality relies on the model developed by Dechow

and Dichev (2002) to empirically determine accruals quality shown in Eqn (1)
below (see Appendix 1 for definitions of variables):
DWCt ¼ b0 þ b1 CFOt1 þ b2 CFOt þ b3 CFOtþ1 þ et ð1Þ
The absolute value of the regression residual provides a measure of accruals

quality, as it represents the portion of accruals that is not estimated by actual
cash flows. A higher (lower) residual signifies higher (lower) accruals estimation
error and therefore lower (higher) accruals quality.
McNichols (2002) tested a variation of the Dechow and Dichev (2002)
model that includes a measure of change in sales and the size of property,
plant and equipment. Both McNichols (2002) and Francis et al. (2005) show
an improvement in model fit by augmenting the original Dechow and
Dichev (2002) model with these variables taken from the Jones (1991)
model. According to McNichols (2002), these variables are important to
forming expectations about current accruals above the contribution of
operating cash flows. We use the McNichols (2002) model to estimate
accruals quality as shown in Eqn (2) below (see Appendix 1 for variable
definitions).
DWCt ¼ b0 þ b1 CFOt1 þ b2 CFOt þ b3 CFOtþ1 þ b4 DREVt þ b5 PPEt þ et ð2Þ
Industry regressions based on the model in Eqn (2) are conducted to calculate
accruals quality for the years 2001 and 2004. The absolute value of the
regression residual is used as our measure of accruals quality.
© 2013 AFAANZ
3.3. Independent variables
Board independence is measured as a dummy variable taking a value of

one if the majority of directors are independent (>50 per cent), zero
otherwise. We relied on the annual reports to identify independent
directors5 with most companies specifying whether directors were indepen-
dent and/or nonexecutive. The assumption was made that nonexecutive
directors were not independent when no reference was made to indepen-
dence. Separation of the roles of board chair and CEO is included as a
dummy variable that takes the value of one when the roles of board chair
and CEO are held by the same person (CEO duality) and zero otherwise.
The number of meetings per year undertaken by the board is used as a
proxy for board commitment or diligence. The existence of an audit
committee is identified by a dummy variable taking the value of one if the
committee exists and zero otherwise.
3.4. Control variables
A measure of shareholder concentration is included as a control variable.

From an agency perspective, shareholder concentration is likely to reduce
agency costs due to less separation of ownership and control. Empirical
studies on the association between ownership structure and company
performance suggest a more complex relation exists between shareholder
concentration and performance. Demsetz and Villalonga (2001) find no
significant relation between ownership structure and firm performance,
arguing that market forces create appropriate ownership structures. There is
also evidence that very high ownership concentration can increase agency
problems and reduce company performance because of the increased
probability of wealth expropriation by powerful shareholders (Claessens
et al., 2002; Setia-Atmaja, 2009). Therefore, we control for the effect of
shareholder concentration with a variable that measures the percentage of
ordinary shares owned by shareholders with more than a 20 per cent
holding.
We control for leverage because the agency costs of debt are likely to
increase with higher debt levels (Meeks et al., 1995), leading to an increased
cost of capital and impaired financial performance. High debt levels can
lead to suboptimal decision-making for new investment decisions and
reduced strategic choices for managers (Marlin et al., 1994; Dawley et al.,
2002). High leverage is also likely to reduce the amount of resources that
companies can expend on implementing and maintaining corporate gover-
5
Non-executive directors can have affiliations with the company (Brooks et al., 2009)
and therefore not be strictly independent as articulated by the ASX Corporate
Governance Guidelines (ASX Corporate Governance Council, 2003).
© 2013 AFAANZ
nance mechanisms. Leverage is measured as total liabilities divided by total

assets. Company size is included as a control variable to capture the
underlying effects of performance and accountability within the independent
samples of small and large companies. Size is measured as the log of total
assets.
Industry membership is used to identify companies with similar risk, growth
and accounting methods. Performance is likely to be related to industry
affiliation (Vafeas and Theodorou, 1998) because companies in the same
industry are relatively homogeneous (Alford, 1992). Dummy variables for the
ten Global Industry Classification Standard (GICS) industry sectors of
consumer discretionary, consumer staples, energy, financial, health care,
industrials, information technology, materials, telecommunications and utilities
are included to control for industry effects.
3.5. Adoption of ASX recommendations
Recall that the first key aim of the study is to examine the association
between implementation of the ASX recommendations and governance choices
made by small and large companies. We compare the governance character-
istics of board independence, dual CEO/Chair, board director meetings and
existence of an audit committee for the sample companies in the years 2001 and
2004.6 This initial phase uses descriptive statistics, independent samples t-tests
and statistical tests of change.
3.6. Regression models
Our second aim is to investigate the association between adoption of the

ASX recommendations and measures of performance and earnings quality.
First, as preliminary analysis, we conduct separate regressions for small and
large companies in the pre- and postreform years of 2001 and 2004. We then
test the hypothesized associations between changes in governance structure and
changes in our measures of performance and earnings quality. The regression
models are expressed below in Eqns (3) and (4) (see Appendix 1 for variable
definitions).
Average ROA=Tobin0 s Q/Earnings Quality for 2001 and 2004

¼ b0 þ b1 Board Independence þ b2 CEO Duality þ b3 Meetings
ð3Þ
þ b4 Audit Committee þ b5 Shareholder Concentration
þ b6 Leverage þ b7 Size + Industry þ et
6
The year 2001 was selected as the comparison year to minimize the effect of companies
altering their governance structure in anticipation of the 2003 implementation of the
ASX recommendations.
© 2013 AFAANZ
DAverage ROA=DTobin0 s Q=DEarnings Quality for 2001 and 2004

¼ b0 þ b1 DBoard Independence þ b2 DCEO Duality þ b3 DMeetings
þ b4 DAudit Committee þ b5 DShareholder Concentration
þ b6 DLeverage þ b7 DSize þ Industry þ et
ð4Þ
4. Results
4.1. Descriptive statistics
Table 1 reports the descriptive statistics in 2001 and 2004. Panel A presents
data for continuous variables, and Panel B for dichotomous variables. The
table also provides a significance test of the difference between small and large
companies in both years. There is a significant difference between small and
large companies for average ROA, Tobin’s Q and earnings quality in 2001 and
2004. Large companies have significantly higher average ROA and earnings
quality in 2001 and 2004. Small companies have significantly higher Tobin’s Q
in 2001 and 2004.
For the governance variables, we find that large company boards are more
active in 2004 than small company boards, as indicated by a significantly higher
average number of meetings. Large companies also have a significantly higher
rate of majority board independence and are more likely to have formed an
audit committee than small companies in 2001 and 2004. Large companies have
a marginally significant lower rate of CEO duality in 2001; however, the
difference in 2004 is not significant.
Panel A of Table 1 also shows the descriptive statistics for the control variables.
The difference in leverage is marginally significant in 2001 and significant in 2004,
with large companies having higher debt levels than small companies. There are
no significant differences in shareholder concentration in either year.
Panel C of Table 1 shows industry classification data measured in 2001.
More than half of the small companies are in the consumer discretionary and
industrials sectors (40 and 14 per cent of the sample, respectively). The
consumer discretionary sector represents the greatest number of large compa-
nies at 19 per cent, followed by information technology, consumer staples and
health care (16, 16, and 14 per cent, respectively). Industries with cell counts of
six or less were combined in regression analyses conducted for small companies.
The correlation matrix for the independent variables and their variance
inflation factor statistics are reported in Table 2. None of the correlations are
of a magnitude that indicates multicollinearity is of concern for the regression
analyses. The highest correlation of 0.16 is between the size and audit
committee variables, and all of the variance inflation factors are less than
two.
© 2013 AFAANZ
Table 1
Descriptive statistics
Small companies (n = 99) Large companies (n = 561)
Variable Mean SD Min Max Mean SD Min Max t-test
Panel A: descriptive statistics of continuous variables

2001
Average ROA 0.99 1.85 8.24 0.44 0.23 0.91 8.24 0.44 4.04***
Tobin’s Q 6.02 11.13 0.34 58.65 2.78 6.73 0.00 58.65 2.78***
Earnings quality 0.23 0.33 0.00 2.09 0.17 0.27 0.00 2.59 1.78**
Meetings 10.37 5.14 3.00 32.00 10.86 4.13 1.00 28.00 0.90
Shareholder 0.23 0.27 0.00 0.86 0.20 0.27 0.00 1.00 0.89
concentration
Leverage 0.44 0.53 0.00 3.52 0.53 0.42 0.00 3.52 1.67*
Size 15.09 1.20 10.68 16.32 18.37 2.36 11.67 26.65 21.02***
2004
Average ROA 0.49 0.88 3.75 0.55 0.06 0.39 3.75 0.55 4.79***
Tobin’s Q 3.91 4.26 0.10 16.03 1.83 1.63 0.00 16.04 4.87***
Earnings quality 0.20 0.34 0.00 2.92 0.12 0.29 0.00 6.06 3.17***
Meetings 9.69 5.17 1.00 28.00 11.10 4.32 1.00 34.00 2.91***
Shareholder 0.15 0.23 0.00 0.79 0.18 0.26 0.00 1.00 1.31
concentration
Leverage 0.34 0.45 0.01 1.81 0.43 0.26 0.01 1.76 1.94**
Size 15.49 1.32 10.46 18.46 18.64 2.18 12.47 26.74 19.32***
Small companies Large companies

(n = 99) (n = 561)
Variable Yes % Yes % v2 test
Panel B: descriptive statistics of dichotomous variables

2001
Board independence 35 35.35 268 47.77 5.23**
CEO duality 14 14.14 48 8.56 *3.08
Audit committee 74 74.75 493 87.88 11.97***
2004
Board independence 49 49.50 360 64.17 7.69***
CEO duality 9 9.09 42 7.49 0.31
Audit committee 82 82.83 539 96.08 26.57***
Number % Number %
Panel C: industry
Consumer discretionary 40 40.41 109 19.43
Consumer staples 6 6.06 88 15.68
Energy 1 1.01 34 6.06
Financial 13 13.13 37 6.60
Healthcare 9 9.09 80 14.26
Industrials 14 14.14 46 8.20
Information technology 6 6.06 92 16.40
© 2013 AFAANZ
Table 1 (continued)
Number % Number %
Materials 9 9.09 54 9.62

Telecommunications 1 1.01 14 2.50
Utilities 0 0.00 7 1.25
Continuous variables are winsorized at the 1 and 99 percentiles. *, **, ***indicate significance
at the 10 per cent, 5 per cent and 1 per cent levels (two-tailed), respectively.
Table 2
Correlation matrix
Board CEO Audit Shareholder VIF

independence duality Meetings committee concentration Leverage statistic
CEO duality 0.01 1.04

Meetings 0.12*** 0.04 1.23
Audit committee 0.08*** 0.05 0.00 1.07
Shareholder 0.04 0.11*** 0.08*** 0.01 1.06
concentration
Leverage 0.06** 0.04 0.03 0.10*** 0.07*** 1.12
Size 0.12*** 0.12*** 0.13*** 0.16*** 0.04 0.07*** 1.36
Pearson correlations reported for interval measures; eta statistic reported for nominal by ratio
measures; phi statistic reported for nominal by nominal measures. Continuous variables are
winsorized at the 1 and 99 per centiles.*, **, ***indicate significance at the 10 per cent, 5 per
cent and 1 per cent levels (two-tailed), respectively.
4.2. Adoption of ASX recommendations
Table 3 presents descriptive statistics and statistical tests of change for

the governance variables for small and large companies between 2001 and
2004.
For small companies, there is a significant increase in the number of
companies that have majority board independence (p < 0.01). There is also a
reduction in the number of companies that have a dual CEO/Chair (p < 0.10),
and an increase in the number of companies forming an audit committee
(p < 0.10). However, there is a small reduction in the number of board
meetings between the two periods (also significant at p < 0.10). For large
companies, there is a significant increase in majority board independence and
formation of an audit committee (p < 0.01). There is a reduction in the number
of companies that have a dual CEO/Chair, but the change is not statistically
significant.
© 2013 AFAANZ
Table 3
Compliance with ASX recommendations in 2001 and 2004
2001 2004
Mean Mean Change Test stat.
Panel A: small companies (n = 99)

Continuous variable
Meetings 10.37 9.69 0.68 1.77*
Dichotomous variables % %
Board independence 35.35 49.49 14.14 6.04***
CEO duality 14.14 9.09 5.05 1.23*
Audit committee 74.74 82.83 8.09 2.04*
Mean Mean Change Sig.
Panel B: large companies (n = 561)

Continuous variable
Meetings 10.86 11.10 0.24 1.16
Dichotomous variables % %
Board independence 47.77 64.17 16.40 43.58***
CEO duality 8.56 7.49 1.07 0.52
Audit committee 87.88 96.08 8.20 30.68***
Test of significance for continuous variable is Wilcoxon signed rank test. Test of significance for
dichotomous variables is related samples McNemar test. Continuous variables are winsorized
at the 1 and 99 per centiles. One-tailed tests when in direction predicted; otherwise two-tailed. *,
**, *** indicate significance at the 10 per cent, 5 per cent and 1 per cent levels, respectively.
Overall, the univariate analysis shows that in the period from 2001 to 2004,
both small and large companies generally moved towards adopting the ASX
recommendations at a similar rate. This raises the prospect that small
companies may have made inefficient choices about their governance structure
in response to the ASX recommendations.
4.3. Pre- and postregulation regression results
Table 4 provides the results of the regression analysis for 2001 and 2004.
Results for small companies are presented in Panel A, and those for large
companies are presented in Panel B.
4.3.1. Average ROA
For small companies, we do not find any of the governance variables to be

significant in either year. These results are consistent with the expectation that
there is no association between the ASX governance recommendations and the
performance of small companies. Of the control variables, leverage has a
negative coefficient and is significant in 2001 and 2004 (p < 0.10 and p < 0.01,
respectively). Size is positive and significant in 2001 and 2004 (p < 0.01).
© 2013 AFAANZ
Table 4
Pre- and postregulation regression results
Average ROA coefficient (t-stat.) Tobin’s Q coefficient (t-stat.) Earnings quality coefficient (t-stat.)
Variable 2001 2004 2001 2004 2001 2004
© 2013 AFAANZ
Panel A: small companies
Constant 8.49 (2.97)*** 4.56 (5.31)*** 94.07 (7.06)*** 23.65 (4.16)*** 0.42 (0.85) 0.64 (1.95)*
Board independence 0.01 (0.03) 0.10 (0.86) 2.15 (1.26) 2.14 (2.70)*** 0.08 (1.24) 0.07 (1.39)
CEO duality 0.37 (0.76) 0.03 (0.13) 2.48 (1.10) 0.01 (0.01) 0.01 (0.11) 0.02 (0.16)
Meetings 0.01 (0.37) 0.01 (1.14) 0.23 (1.48) 0.01 (0.06) 0.01 (0.31) 0.01 (0.60)
Audit committee 0.06 (0.14) 0.15 (0.97) 1.75 (0.95) 1.61 (1.62) 0.11 (1.52) 0.01 (0.04)
Shareholder concentration 1.02 (1.46) 0.40 (1.56) 1.74 (0.53) 0.43 (0.25) 0.11 (0.88) 0.16 (1.53)
Leverage 0.67 (1.67)* 1.11 (7.03)*** 5.40 (2.89)*** 2.93 (2.80)*** 0.09 (1.23) 0.02 (0.28)
Size 0.54 (2.98)*** 0.29 (5.28)*** 6.03 (7.10)*** 1.48 (3.99)*** 0.01 (0.14) 0.03 (1.50)
Adjusted R2 0.28 0.63 0.57 0.32 0.01 0.01
Model F statistic 3.51*** 12.31*** 9.59*** 4.05*** 1.14 0.91
Panel B: large companies
Constant 2.22 (6.94) 1.35 (9.04) 13.00 (6.47) 4.66 (7.90) 0.47 (6.01)*** 0.50 (7.62)***
Board independence 0.15 (2.11)** 0.01 (0.02) 0.21 (0.46) 0.22 (1.69)* 0.02 (0.80) 0.01 (0.69)
CEO duality 0.30 (2.32)** 0.14 (2.37)** 0.93 (1.14) 0.30 (1.29) 0.07 (2.19)** 0.01 (0.31)
Meetings 0.01 (0.08) 0.01 (1.68)* 0.17 (2.95)*** 0.04 (2.62)*** 0.01 (1.48) 0.01 (0.39)
Audit committee 0.14 (1.26) 0.12 (1.53) 0.38 (0.54) 0.35 (1.11) 0.13 (4.74)*** 0.06 (1.73)*
Shareholder concentration 0.06 (0.44) 0.15 (2.47)** 1.22 (1.40) 0.49 (2.03)** 0.03 (0.86) 0.03 (1.00)
J. Christensen et al./Accounting and Finance
Leverage 0.24 (2.67)*** 0.36 (5.63)*** 8.81 (15.74)*** 0.20 (0.81) 0.06 (2.85)*** 0.08 (3.04)***
Size 0.12 (7.24)*** 0.07 (9.11)*** 0.73 (7.21)*** 0.15 (5.06)*** 0.01 (2.86)*** 0.02 (5.51)***
Adjusted R2 0.14 0.19 0.39 0.11 0.07 0.06
Model F statistic 6.69*** 9.10*** 22.98*** 5.47*** 7.19*** 5.84***
Industry variables are not reported. Continuous variables are winsorized at the 1 and 99 per centiles. *, **, *** indicate significance at the 10 per
cent, 5 per cent and 1 per cent levels (two-tailed), respectively.
19
For large companies, a significant positive association is found for board

independence in 2001 (p < 0.05). A significant negative relation is observed
between CEO duality and performance in 2001 and 2004 (p < 0.05). The
surprising result is that the positive relation between board independence and
average ROA in 2001 is not observed in 2004. Also surprising is the
marginally significant negative relation between board meetings and perfor-
mance in 2004 (p < 0.10). A possible explanation for this result is that more
board meetings are held when the company is experiencing poor perfor-
mance. There is no significant association between the presence of an audit
committee and average ROA in either 2001 or 2004. Of the control variables,
we find that shareholder concentration has a significant positive coefficient in
2004 (p < 0.05). Leverage has a negative coefficient and is significant in 2001
and 2004 (p < 0.01). Size is positive and significant in 2001 and 2004
(p < 0.01).
Overall, there is some evidence that majority board independence and
separation of the CEO and board chair roles were positively related to the
performance of large companies prior to the ASX recommendations.
However, our results provide preliminary evidence to suggest that the
increased adoption of the ASX recommendations between 2001 and 2004 is
not associated with improved performance for small and large companies.
While CEO duality is associated with lower performance in both years for
large companies, the implementation of the ASX recommendations did not
lead to a statistically significant reduction in duality for these companies (see
Table 3).
4.3.2. Tobin’s Q
For small companies, we find that board independence is significant and

positive in 2004. None of the other governance variables are significant in either
year. Of the control variables, we find that leverage has a positive coefficient
and is significant in 2001 and 2004 (p < 0.01), and size is negative and
significant in 2001 and 2004 (p < 0.01).
For large companies, board independence is marginally significant and
positive in 2004 (p < 0.10). The meetings variable is significant and negative in
2001 and 2004 (p < 0.01). Again, this result can be explained by the holding of
more board meetings by poorly performing companies to address their
performance issues. Of the control variables, shareholder concentration is
significant in 2004 and has a negative coefficient (p < 0.05). Leverage is
significant in 2001 and has a positive coefficient (p < 0.01). Size is negative and
significant in 2001 and 2004 (p < 0.01).
Overall, with the exception of board independence, there is again limited
evidence that implementation of the ASX recommendations has significantly
enhanced performance measured by Tobin’s Q for small and large
companies.
© 2013 AFAANZ
4.3.3. Earnings quality
For the small company regression with earnings quality as the dependent
variable, we do not find any of the governance or control variables to be
significant in either 2001 or 2004. Moreover, the model is not significant.
Hence, there appears to be no association between the governance mechanisms
and earnings quality either before or after the implementation of the ASX
recommendations.
For large companies, the audit committee variable is significant and negative
for 2001 and 2004 (p < 0.01 and p < 0.10, respectively), showing the existence
of an audit committee is associated with higher accruals quality.7 A significant
negative relation is found between CEO duality and earnings quality (p < 0.05)
in 2001, indicating that separation of the roles of CEO and board chair is
associated with lower earnings quality prior to the ASX recommendations.
Following the implementation of the recommendations, this relationship
remains negative but is no longer significant. Of the control variables, we find
that leverage is significant in 2001 and has a negative coefficient, yet in 2004
leverage is significant and positive (p < 0.01). Size is negative and significant for
large companies in 2001 and 2004 (p < 0.01).
These results provide no evidence of a relationship between higher earnings quality
and any of the governance mechanisms tested for small companies, either before or
after the implementation of the ASX recommendations. For large companies, only
the presence of an audit committee is positively related to earnings quality.
4.4. Change regressions
To test our hypotheses, we conduct regression analysis using change

variables over pre- and post-ASX regulation periods (2001 and 2004) for the
independent samples of small and large companies. For this analysis, the
change in average ROA, Tobin’s Q and earnings quality is regressed on
variables that indicate change in company governance structure to comply with
the ASX recommendations. Variables indicating change in governance
included in the analysis are as follows: a change to a majority independent
board structure, a change from CEO duality to separate roles, an increase in
the number of board meetings, and the formation of an audit committee. The
control variables for size, leverage and shareholder concentration are included
in the analysis and are measured as the change from 2001 to 2004.8 The results
of the analyses for small and large companies are reported in Table 5.
7
A smaller value for this variable indicates higher accruals quality.
8
We also conducted regressions including the average figures for the control variables
and the change amounts. Results are qualitatively similar to those reported. Further,
given the high correlation between the average and change amounts for size and
leverage, we report the results for the change variables only.
© 2013 AFAANZ
Table 5
Change regressions
DTobin’s
DAverage ROA Q coefficient DEarnings quality
coefficient (t-stat.) (t-stat.) coefficient (t-stat.)
Panel A: small companies

Constant 0.90 (1.92) 2.73 (1.10) 0.02 (0.23)
DBoard independence 0.06 (0.14) 1.01 (0.44) 0.13 (1.48)
DCEO duality 0.71 (0.12) 0.58 (0.19) 0.05 (0.40)
DMeetings 0.12 (0.31) 3.82 (1.91)* 0.01 (0.02)
DAudit committee 0.28 (0.62) 0.10 (0.04) 0.35 (3.61)***
DShareholder Concentration 1.12 (1.39) 1.94 (0.46) 0.13 (0.81)
DLeverage 1.15 (3.14) 6.42 (3.34)*** 0.10 (1.33)
DSize 0.26 (1.49) 2.70 (2.91)*** 0.03 (0.95)
Adjusted R2 0.28 0.29 0.11
Model F statistic 3.86*** 4.02*** 1.89**
Panel B: large companies
Constant 0.13 (1.49) 0.28 (0.56) 0.03 (1.32)
DBoard independence 0.02 (0.28) 0.22 (0.46) 0.03 (1.50)
DCEO duality 0.36 (2.07)** 0.91 (0.92) 0.03 (0.77)
DMeetings 0.11 (1.37) 0.60 (1.40) 0.01 (0.20)
DAudit committee 0.13 (1.06) 0.36 (0.50) 0.14 (4.33)***
DShareholder concentration 0.20 (1.03) 0.25 (0.22) 0.03 (0.52)
DLeverage 0.34 (3.21)*** 8.33 (14.17)*** 0.02 (0.84)
DSize 0.07 (1.84)* 0.84 (4.00)*** 0.01 (1.29)
Adjusted R2 0.05 0.39 0.14
Model F statistic 3.26*** 27.96*** 8.17***
Industry variables are not reported. Continuous variables are winsorized at the 1 and 99 per
centiles. *, **, *** indicate significance at the 10 per cent, 5 per cent and 1 per cent levels (two-
tailed), respectively.
4.4.1. Change to majority independent board of directors
We find no evidence that change to a majority independent board of directors

improves performance or accountability for either small or large companies.
Hypothesis 1a and 1c, which predicts that this change is associated with
improved performance and earnings quality for large companies, is not
therefore supported. The results do provide support for hypothesis 1b and 1d,
which predicts that change to a majority independent board is not associated
with improved performance and earnings quality for small companies.
4.4.2. Change to separation of the roles of CEO and board chair
There is support for hypothesis 2a, with the results for large companies
indicating a change from CEO duality to separate roles improves average ROA
(p < 0.05). The lack of association between these variables for small companies
© 2013 AFAANZ
provides support for hypothesis 2b. We find no evidence that a change to

separate roles improves earnings quality for either small or large companies.
Hypothesis 2c, which predicts an association for large companies, is not
therefore supported while there is support for hypothesis 2d, which predicts no
association for small companies.
4.4.3. Change in number of board meetings
There is no support for hypothesis 3a and 3c, which predicts that a change to
more board meetings surrounding the reform period is associated with
improved company performance and accountability for large companies. The
results for small companies indicate that a change to more board meetings
surrounding the reform period is not associated with an increase in ROA, but is
marginally significantly associated with a higher Tobin’s Q (p < 0.10).
Hypothesis 3b, which predicts no association between these variables, is
therefore partially supported. Hypothesis 3d is supported as there is no
association between a change to more board meetings and an improvement in
earnings quality for small companies.
4.4.4. Change to the adoption of an audit committee
There is support for hypothesis 4a that change to the adoption of an audit

committee is associated with improved accountability for large companies.
However, we also find that the adoption of an audit committee is significantly
related to an increase in earnings quality (at p < 0.01) for small companies, and
hence, hypothesis 4b is not supported.
4.4.5. Change in the control variables
An increase in leverage has a significant positive association with an increase

in Tobin’s Q for both small and large companies, suggesting a favourable
response to increased leverage from the market. In contrast, increased leverage
has a significant negative association with an increase in average ROA for large
companies. An increase in size has a significant negative association with an
increase in Tobin’s Q for both small and large companies.
4.5. Additional analysis
We conducted further regression analysis to isolate the association of the

ASX guidelines with performance and accountability using interaction
variables. For this analysis, separate regressions were conducted for small
and large companies using a pooled sample from the pre- and post-ASX
regulation periods. Each of the governance variables and an interaction
between a dummy variable for the year of observation (2001 or 2004) were
© 2013 AFAANZ
included. The results for the interaction term do not indicate any differential
effect between the pre- and postregulation periods. The untabulated results for
this analysis are consistent with the pre- and postregression analysis, and the
change analysis reported in Tables 4 and 5, respectively.
We tested the sensitivity of the small company results to the criteria adopted
for defining small companies, using two alternative criteria: companies with 50
or fewer employees and companies that fall within the bottom two deciles of
the number of employees. The untabulated results of these additional analyses
are qualitatively similar to the reported results.
An additional test was conducted for the small company sample to determine
whether there is any influence on the results of companies with extremely poor
performance. The average ROA analysis is conducted with the sample
censoring on the bottom 10 percentile of companies based on average ROA.
The results of this analysis are qualitatively the same as those reported in the
main analysis. Further robustness testing was conducted for the issue of
insolvency. The exclusion of 34 cases with debt to assets ratios greater than one
in either 2001 or 2004 made no qualitative difference to the results.
A potential problem with analysis of the relation between corporate
governance and performance is the issue of endogeneity, as it is possible that
governance and performance affect each other simultaneously (Schultz et al.,
2010; Brown et al., 2011). Two tests were conducted to assess the effect of
endogeneity on our results. First, the average ROA regression was rerun with
lagged ROA as the dependent variable. The results for this unreported
regression are qualitatively the same as the main results. Second, we estimated
an instrumental variable using the procedure suggested by Frankel et al.
(2006) and Sun and Cahan (2012). This involves ordering the endogenous
variable and then assigning cases to three ranked portfolios. The predicted
values from a regression of the ranked portfolio variable on the endogenous
variable are the estimated instrument variable. This technique was used to
estimate instrumental variables for board independence and meetings. Results
for the average ROA regressions using these instrumental variables were the
same as for the main results. While the tests suggest that the reported results
are robust to endogeneity problems, it is acknowledged that both tests have
drawbacks.9
5. Conclusion
This study examines whether the implementation of the 2003 ASX

governance recommendations influenced the governance choices of small
companies and whether compliance improves their financial performance and
9
The assumption for the lagged variables is that endogeneity does not persist over time.
For the portfolio ranked variables, it is assumed that only the exogenous part of the
regressor determines the rank portfolio assignment (Larcker and Rusticus, 2010).
© 2013 AFAANZ
accountability. Our analysis examines small and large companies because we

are interested in the different effects of the governance recommendations on the
two groups. Our results indicate a significant shift to compliance between 2001
and 2004 with higher board independence and audit committee existence for
both small and large companies. There is also a marginally significant decline in
CEO duality in small companies from the pre- to postreform period.
In general, we find that adoption of the ASX recommendations is not
associated with financial performance or earnings quality for small companies.
There are three exceptions to this finding. First, our preliminary regression
analysis finds a significant positive relation between Tobin’s Q and majority
board independence in the postreform period. We suggest this result indicates
that the capital market views board independence favourably. Second, our
change analysis indicates a significant relation between the formation of an
audit committee and an increase in earnings quality and a marginally
significant relation between an increase in board meetings and Tobin’s Q.
Overall, therefore, we find support for hypotheses 1b, 1d, 2b, 2d and 3d. There
is partial support for hypothesis 3b, but hypothesis 4b is not supported.
For large companies, our preliminary analysis indicates some significant
associations between company performance and governance structures in both
the pre- and postreform periods. This analysis also finds that the separation of
the CEO and board chair roles and the presence of an audit committee are
significantly related to higher earnings quality in the prereform period.
Presence of an audit committee is marginally significant in the postreform
period. Also surprisingly, we find that board meeting frequency for large
companies has a strong negative association with market performance
measured by Tobin’s Q in the pre- and postreform periods. Our change
analysis finds that a change to a majority independent board and an increase in
board meetings are not associated with improved performance or earnings
quality. A change to separate roles for CEO and board chair is associated with
improved ROA, while formation of an audit committee is associated with
increased earnings quality. Overall, for large companies, no support is found
for hypotheses 1a, 1c, 2c, 3a and 3c, while hypotheses 2a and 4a are supported.
The results are consistent with the view that signalling concerns compel some
companies to comply with recommendations despite their voluntary nature.
The results are also consistent with the possibility that the cost-effective ‘bundle
of governance mechanisms’ (Rediker and Seth, 1995, p. 87), particularly for
small companies, lie outside the boundary conditions imposed by the ASX
Corporate Governance Council (2003) regulatory reforms. Further research is
needed to determine whether compliance with the guidelines compromises
efficiency for some companies.
The policy implication is that the comply or explain principle is not
sufficiently flexible and influences small companies to make suboptimal
governance choices. Regulators should consider ways to mitigate compliance
pressure for small companies. This could be achieved, for example by specific
© 2013 AFAANZ
exemptions based on company size, or a tiered structure for governance

recommendations that better reflect the needs of small companies. One of the
key issues in developing alternative governance guidelines for small companies
is determining the appropriate company size for application of recommenda-
tions. While our results are robust to alternative definitions of small companies,
they may not be generalizable to other definitions of small companies. Future
research could test alternative classifications of small companies, and consid-
eration could be given to how the adoption of governance structures relates to
performance and accountability across the range of company size.
There are limitations associated with the sample used in the study. The
analysis is conducted for companies that were listed in both 2001 and 2004,
which increases the probability of survivorship bias. However, the sampling
method does allow for comparison between the regression models, as a
consistent sample of companies is used for each analysis. Moreover, the results
are less likely to be affected by bias from including start-up or delisted
companies in the sample. Overcoming these sampling limitations provides a
potential avenue for further research. A further sample-related limitation arises
in relation to our measure of accruals quality. Calculation of the measure
requires lead and lag year operating cash flow data. For the 2004 accruals
quality measure, the lag year is 2003, which is proximate to the release of the
ASX recommendations. We suggest that our measure is appropriate because
any change in governance mechanisms is unlikely to be related to cash flows,
and the implementation of the ASX recommendations was anticipated by
companies.
Another limitation of the study is that it tested a limited subset of the ASX
Corporate Governance Council (2003) governance recommendations. These
included key recommendations that could readily be operationalized from
publicly available data. Future studies might consider alternative measures of
compliance with the recommendations and how other recommendations not
examined in this study can be operationalized and tested. Quantifying the costs
of implementing the recommended corporate governance mechanisms and
examining their relation to company size would further inform the develop-
ment of governance regulation.
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Appendix: Definitions of variables
Eqns 1–2 (all variables scaled by total assets)
ΔWCt = Comprehensive measure of change in working capital accruals

including change in accounts receivable, accounts payable, current inventory,
current investments, current provisions, and other current assets and liabilities.
CFOt1 = cash flow from operations in t1.
CFOt = cash flow from operations in t.
CFOt+1 = cash flow from operations in t+1.
ΔREVt = change in operating revenue from t1 to t.
PPEt = Property Plant and Equipment reported at t.
et = residual.
Eqns 3–4
Average ROA = average return on assets for 2 years (2001 and 2002, or 2004
and 2005).
Tobin’s Q = (market capitalization + book value of liabilities)/total assets.
Earnings quality = accruals quality determined as the absolute value of the
residual of Eqn (2) for 2001 or 2004.
Board independence = dummy variable for majority board independence; 1 if
a majority of directors are independent, and 0 otherwise.
CEO duality = dummy variable for dual role of CEO/Chair; 1 if the CEO is
also the chair, and 0 otherwise.
Meetings = number of board meetings held per year.
Audit committee = dummy variable for audit committee existence; 1 if there is
an audit committee, and 0 otherwise.
Shareholder concentration = percentage of company shares owned by share-
holders with >20 per cent shareholding.
Leverage = total liabilities/total assets.
Size = natural log of total assets.
© 2013 AFAANZ
Industry = GICS industry grouping in 2001.

DAverage ROA = change in average return on assets over pre- and postrec-
ommendation period; prerecommendation average is for 2001/2002, and
postrecommendation average is for 2004/2005.
DTobin’s Q = change in Tobin’s Q over pre- and postrecommendation period;
calculated as (market capitalization + book value of liabilities)/total assets.
DEarnings quality = change in accruals quality assets over pre- and postrec-
ommendation period accruals quality is determined as the absolute value of the
residual of Eqn (2).
DBoard independence = dummy variable for change over the pre- and
postrecommendation period to majority board independence; 1 if the company
implements a majority independent board structure, and 0 otherwise.
DCEO duality = dummy variable for change over the pre- and postrecom-
mendation period from dual role of CEO/Board Chair to separate roles; 1 if the
company moves from having a dual CEO/board chair structure to separate
roles, and 0 otherwise.
DMeetings = dummy variable coded 1 if the company increases the number of
board meetings over the pre- and postrecommendation period, and 0 otherwise.
DAudit Committee = dummy variable for change over the pre- and postrec-
ommendation period in the existence of an audit committee; 1 if an audit
committee is formed, and 0 otherwise.
DShareholder concentration = change in percentage of company shares
owned by shareholders with >20 per cent shareholding from 2001 to 2004.
DLeverage = change in total liabilities/total assets from 2001 to 2004.
DSize = change in natural log of total assets from 2001 to 2004.
© 2013 AFAANZ

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Accounting and Finance

Do corporate governance recommendations improve the

Jacqueline Christensena, Pamela Kenta, James Routledgea,

This study examines whether the implementation of the 2003 Australian

Key words: Small companies; Governance; Performance; Accountability

JEL classiﬁcation: M40, M41

This study examines whether comply or explain governance regulation

the performance and accountability of small listed companies. Signiﬁcant

Compounding these signalling considerations is a misunderstanding about

The study contributes to the existing literature in a number of ways. First, to

(ROA). Finally, an increase in board meetings is marginally associated with an

2. Theory and hypothesis development

We develop our hypotheses by reference to four theoretical perspectives that

2.1. Board independence

H1a: For large companies, the change to a majority independent board of

H1d: For small companies, the change to a majority independent board of

2.2. Separation of CEO and board chair

ASX Recommendation 2.3 relates to the separation of the roles of board

2.3. Board commitment

Principle 2 of the ASX recommendations states that companies should have a

2.4. Presence of an audit committee

ASX Recommendation 4.2 proposes that the board of directors should

board into committees, implying audit committees are likely to be more

3.2. Dependent variables

3.2.1. Performance measures

Various accounting based measures have been used in prior studies to

3.2.2. Earnings quality

Our measure of earnings quality relies on the model developed by Dechow

DWCt ¼ b0 þ b1 CFOt1 þ b2 CFOt þ b3 CFOtþ1 þ et ð1Þ

The absolute value of the regression residual provides a measure of accruals

DWCt ¼ b0 þ b1 CFOt1 þ b2 CFOt þ b3 CFOtþ1 þ b4 DREVt þ b5 PPEt þ et ð2Þ

3.3. Independent variables

Board independence is measured as a dummy variable taking a value of

3.4. Control variables

A measure of shareholder concentration is included as a control variable.

nance mechanisms. Leverage is measured as total liabilities divided by total

3.5. Adoption of ASX recommendations

3.6. Regression models

Our second aim is to investigate the association between adoption of the

Average ROA=Tobin0 s Q/Earnings Quality for 2001 and 2004

DAverage ROA=DTobin0 s Q=DEarnings Quality for 2001 and 2004

4.1. Descriptive statistics

Small companies (n = 99) Large companies (n = 561)

Variable Mean SD Min Max Mean SD Min Max t-test

Panel A: descriptive statistics of continuous variables

Small companies Large companies

Variable Yes % Yes % v2 test

Panel B: descriptive statistics of dichotomous variables

Materials 9 9.09 54 9.62

Board CEO Audit Shareholder VIF

CEO duality 0.01 1.04

4.2. Adoption of ASX recommendations

Table 3 presents descriptive statistics and statistical tests of change for

Panel A: small companies (n = 99)

Mean Mean Change Sig.

Panel B: large companies (n = 561)

4.3. Pre- and postregulation regression results

4.3.1. Average ROA

For small companies, we do not ﬁnd any of the governance variables to be

Variable 2001 2004 2001 2004 2001 2004

For large companies, a signiﬁcant positive association is found for board

For small companies, we ﬁnd that board independence is signiﬁcant and

4.3.3. Earnings quality