performance and accountability of small listed companies? Jacqueline Christensena, Pamela Kenta, James Routledgea,. Jenny Stewartb. aBond Business ...
Accounting and Finance 55 (2015) 133–164
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, Griffith Business School, Griffith University, Nathan, QLD, Australia
b
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 systematically 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
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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 recommendations, 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 companies 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
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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 recommendations 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 implementation 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 preand 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 20 per cent shareholding. Leverage = total liabilities/total assets. Size = natural log of total assets.
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Industry = GICS industry grouping in 2001. DAverage ROA = change in average return on assets over pre- and postrecommendation 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 postrecommendation 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 postrecommendation 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 postrecommendation 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.
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