Board independence and firm performance: evidence from ASX-listed companies

There is an explosion of research on corporate governance in the past two decades; two major corporate governance models have been identified in the literature - the outsider system in the U.K. and U.S., and the insider system in Germany and Japan. Commentators tended to favour the insider system during the 1980s, when the economies of Germany and Japan outperformed others, and tended to favour the outsider system in the 1990s, when the economies of the U.S. looked better. The Australian market is often described as forming a part of the Anglo-Saxon outsider model; some scholars, however, raised questions about this classification, and pointed out that the Australian market may have more in common with Germany and Japan in terms of corporate ownership and control. From 2003, Australian listed companies have been subject to new corporate governance guidelines, which identify independent directors as a key component of effective governance. It appears that these recommendations are based on the Anglo-Saxon model, whose focus is on the agency conflict between managers and shareholders. Matching the trend towards greater board independence, the research on the empirical link between board characteristics and firm performance, primarily from the US and more broadly in recent years, is growing; most of them use agency theory as their underlying theoretical arguments. The mixed evidence, however, suggests the need for an in-depth investigation. This study gives an examination of various theoretical perspectives on boards of directors, to enhance our understanding on the potential relationship between board independence and corporate performance. It is found that agency theory, stewardship theory and organizational portfolio theory offer different expectations. From an agency perspective, where the board of directors is more independent of management, company performance would be higher. Stewardship theory proposes that board of directors with a lower level of independence would lead to better performance. The organizational portfolio model, as a theory waiting for empirical testing, suggests that board independence would be both proactive and reactive to performance. To identify the effect of board independence on firm performance, and the effect of firm performance on board independence, this study follows an archival research approach using secondary data, which has been typically adopted by the research surrounding this topic. It may be the first Australian study which presents direct evidence on the potential consequences of the recently altered regulatory environment with respect to board composition and structure. It is also designed to overcome the methodological limitations identified in prior research to provide improved evidence in this field. The results indicate that, for Australian listed firms, there is no strong relationship between board independence, and past or subsequent performance. The evidence casts doubts on the hope that promoting board independence would add value to Australian corporations. It appears that appointing independent members to the boards may merely represent firms' attempts to comply with institutional pressures, and therefore would not be linked to performance. It is suggested that, despite agency theory's policy influence, whether certain corporate governance practices recommended by the theory would lead to better performance need to be empirically tested. The regulatory bodies in Australia and other economies should be mindful of the differences between the markets when they look for the solutions to their corporate governance issues.