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This study investigates whether the monitoring of company management by an independent board of directors serves to enhance firm performance in Australia. The paper explores in detail the impact of the level of independence of the main board and sub-committees including audit, remuneration and nomination on performance in a sample of 250 listed companies. From the perspective of a regulator, the study's findings have implications and suggest that an independent main board produces superior results. The shareholding of independent directors is also found to negatively impact performance for this data, suggesting that their role as independent arbiter is restricted by shareholding. Interestingly, the returns to firm performance engendered by independence did not extend to the composition of sub-committees, where the presence of outside directors did not significantly influence performance.
Keywords: governance, board of directors, agency theory, Australia.
JEL classification: G30.
1. INTRODUCTION
Agency theory defines the agency relationship where the principal (or owner) delegates tasks to an agent (or manager). The theory highlights costs associated with the principal-agent relationship, which include the opportunistic behaviour or self-interest of the agent taking priority over the principal's interest. Mallin (2004) highlighted a number of dimensions to this including the agent misusing their power for financial or other advantage; and the agent not taking appropriate risks in pursuance of the principal's interests - often because managers are more risk-averse than the companies they lead. Another cost arises due to the principal and agent having access to different levels of information; the agent (manager) usually being in control of superior and more detailed information than that of the owner (information asymmetry). This requires the owner to institute expensive monitoring of the manager's actions to redress the knowledge imbalance.
Fama (1980) argued that the boards of directors provide the most critical, internally based method for monitoring the performance of managers. They have the ability to directly oversee the performance of managers and to offer incentives to managers that reward performance in line with owner expectations; or, equally, discipline managers when these are not met. Fama and Jensen (1983) note that effective monitoring requires the board of directors to act as an independent arbiter between management and owners, as collusion could result in an overall loss to the owners. To...