Agency Costs, Corporate Governance and Ownership Structure: Evidence from

Australia
Darren Henry*
Department of Economics and Finance
School of Business
La Trobe University

Abstract
This paper examines the level of agency costs inherent in listed Australian companies
over the period from 1992 to 2002, and evaluates governance and ownership attributes
that are hypothesised as mitigating agency cost occurrence. Agency costs are shown to be
higher for Australian firms relative to levels reported for US and UK companies. Agency
cost levels are significantly related to board independence, the magnitude and nature of
director remuneration, the existence of CEO-chairperson duality, corporate dividend
policy and institutional share ownership, and evidence is provided of non-linear
relationships with levels of director and external ownership. It is found that superior
internal governance structure lowers the level of agency costs and that internal
governance and external shareholding influences are substitute agency-mitigating
mechanisms.

JEL Classification: G32, G34

Keywords: Agency theory, corporate governance, ownership, monitoring, agency costs

__________________________
*

Corresponding author Address: School of Business, La Trobe University, Bundoora, Victoria

3086, Australia, Telephone: +61-3-94791730, Fax: +61-3-94791654, E-mail address:

d.henry@latrobe.edu.au

Agency Costs, Corporate Governance and Ownership Structure: Evidence from

Australia
1. Introduction
Agency problems are increasingly inherent in the modern-day corporation, owing to the
widening separation of ownership and control responsibilities, growing business
diversification and segmentation across industry and business lines, and investor
emphasis on near-term performance and return outcomes. Agency costs can manifest in
various forms under these circumstances, including self-serving behaviour on the part of
managers focused on status or empire-building objectives, excessive perquisite
consumption, non-optimal investment decision-making or acts of accounting mismanagement or corporate fraud. The adverse implications of these actions are then felt in
the form of the destruction of shareholder wealth and wider impacts on other corporate
stakeholders, such as debt providers, employees and society in general. The realisation of
the consequences flowing from the incidence of agency problems have led to emphasis
being placed on the importance of competitive markets for managerial labour and
corporate control as monitoring mechanisms designed to limit the degree of agency
divergence, the role of institutional shareholders as substitute agency devices and the
development and enforcement of codes of corporate governance practice to enhance
director and management oversight and create desirable incentive structures within firms.
The purpose of this paper is to examine the incidence of agency costs among
companies listed on the Australian Stock Exchange (ASX), and to evaluate the
effectiveness of ownership and corporate governance mechanisms in limiting or
controlling the magnitude of agency-related costs within these companies. The Australian
market is a particularly interesting environment to examine this issue, as it is perceived as
potentially being prone to substantial agency-related problems. This perception is based,
initially, on the ASX being considerably smaller than similar corporate sectors in the US
and the UK, resulting in a market capitalisation structure that is concentrated amongst
larger listed companies, lower levels of domestic, and foreign, institutional investment, a
resultant reduction in the extent of analyst following across the company spectrum, and a
smaller overall pool of available managerial and director labour. Following from this,
Australia also has a quite unique market for corporate control, and one that would appear

to be less effective in disciplining or correcting agency-based corporate control problems.

Although, similar to the UK environment, the corporations and stock exchange listing
legislation in Australia prohibits listed companies from employing pre-bid anti-takeover
devices (such as poison pills, dual class recapitalisations, board classification, charter
amendments and the like), considerable flexibility is available for target companies
following takeover announcements and target directors are seen as having a highly
influential role in determining takeover outcome. For instance, Henry (2004) documents a
takeover hostility or resistance rate of approximately 50% and a success rate of 66% in
takeover bids for ASX-listed companies over the period from 1992 to 2002. These
takeover hostility and success rates are alarmingly higher and lower, respectively, than
those observed in other countries, and even in the UK where the takeover legislation is
relatively comparable. This would suggest that the threat of takeover may be a less
powerful agency substitute than in other markets such as the US and the UK.
The introduction of formal corporate governance requirements has also only
recently occurred in Australia, with the ASX Corporate Governance Council releasing a
Principles of Good Corporate Governance and Best Practice Recommendations document
in April 2003, which becomes observable for ASX-listed companies from the 2004
annual reporting period onward. This corporate governance code is not legislatively
mandated and is centred on a disclosure-based If not, why not principle, resulting in
uncertainty in relation to adherence rates and its overall impact on corporate structure and
decision-making. As such, it is forseeable that Australian companies, and particularly
those of smaller size, may have less-developed corporate governance regimes and be
more susceptible to experiencing agency problems.
This paper will examine the pattern of agency costs for a sample of ASX-listed
companies over the period from 1992 to 2002. Agency costs will be measured using a
number of proxies commonly applied within the literature, and then compared to levels
reported in prior studies to determine whether a different agency-cost environment exists
in Australia. This will be followed by an examination of the relationship between selected
ownership structure and governance-related variables and these agency cost proxies to
determine the effectiveness of recognised substitute and monitoring mechanisms in
controlling observed agency problems. Further robustness testing will discriminate across

firm size classifications, as agency costs are suggested as being more prevalent in larger
corporations, and consider the interaction between internal and external governance
measures and the incidence of agency costs. The longitudinal nature of the sample period
employed and modelling using firm fixed effects will allow for consideration of the
dynamics associated with these relationships over time, while also controlling for
unobserved sample firm heterogeneity that may impact on agency problems within
individual firms. Beyond identifying factors that are effective in minimising agency
problems and costs, this analysis may also have implications for the corporate governance
reform process in Australia, and inform in regard to the importance of ownership
structure on corporate decision-making and performance, which is one aspect not directly
addressed by the ASX Corporate Governance Council.
Evidence is provided indicating that Australian companies are increasingly
subject to agency costs in comparison to US and UK firms. Attributes that are found to
significantly influence the level of agency costs include corporate dividend policy, the
degree of board independence, the existence of CEO and board chairperson duality, board
remuneration and the level of institutional ownership, and there is evidence of non-linear
relationships between director and external ownership and agency costs. Conflicting
results are observed in regards to the relationship between firm size and agency costs,
although different factors are found to impacts on the level of agency costs for small and
large firms. An index measure representing firm internal governance structure is found to
be negatively related to the level of agency costs, and internal governance and external
ownership influences are shown to be substitute mechanisms in influencing the extent of
agency costs observed.
The remainder of the paper proceeds as follows. Section 2 provides a review of
prior relevant literature and hypothesis development for the paper. Section 3 describes the
methodological approach followed, outlines sample construction and data issues, and
defines the variables employed in the empirical analysis. Section 4 presents descriptive
statistics, the multivariate analysis results and robustness testing, and Section 5 concludes
the paper.

2. Prior literature discussion and hypothesis development

2.1 Prior literature discussion

A number of approaches have been employed within the literature to shed light on the
existence of agency costs within corporations and the attributes that aid in mitigating such
undesirable costs. Firstly, there is a stream of research evaluating the association between
different agency-mitigating mechanisms and interpreting from this the agency cost
consequences and the attributes that impact prominently on agency costs. Early studies in
this regard include Jensen, Solberg and Zorn (1992) which identified an interrelationship
between levels of inside ownership, leverage and dividend payout, with inside ownership
negatively impacting on debt and dividend levels. This suggests that inside ownership
and financing policy (leverage and dividend payout) are substitute mechanisms in
potentially reducing agency costs. Similar conclusions are drawn by Mohd, Perry and
Rimbey (1995) who find that inside ownership and leverage negatively impact on
dividend payout ratios, and that higher institutional investment significantly increases
payout ratios, suggesting that firm dividend policy is determined in a manner consistent
with minimising agency-related costs. Agrawal and Knoeber (1996) provide some
evidence of interrelationships between alternative agency mechanisms, including
leverage use, insider ownership, institutional ownership, the existence of blockholders
and takeover market activity, and Crutchley, Jensen, Jahera Jr. and Raymond (1999)
provide evidence of simultaneity between various agency-control mechanisms and
support for institutional ownership substituting for other attributes mitigating agency
costs.
The second approach taken in the empirical literature has been the evaluation of
the association between agency control mechanisms and firm performance outcomes,
with positive performance effects of agency attributes intimated through their
contribution to lowering agency costs. Although this strain has spurned extensive
research, substantial inconsistency is observed across studies evaluating the impact of
individual agency-controlling mechanisms on firm performance. Potential governancerelated attributes that have been evaluated in this context include the size of the board of
directors (Jensen, 1993; Yermack, 1996; Eisenberg, Sundgren and Wells, 1998; and
Bhagat and Black, 2002), the composition of the board of directors (Baysinger and
Butler, 1985; Hermalin and Weisbach, 1991; Agrawal and Knoeber, 1996; Yermack,

1996; Klein, 1998; John and Senbet, 1998; Vafeas and Theodorou, 1998; Mak and Li,
2001; Bhagat and Black, 2002; Weir, Laing and McKnight; 2002; and Brown and Caylor,
2006), CEO and board chairperson duality (Brickley, Coles and Jarrell, 1997; Dalton,
Daily, Ellstrand and Johnson, 1998; and Dedman and Lin, 2002), board committee
formation and independence (Klein, 1998; Vafeas and Theodorou, 1998; and Brown and
Caylor, 2006), and managerial remuneration and compensation structure (Lewellen,
Loderer and Martin, 1987; Jensen and Murphy, 1990; Yermack, 1995 and 1997; Shleifer
and Vishny, 1997; and Conyon, 1998).
There has also been significant investigation into the role of shareholding
influences on firm performance, with Morck, Shleifer and Vishny (1988), McConnell and
Servaes (1990), Hermalin and Weisbach (1991), Short and Keasey (1999) and Cui and
Mak (2002) providing evidence of a statistically significant non-linear relationship
between managerial ownership and firm performance, and McConnell and Servaes
(1990) and Zeckhauser and Pound (1990) identifying positive relationships between
performance and levels of institutional and large external ownership respectively.
Contrasting with these results, however, Denis and Denis (1994), Craswell, Taylor and
Saywell (1997), Loderer and Martin (1997), Demetz and Villalonga (2001) and Mak and
Li (2001) in relation to managerial ownership, and Morck, Shleifer and Vishny (1988),
Short and Keasey (1997) and Faccio and Lasfer (2000) evaluating institutional
ownership, identified no statistically significant performance impacts.
Given the inconsistent findings based on the examination of individual attributes,
increasing focus has been placed on considering the overall governance or agency
structure of firms, using measures such as shareholder rights or takeover vulnerability
indices. This approach relates to the expectation that firms offering lower protection for
shareholder claims, those with poorer governance practices or firms that are increasingly
immune to takeover threat are more likely to experience agency and managerial
entrenchment problems leading to incurrence of agency costs and lower relative
performance. The evidence in this regard is much more conclusive, with La Porta, Lopezde-silanes, Shleifer and Vishny (1998) and (2000), Black (2001), Gompers, Ishii and
Metrick (2003), Bebchuk, Cohen and Ferrell (2004), Klapper and Love (2004), Black,
Jang, Kim and Park (2005), Cremers and Nair (2005) and Black, Jang and Kim (2006) all

finding a positive association between measures representative of superior corporate

governance quality, stronger shareholder rights or increased takeover vulnerability and
firm performance.
The final relevant subset of literature, and that which is most closely aligned to
this paper, involves those studies that have directly attempted to measure (or proxy for)
the level of agency costs inherent in firms, and then evaluated the factors that
significantly impact on the variation in firm agency costs within cross-sectional or
longitudinal sample constructs. Ang, Cole and Wuh Lin (2000) applied this method to a
sample of non-listed US small businesses based on measuring agency costs, using
operating expense and asset turnover ratios, relative to a zero-agency cost base firm
represented by a 100% owner-manager firm. Agency costs were found to be negatively
related to the managers ownership interest and the extent of external bank monitoring
and positively related to the number of shareholders and the existence of an outside (nonowner) manager. Fleming, Heaney and McCosker (2005) identified similar results in an
analysis of non-listed Australian firms. Singh and Davidson III (2003) found that larger
managerial ownership and smaller-sized boards both enhance asset utilisation ratios for
larger listed US companies. Doukas, Kim and Pantzalis (2000) examined agency cost
determinants for listed US firms and concluded that greater analyst following generally
reduces agency costs, but its effect is more prominent for single-segment as opposed to
diversified firms. They also provided evidence of non-linear relationships between inside
ownership and leverage and the level of agency costs, whereas agency costs are found to
be positively associated with the level of institutional ownership. In a similar study of
listed UK firms, Doukas, McKnight and Pantzalis (2005) find that greater analyst
following only reduces agency costs for small firms.

2.2 Hypothesis development for agency cost determinants

Prior research has focused primarily on ownership structure, and particularly the degree
of separation of control and ownership claims, as a key determinant of agency costs.
Although it is not possible to identify the zero-agency-cost case with listed firms,
managerial (director) ownership remains a likely candidate as an agency-control
mechanism. Such an expectation is consistent with the convergence of interest

hypothesis proposed by Jensen (1993), where a larger managerial ownership interest

should more closely align the decision-making and wealth interests of managers with
those of company shareholders, resulting in the minimisation of agency problems. This
would suggest a negative relationship between the level of managerial ownership and the
extent of agency costs. Beyond a certain level of managerial ownership, however, it is
foreseeable that managers may become entrenched in their position, whereby personal
wealth consequences are offset by incentives to extract private benefits from incremental
or excessive consumption or use of corporate resources. The result of this being growing
agency problems as managerial control exceeds this entrenchment level of ownership,
and a non-linear relationship between managerial (director) ownership and agency costs.
Outside ownership interests are suggested as providing a watchdog or external
monitoring influence on board and managerial decision-making. Institutional investors
provide an alternative source of oversight of managerial and firm performance, and they
may choose to use their voting rights to influence corporate decision-making and board or
management structure. Effective monitoring (or actual activism) from institutional
shareholders should help to facilitate the alignment of shareholder and managerial
interests and, therefore, lower expected agency costs. Australian institutional investors,
however, are not overwhelmingly renown for their activist ways and the evidence
discussed above is also not definitive in its support of the efficient monitoring
hypothesis. Similarly, other outside substantial corporate shareholders (or blockholders)
also have an incentive to efficiently monitor firm performance to maximise the value of
their shareholdings, which should reduce the extent of agency problems. Identical
concerns to those regarding director ownership apply, however, in relation to the
potential entrenchment of corporate substantial shareholders if their ownership interest
exceeds the level required to obtain effective control of corporations. Achievement of
effective ownership and voting control may lead to entrenchment-related agency costs,
such as empire-building, underinvestment or the development of excessive financial
slack, which cannot be resolved through effective external monitoring or the market for
corporate control.
Other agency-reduction mechanisms that have been suggested in prior literature
include the employment of debt financing (leverage), dividend policy and/or share-

repurchase programs, and the adoption of effective corporate governance practices.

Leverage is suggested as having a positive incentive effect on firm management resulting
from the adverse consequences associated with defaulting on debt obligations. The use of
external debt finance will also result in the firm likely being subjected to additional
outside monitoring by debt providers, which have similar incentives to major institutional
investors or external blockholders in relation to protecting their investment interests. As
such, increasing leverage use should reduce the extent of agency costs inherent in a firms
operating structure. A higher relative dividend payout (or a higher effective dividend
yield) is also expected to minimise agency costs, as dividends lower the level of available
liquidity which increases the potential default risk of firms and, the higher are dividends
relative to earnings, the stronger is the focus likely to be on future earnings performance
as a means of maintaining the current dividend payout level.
The potential benefits from best practice achievement in relation to the corporate
governance code introduced in Australia are indicated to include improved corporate
decision-making and optimising corporate performance and accountability in the
interests of shareholders and the broader economy (ASX Corporate Governance
Council, 2003: page 5). This would suggest that one perceived benefit of corporate
governance reform is associated with minimising agency costs. Although governance
regulations do not typically advocate an optimal board size, it is suggested that smaller
boards of directors are more organisationally functional and effective in decision-making
and less easily controlled by a dominating influence (such as the CEO or a substantial
shareholder). Firms with relatively smaller-sized boards are, therefore, seen as being less
susceptible to agency problems and associated agency costs. Similar benefits are
expected to be derived from separating the roles of CEO and board chairperson, based on
such separation limiting the control or influence of any one individual on board decisionmaking.
Another governance attribute that has been hypothesised as influencing firm
performance and the agency environment is board composition or, more specifically, the
appointment of outside or independent board members. The presence of independent
directors is justified on the basis that they provide an outside source of monitoring of
management decision-making and performance and a shareholder-representative voice in

overall company strategic planning, which is thought to improve board integrity and
effectiveness. An increasingly independent board should also, therefore, result in lower
agency costs at the firm level. The other prominent issue debated in corporate governance
circles is the link between director and management compensation and performance.
Agency theory ideals suggest that higher management pay and/or linking monetary or
share bonuses or option entitlements to specific firm performance targets should act as a
positive incentive mechanism, help in minimising agency costs and aid in improving firm
performance.

3. Variable and sample description and methodological approach

3.1 Measurement of agency costs
Various measures have been employed in the prior literature to proxy for the level of
agency costs present in firms. This paper employs four different proxy measures that
relate to various aspects of firm operations, in an attempt to provide a comprehensive and
robust representation of the agency cost environment for listed Australian firms.
Following Ang, Cole and Wuh Lin (2000) and Singh and Davidson III (2003), the asset
utilisation ratio is employed as a relative measure of agency costs. The asset utilisation
ratio, defined as total revenue divided by total assets, provides a quantitative measure of
the effectiveness of firm investment decisions and the ability of the firms management to
direct assets to their most productive use. Firms with lower asset utilisation ratios are
seen to be making non-optimal investment decisions or using funds to purchase
unproductive

(non-revenue-generating)

assets,

and

creating

agency

costs

for

shareholders. Variations of the operating expense ratio adopted by Ang, Cole and Wuh
Lin (2000), or the selling, general and administrative expense ratio used by Singh and
Davidson III (2003), to proxy for agency costs by capturing superfluous or perquisite
expenditure in excess of that required to efficiently operate firms are unable to be
operationalised in this study due to the unavailability of detailed and specific expense
information for listed Australian companies.
The second agency cost proxy used is the asset liquidity ratio, which is defined as
the sum of cash and marketable securities scaled by total assets (Prowse, 1990). The
larger the proportion of total firm assets that are held in liquid form, the greater is

10

management discretion in relation to the employment of these funds which increases the
likelihood that some or all of these funds may be invested sub-optimally. Thus, firms
with higher asset liquidity ratios are likely to be subject to greater agency costs. The third
agency cost measure employed in this paper is the magnitude of firm free cash flows,
with greater retention of free cash flows within the firm envisaged as being indicative of
potential agency problems and the existence of agency costs. Similar to Lehn and Poulsen
(1989), free cash flows are calculated as Operating Income before Depreciation less
Corporate Income Tax Paid, Interest Expenses and Dividends Paid, with this sum divided
by Total Assets.
The final agency cost proxy represents a measure of firm managerial
performance, based on the premise that poorly-performing managers are more likely to
make decisions that give rise to agency costs. This measure, termed Qagency, is
formulated as an indicator variable based on sample firm annual Tobins Q ratios. This
indicator variable is assigned a value of one if the firms Tobins Q ratio is greater than
1.00, and is given a value of zero if the Tobins Q ratio is less than or equal to 1.00. The
Tobins Q ratio is calculated as (Market capitalisation of equity + Book value of
preference shares + Book value of long-term debt) / Book value of total assets. Sample
firms with Tobins Q ratios greater than 1.00 are perceived as well-managed firms that
are creating value for shareholders and are, therefore, less likely to be generating
detrimental agency costs, whereas firms with Tobins Q ratios less than unity are
destroying shareholder value, where part of this value loss is expected to be associated
with agency costs. It is also possible that the Qagency indicator variable may be
identifying sample firms with higher (Tobins Q ratio > 1.00) and lower (Tobins Q ratio
1.00) growth opportunities, with firms having lower growth opportunities being
increasingly prone to resource wastage or making non-optimal investment decisions,
which creates agency costs for shareholders.

3.2 Definition of explanatory and control variables

The variables evaluated in this paper as potential determinants of agency cost levels can
be categorised as representing ownership influences, financial policy attributes or
corporate governance mechanisms. In terms of ownership structure, director ownership is

11

measured as the percentage of total firm equity capital (excluding shares attributable to
underlying share bonus, incentive and option plans) held by all company directors.
Institutional ownership is determined as the total percentage shareholding of all
institutional shareholders within the Top 20 shareholders of the company. For definitional
purposes, institutional shareholders include life and non-life insurance companies, fund
management companies, superannuation and pension funds, listed investment companies
and investment and unit trusts. Bank and other nominee company shareholdings are
excluded, unless they are recognised as being institutional holding accounts. External
ownership is defined as the sum of all individual non-institutional and non-director
shareholdings exceeding 5% of company issued equity capital. This 5% shareholding
threshold is employed as it is the minimum ownership level at which the Listing Rules of
the ASX require ultimate shareholder notification to be disclosed to the wider market.
To investigate the impact of capital structure choice on agency costs, the total
debt to total assets ratio is employed to characterise the leverage position of firms.
Dividend yield, calculated as dividends per share divided by end-of-year share price, is
used to identify the dividend payout policy of firms, with a negative relationship between
dividend yield and agency costs expected.
A number of corporate governance attributes are also hypothesised as influencing
the magnitude of agency costs, as discussed previously in Section 2.2. The size of the
board of directors is represented by the natural logarithm of the total number of board
members. A dummy variable is included to signify the existence of CEO and board
chairperson duality, which is given a value of one if the CEO is also the chairperson of
the board of directors and zero otherwise. Board of director composition is measured
from the perspective of independence, represented by the number of independent
directors on the board relative to the total number of board members. Directors are
classified as independent if they are not currently, and have not within the last three years
been, employed by the company in an executive role, are not a substantial shareholder or
an officer or affiliate of a substantial shareholder in the companys equity, are not a
principle adviser or consultant to the company or work for a firm acting in such a

12

capacity, are not a relative or descendent by birth or marriage of company founders or

have any other material business or related party relationship with the firm.1
Also included as potential agency-cost mitigation mechanisms are two variables
relating to the remuneration structure for sample firm directors. The first of these
variables is the level of remuneration of the board of directors, which is calculated as the
natural logarithm of the sum of the total annual benefits paid to all board members.2 It is
expected that higher director remuneration should provide an incentive for directors to act
in the interests of shareholders as a means of ensuring their job security and continuing
access to these remuneration benefits, and particularly if this remuneration represents a
substantial component of their total wealth portfolio. Thus, higher director remuneration
is expected to result in lower agency costs. The second variable is an indicator variable of
the existence of outstanding options issued to executive directors, which is given a value
of one if there are outstanding options on issue to executive directors at the end of the
applicable financial year and zero otherwise. This variable only applies to executive
directors, as providing incentive-based compensation to outside (independent) directors is
considered to not be prudent practice in Australia.
The analysis also controls for a number of firm-specific factors that are expected
to influence the agency-cost nature of sample firms. These include firm risk, which is
calculated as the standard deviation of daily share returns in the relevant financial year,
and firm size, which is calculated as the natural logarithm of total revenue at the end of
the financial year. It is expected that riskier firms will exhibit lower agency costs due to
their greater susceptibility to distress or failure, and agency costs are anticipated as being
1

This definition is in line with that proposed by the ASX Corporate Governance Council (2003), as part of

their recommendations in relation to preferred board of director composition.

2

Prior to an amendment to Section 300A of the Corporations Act in 1998, only a ranged scale of total

benefits paid to unidentified directors and the total remuneration for all directors and details regarding the
numbers of shares and options held by directors was required to be disclosed in annual reports. Since 1999,
companies are now required to provide detailed remuneration for individual identified directors and the five
most highly remunerated executives (including separate information regarding salary, bonuses, retirement
benefits and superannuation entitlements) and the value of share bonuses and options granted to directors.
As such, for the entire analysis period from 1992 to 2002, only information relating to the total annual
benefits paid to all directors and outstanding shares and options issued was consistently available.

13

increasingly prevalent in larger firms which tend to be more diversified and have more
complex organisational structures.

3.3 Sample selection and data description

The company sample employed in the analysis was derived from the random selection of
120 companies out of the largest 300 companies, based on market capitalisation value,
listed on the ASX as at the end of June 1996.3 Listed property and investment trust
companies, which have different management and governance structures, and banking
and regulated utilities companies, which have unique financing and ownership structures,
were excluded from selection availability. Relevant data for these sample firms was then
collected for the annual periods from 1992 to 2002. The sample period ends in 2002 due
to the desire to examine internally-developed governance practices in response to firms
agency environments, rather than the adoption of those dictated by the ASX Corporate
Governance Council in 2003. This provided a final sample of 1,127 firm-level yearly
observations, with missing year observations being associated with firms that initially
listed on the ASX after 1992 or firms that were delisted from the ASX after 1996, with
the latter mainly due to acquisition.
Accounting, financial and market-based data was obtained from the Thomson
Financial Company Analysis database, and share price information used to calculate firm
risk measures was obtained from the Securities Industry Research Centre of Asia-Pacific
(SIRCA) ASX Daily Data database. Corporate governance attributes and ownership
information were hand-collected from sample company annual report documents, which
were obtained from either the Connect4 Annual Report database, the Aspect Financial
DatAnalysis database or from Thomson Research. Director independence classification
was determined using annual report information from directors reports, director profiles,
reports on corporate governance practice, shareholder information and annual report
notes relating to related party transactions and director and executive remuneration.
3

Although selection is skewed towards larger companies for data availability reasons, this is still

representative of a substantial company size spread. As at June 1996, the largest listed company on the
ASX had a market capitalisation of $37,447 million, whereas the company ranked 300 on the basis of
market capitalisation was valued at only $102 million.

14

3.4 Research methodology

Given the eleven-year panel structure of the sample firm data employed in this study,
formal fixed effects multivariate regression analysis is conducted to investigate the
relationship between the agency-mitigation attributes and the proxy dependent variables
representing the extent of agency costs prevalent within sample firms. Fixed effects
modelling allows for the control of unobserved heterogeneity across the sample firms,
which also goes some way to removing omitted variable bias concerns and provides
robust regression model estimates. The base multivariate model that will be evaluated is
represented as follows:
Agency cost it = + 1 ( Leverageit ) + 2 ( Dividend yield it ) + 3 (CEO chair duality it )
+ 4 ( Board independen ceit ) + 5 ( Board sizeit ) + 6 ( Board remunerati onit ) +

7 ( Executive option useit ) + 8 ( Institutio nal ownership it ) + 9 ( External ownership it ) +

10 ( Director ownership it ) + 11 ( Firm risk it ) + 12 ( Firm sizeit ) + i + eit

(1)

where:
Agency costit = the dependent variables employed to proxy for the extent of agency costs
for firm i in year t. The model in equation (1) will be estimated for each of the four
agency cost measures.
= overall intercept term
i = the firm-specific fixed effect
eit = the unobserved error component
The independent variables are defined previously in Section 3.2. The regression
models tested also include a set of year dummy variables to control for events common to
all sample firms. The above model will also be re-estimated after including squared terms
for the external and director ownership variables, as a means of evaluating the existence
of non-linear ownership effects on agency cost levels. For the indicator agency cost proxy
variable defined based on above- or below-unity Tobins Q ratios, a fixed effects logit

15

regression model is estimated due to the binary nature of this dependent variable.4
Hypothesis expectations in relation to the explanatory variables included in the model
were previously outlined in Section 2.2, and are summarised in Table 1 below.
INSERT TABLE 1 ABOUT HERE
Note the difference in hypothesis expectations across the different agency cost
proxies in Table 1, where different variable specifications imply alternative agency cost
implications. Higher agency costs are expected for sample firms with lower asset
utilisation (or efficiency) ratios or which exhibit poor management performance and
destroy shareholder value based on Tobins Q ratios less than unity, whereas agency costs
are expected to be more prominent in firms with higher proportions of liquid assets and
sample firms that retain greater amounts of free cash flow.

4. Empirical analysis results

4.1 Descriptive statistics
One objective of this paper is to determine whether Australian firms experience greater
agency costs than those evident in other countries. For this purpose, Table 2 presents
descriptive statistics for the four agency cost proxy variables, and the hypothesised
agency-mitigation mechanisms, for the overall eleven-year sample period from 1992 to
2002 and mean statistics for individual years within this overall period. Across the
sample firms, the average asset utilisation ratio was 0.8549, with the median firm
operating at an efficiency level of 0.19 less than this mean level. These sample statistics
can be compared to the mean (median) asset utilisation ratios of 1.43 (1.24) for US listed
firms in Singh and Davidson III (2003) and 2.69 (2.16) for small, unlisted Australian
businesses in Fleming, Heaney and McCosker (2005). In terms of asset liquidity, the
mean and median proportion of total assets held in liquid form for sample firms is 9.69%

One potential concern with estimating a fixed effects logit model in this circumstance is the loss of

observations relating to sample firms which have Qagency variable values that do not change across the
panel period from 1992 to 2002 (such as firms which have Tobins Q ratios that are always above or below
unity). As a check, random effects logit models, which are not subject to this constraint, were also
estimated for comparison purposes, with similar overall results obtained.

16

and 5.04% respectively, which can be compared to the mean asset liquidity ratios of 12%
and 11% for US and Japanese firms respectively reported in Prowse (1990).
Sample firms are identified as retaining average free cash flows approximating
4.19% of total assets, although the median firm chose not to distribute cash flows
representing 5.31% of total assets. The mean and median Tobins Q ratio for sample
firms across the entire analysis period were 1.2521 and 1.1124 respectively, with
approximately 63% of firm-year observations recording Tobins Q ratios greater than
1.00. These ratios can be compared to mean (median) Tobins Q ratios of 1.1294 (0.8595)
for US manufacturing firms in Doukas, Kim and Pantzalis (2000) and 2.1924 (1.4000) for
a sample of UK listed firms analysed in Doukas, McKnight and Pantzalis (2005).
Although not perfect comparisons, due to sample and time period differences, this
analysis indicates that listed Australian companies may indeed experience greater agency
costs than those prevalent in larger capital markets, which is particularly evident based on
the asset utilisation and Tobins Q ratio comparisons. This, therefore, emphasises the
importance of identifying mechanisms which are effective at mitigating agency costs
within the Australian corporate environment.
INSERT TABLE 2 ABOUT HERE
In regards to the attributes hypothesised as influencing the extent of agency costs
observed, sample firms maintained mean and median leverage ratios of approximately
50%, and the average firm paid an annual dividend yield of 4.00%. In regards to the
corporate governance characteristics of sample firms, company boards of directors
contained a majority of independent directors, with board independence averaging
54.05% across the overall analysis period, the average and median board size stood at
eight members, and in less than 20% of sample firm year-level observations was the CEO
also the board chairperson. Total benefits paid to company boards of directors averaged
$2.714 million, although there is evidence of significant growth in director remuneration
from 1992 to 2002, and approximately half of sample firms employed share options as a
means of partially compensating (or motivating) executive directors. Share ownership by
company directors averaged 6.06% of total equity capital, although this figure is biased
upward by the inclusion of a number of largely inside-held companies, with median
director ownership representing less than 0.20% of issued share capital. Institutional

17

ownership averaged approximately 23% of sample company issued capital, however, this
figure is expected to understate true levels due to the exclusion of nominee shareholdings
and institutional investors outside of the Top 20 shareholders within companies. Mean
external blockholder ownership was 24.49% of sample firm issued equity capital,
although this figure is influenced by a number of sample firms having majority parent
ownership, as demonstrated by the substantially lower median external ownership level.
Panels B and C in Table 2 provide information about movements in dependent
and explanatory variables across individual years within the overall sample period. In
general terms, most variables are quite stable across the eleven-year sample period. There
is evidence of very little movement in asset utilisation or liquidity ratios from 1992 to
2002, which suggests no substantial improvement in sample firm efficiency during this
period. Average free cash flow retention ranges from 1.59% to 5.71% of total assets
across the analysis period, and sample firm mean Tobins Q ratios vary from 1.1100 in
1992 to a maximum of 1.3648 in 1997. Dividend yields have remained relatively constant
over time, whereas there is some indication from Panels B and C in Table 2 that firms
have become marginally more levered over the sample period. The degree of board
independence has increased over the analysis period and peaks at a mean level of almost
61% in 2002 and, interestingly, there appears to be a trend towards more CEOchairperson duality towards the end of the sample period after an initial decline up until
1996. There is also evidence that sample firms are increasingly introducing share option
components into board remuneration packages, although the incidence of this practice
peaked in 2000. In regards to trends in ownership, the mean level of director ownership
has remained relatively constant over the sample period, whereas average institutional
ownership has increased approximately 4.50% from 1992 to 2002 and mean external
substantial shareholder ownership has declined by around 7% over the same period.
Sample firms appear to have become marginally more risky over time and, as expected,
average revenue levels have more than doubled over this eleven-year period.

4.2 Relationships between explanatory variables

Table 3 presents pairwise correlation coefficients for the independent variables for the
overall sample period. This information is useful, not only to identify any potential

18

problems in regard to excessive multicollinearity which may contaminate multivariate

regression models, but also to shed light on the nature of the association between
difference agency control mechanisms and whether they represent substitutable or
complementary attributes. Expected correlations that are evident include the positive
association between company size and board size and board remuneration, with larger
firms envisaged to have larger overall board representation and to be able to offer these
board members greater compensation. Similarly, it is not surprising to find that total
board remuneration is positively correlated with board size.
Other interesting correlations observed include greater institutional ownership
increasing the degree of board independence, whereas board independence is negatively
correlated with the levels of director and external ownership. Increasingly independent
boards also appear to favour the use of option incentives for executive directors and are
less likely to have an executive chairperson. Higher institutional ownership is also
associated with higher board remuneration, greater use of incentive-related executive
compensation and reduced likelihood that the CEO is also board chairperson. Institutional
ownership, however, is lower in sample firms that have a higher director or external
ownership presence, which may suggest that they perceive a greater potential for agency
problems in such situations or that any independent monitoring will be less effective in
such firms. Director ownership, on the other hand, is positively correlated with instances
of CEO-chair duality, and is higher when sample firms exhibit lower external ownership
influences.
Overall, the information in Table 3 suggests that the different shareholder
categories are substitute agency or monitoring mechanisms, and that institutional
ownership seems to reinforce perceived good governance practice, such as greater
board independence, division of authority and the use of salary and incentive-based
compensation. In regards to corporate governance attributes, there appears to generally be
positive correlation between variables employed to represent major governance
requirements recommended by the ASX Corporate Governance Council. This could
imply that benefits such as performance improvement or the reduction in agency costs
may be best achieved in association with an overall review of firm governance structure,
rather than being derived from individual governance reform initiatives.

19

INSERT TABLE 3 ABOUT HERE

4.3 Multivariate analysis results

This section presents the regression model results relating the financial, ownership and
corporate governance variables of interest to the four dependent variables proxying for
the extent of agency costs present in sample firms. Expectations regarding these
relationships have been discussed previously and are summarised in Table 1. Two
regression models are presented in each sub-section, with Model 1 representing the base
model outlined in equation (1) and Model 2 incorporating potential non-linear director
and external ownership effects.

4.3.1 Asset utilisation ratio as a proxy for agency costs

Table 4 presents the model regression results employing the asset utilisation (or turnover)
ratio as the dependent variable. The results for Model 1 indicate a positive relationship
between director ownership and asset utilisation, which is consistent with personal
shareholdings by directors bonding them to the company and acting as an agencymitigation device. Institutional and substantial external ownership both negatively impact
on asset utilisation, although the regression coefficients for these variables are not
statistically significant. In terms of the individual corporate governance attributes, many
of these are found to significantly impact on sample firm asset efficiency. Asset
utilisation is found to be significantly enhanced by smaller boards, and boards of
directors that are increasingly independent. Interestingly, asset utilisation is significantly
higher in firms where the CEO is also the board chairperson, which is inconsistent with
the perception that CEO-chairperson duality is an undesirable governance attribute. Also
inconsistent with prior expectations is the negative relationship identified between the
magnitude of board remuneration and asset efficiency, which suggests that higher pay
does not lead to improved performance, at least measured using asset utilisation ratios.
Sample firms that pay higher relative dividends are also found to generate higher revenue
per dollar of assets, which suggests that dividend policy may act as a bonding mechanism
for managerial behaviour and earnings performance.

20

For the other control variables included in the regression, the level of business
risk is found to be positively related to asset utilisation, which is consistent with a higher
default probability providing an increased incentive to focus intently on firm
performance. Larger firms, however, are also found to better utilise assets at their
disposal, which is inconsistent with the idea that larger firms generate greater agency
costs. The model as a whole is statistically significant in explaining variation in sample
firm asset utilisation ratios, and the firm-specific fixed effects are highly significant,
indicating substantial firm heterogeneity across the sample.
Model 2 in Table 4 allows for the incorporation of non-linear ownership effects
on asset utilisation ratios. The results provide no indication that director ownership has
different impacts on firm asset utilisation at high and low levels, suggesting that the linear
positive relationship observed in Model 1 dominates at all levels of director ownership.
There is, however, evidence of a statistically significant non-linear (quadratic)
relationship between external ownership and asset efficiency, with positive bonding
effects observed at low, but greater than 5%, ownership levels, whereas asset utilisation
decreases at higher levels of external ownership. The ownership level where this
relationship turns-over is 27.85%, which approximates the ownership level required in
companies listed on the Australian Stock Exchange to obtain effective voting control. The
inclusion of these non-linear ownership variables does not alter the statistical significance
of the other governance and financial variables, although the results suggest that these
alternative attributes may be less effective in situations of parent or effective shareholder
control.
INSERT TABLE 4 ABOUT HERE

4.3.2 Asset liquidity ratio as a proxy for agency costs

Table 5 provided the fixed effects regression model results when the asset liquidity ratio
is used as a representation of agency cost propensity. The results for Model 1 indicate a
statistically significant positive relationship between director ownership and asset
liquidity, which is inconsistent with director ownership lowering the extent of agency
costs. There is also a positive, and statistically significant, relationship between the
existence of CEO-chair duality and asset liquidity ratios which, as opposed to the finding

21

in Table 4, suggests that such duality has adverse agency cost implications. Higher board
remuneration and greater levels of institutional ownership are found to significantly lower
asset liquidity ratios, however, and a statistically significant negative relationship is also
identified between firm size and asset liquidity. This, once again, indicates that agency
costs are lower in larger firms. The other factor shown to impact on asset liquidity is
dividend yield, with firms that pay higher dividends maintaining a higher proportion of
their total assets in cash and marketable forms. As opposed to having the desired agencymitigating effect, this could be explained by firms retaining excess liquidity to aid in
meeting dividend policy requirements.
In Model 2 in Table 5 there is some evidence of a non-linear relationship between
director ownership and asset liquidity ratios with a negative coefficient on the director
ownership squared term, however, it is not statistically significant. There is no evidence
in Table 5 to indicate that the existence of external substantial shareholders has any linear
or non-linear influence on the liquidity make-up of firm asset structures.
INSERT TABLE 5 ABOUT HERE

4.3.3 Free cash flows as a proxy for agency costs

Consistent with Jensen (1986), the results in Table 6 indicate statistically significant
negative relationships between leverage use and dividend yield and the level of firm free
cash flows, suggesting that commitments to dividend or debt payments are effective as
tools to reduce free cash flow accumulation.5 Board remuneration is also found to be a
suitable control of free cash flows, with higher director salaries significantly lowering the
proportion of free cash flows retained within sample firms. The use of share option plans
to motivate executive directors does not, however, provide the hypothesised agency
benefits, as free cash flow retention is found to be significantly higher in firms offering
this form of compensation. A positive relationship is also evident between firm size and
firm free cash flows which, different to the results in Tables 4 and 5, suggests that larger
firms may be subject to greater agency costs. Alternatively, given the definition used to
calculate free cash flows, it could be that larger firms are relatively more profitable (as
5

Note that these are probably not surprising findings given the manner used in this paper to calculate free

cash flows.

22

the results in Table 4 indicate that they have superior asset efficiency) which leaves
greater cash flows available following debt financing and income distributions.
Model 1 in Table 6 indicates that ownership structure has no impact on free cash
flow retention, although the non-linear specifications incorporated in Model 2 suggest
that free cash flows are lower in the presence of director share ownership, however, free
cash flow retention increases beyond a certain level of director ownership. This critical
level of director ownership is 28.48% of total equity capital, which is, once again, the
approximate ownership interest required to obtain effective control of the typical firm and
may be associated with agency-conflict motives such as perquisite consumption,
underinvestment or personal wealth risk reduction.
INSERT TABLE 6 ABOUT HERE

4.3.4 Management performance indicator as a proxy for agency costs

The final agency cost proxy examined is the indicator variable, Qagency, with the results
for the determinants of this dependent variable provided in Table 7. Positive regression
coefficients are identified for the board independence and board remuneration variables,
which is consistent with more independent boards and salary incentives for directors
enhancing managerial performance and reducing agency costs. Similarly, the presence of
greater institutional and external ownership and monitoring is found to reduce the
probability of agency costs arising, in the form of Tobins Q ratios less than unity. Higher
dividend payments increase the likelihood of firms recording Tobins Q ratios less than
one, which would suggest that dividend policy is not a mechanism used to create value
for shareholders. An alternative explanation could be that firms offering higher dividend
yields have fewer growth opportunities requiring internal funding, which would explain
these firms paying greater dividends and having lower Tobins Q ratios. The results for
both models in Table 7 also indicate that larger firms are more likely to have Tobins Q
ratios less than one, suggesting that larger firms generate greater agency costs for
investors.
In relation to the possibility of non-linear ownership effects, there is some
suggestion in the Model 2 results that director incentives may differ between low and
high ownership levels, although the regression coefficients for these variables are not

23

statistically significant, and a positive regression coefficient is observed at all levels of

substantial external ownership.
INSERT TABLE 7 ABOUT HERE

4.4 Robustness testing

4.4.1 Effect of firm size
The results reported in Tables 4 to 7 above provide mixed evidence relating to the impact
of firm size on agency cost propensity. Based on the asset utilisation and asset liquidity
proxies, agency costs are found to be more prevalent amongst smaller listed Australian
firms, whereas larger firms exhibit greater agency cost tendencies according to free cash
flow and Tobins Q measures. As a means of adding further clarity to these conflicting
results, the sample is split into small and large size firms based on a below- or abovemedian annual total revenue classification. Table 8, below, compares mean and median
differences in the agency cost proxy variables across the large and small sub-sample
categories.
INSERT TABLE 8 ABOUT HERE
This analysis does not, however, yield any more conclusive findings, with results
in line with the previous multivariate analysis identified. Larger firms have significantly
higher asset utilisation ratios and lower asset liquidity ratios, however, they are also
found to retain significantly more free cash flow and exhibit lower Tobins Q ratios,
although median Tobins Q ratios are not significantly different between small and large
sample firms. Similar results are also obtained when firm size is alternatively measured
based on market capitalisation and total asset values. Thus, it is not possible to draw a
definitive conclusion as to how firm size impacts on agency cost outcomes for sample
firms.
The regression models tested for the overall firm sample, excluding the firm size
control variable, are also re-estimated for the small and large firm sub-samples to
evaluate whether the determinants of agency costs vary across the different size
categories. The results of the analysis, although not tabulated for brevity reasons, confirm
this to be the case. The agency cost proxies for smaller firms are found to be primarily
determined by ownership and corporate governance attributes, with the existence of CEO

24

and board chairperson duality, the degree of board independence and the level of director
remuneration all statistically significant determinants for a number of the agency cost
variables. The hypothesised non-linear influence of director ownership is also found for
three out of the four agency cost proxies for smaller firms. For large firms, on the other
hand, it is the financial factors that are found to be the strongest determinants of agency
cost levels, with leverage and dividend policies consistently being significantly correlated
with the dependent variables. Variations in board size are identified as the only
statistically significant individual corporate governance variable, and institutional
investors are the only shareholder group found to reduce the extent of agency costs
observed for larger firms. These results suggest that heterogeneity in corporate
governance practices is more prominent among smaller-sized firms, and that concentrated
ownership by directors and external substantial shareholders is increasingly prevalent and
more likely to be a dominant agency influence.

4.4.2 Evaluation of overall internal governance structure

There is substantial empirical literature documenting that representations of overall
corporate governance structure have significant explanatory power for firm performance,
and the evidence presented in this paper suggests correlation between individual
corporate governance attributes for Australian firms. As such, the second robustness test
combines the individual corporate governance attributes evaluated in this paper into a
proxy measure of overall firm internal governance. This index measure, termed Internal
governance, is calculated as the summation of the following binary-defined variables:
Independent board which is given a value of one if greater than 50% of board directors
are classified as independent, otherwise zero;
Independent chair which is given a value of one if the board chairperson is an
independent director, otherwise zero;
Small board which is given a value of one if annual board size is less than the annual
sample median board size, otherwise zero;
High director pay which is given a value of one if annual relative board remuneration
(calculated as total benefits paid to directors / total revenue) is greater than the annual
sample median level of relative board remuneration, otherwise zero; and

25

Executive option use which is given a value of one if there are outstanding share
options on issue to executive directors at the end of the financial year, otherwise zero.
The Internal governance variable, therefore, has a possible range from one to five,
with a higher score representative of stronger governance in the spirit of requirements
incorporated into the ASX Corporate Governance Council guidelines.6 This variable is
substituted in the regression models for the five individual corporate governance
variables to examine whether the combined internal governance environment of firms
influences the extent of observed agency costs. The three shareholder classification
variables are also retained within the model to incorporate external monitoring and
governance influences, and interaction terms between the internal governance index
variable and each of the three shareholder variables are also included to evaluate whether
ownership influences act as complementary or substitute mechanisms with internal
governance in influencing agency costs. The results for this revised model using the four
agency cost proxy dependent variables are provided in Table 9.
INSERT TABLE 9 ABOUT HERE
The regression coefficients for the internal governance variable have the expected
sign (in terms of reducing the level of agency costs) in all four models, with the
regression coefficients being statistically significant in the models employing the asset
utilisation ratio and Qagency indicator as dependent variables. This is consistent with
superior overall internal governance structure lowering agency costs for shareholders.
The interaction terms included in the models indicate that internal governance structure
and external governance, in the form of shareholder monitoring and incentive influences,
are substitute agency-mitigating mechanisms, with director ownership significantly
offsetting the influence of internal governance practices in relation to lowering asset
liquidity and free cash flow retention. Similarly, higher institutional and external
6

This internal governance measure is not a comprehensive representation of all of the requirements in the

ASX Corporate Governance Council code of best practice, rather it focuses on the governance attributes of
interest in this paper. Other best practice recommendations proposed by the ASX Corporate Governance
Council relate to the existence and composition of various suggested board sub-committees (audit,
nominating and compensation), expanded disclosure policies and risk management planning, among others.

26

ownership is identified as significantly eroding the positive benefits that stronger internal
governance has on the asset utilisation and managerial performance of sample firms.
When the models are re-estimated including the squared terms for director and external
ownership and corresponding interaction terms with internal governance, further
evidence of the substitutability between internal and external governance is identified,
with high levels of director ownership offsetting the beneficial effects of superior internal
governance on asset liquidity and free cash flow levels and high external ownership
dominating the asset efficiency gains derived from improved internal governance
practices.

5. Concluding remarks
This paper has focused on examining the agency cost environment associated with listed
companies on the Australian Stock Exchange, which is an issue that has not previously
been addressed empirically. Importance is placed on this research question due to
differences in institutional, ownership and corporate governance characteristics observed
in the Australian market that are hypothesised as making potential agency problems
increasingly prevalent in the Australian context. This, subsequently, also emphasises the
relevance of identifying mechanisms that are effective in mitigating resultant agency
costs. The analysis conducted using data for the period from 1992 to 2002 provides
substantial evidence supporting this initial conjecture, and particularly from the viewpoint
of Australian companies exhibiting considerably lower asset utilisation and Tobins Q
ratios than comparative samples of US and UK listed firms. Fixed effects regression
analysis indicates that greater institutional investment leads to a significant reduction in
agency costs and evidence is provided of non-linear relationships between director and
external ownership and the extent of agency costs generated by companies. Individual
corporate governance attributes that are shown to be effective in mitigating agency costs
include board independence and, particularly, the nature of board remuneration, whereas
mixed implications are identified in relation to the influence of CEO-chair duality on the
resolution of agency problems. The analysis provides limited evidence, however, in
relation to the effectiveness of capital structure or dividend policy choice in controlling
the creation of agency costs.

27

Further analysis provides varying evidence as to whether agency cost levels can
be differentiated on the basis of company size, although alternative attributes are found to
influence agency cost propensity for large and small firms. The impact of ownership and
corporate governance variables on agency cost levels is more prevalent for smaller firms,
whereas financing decisions and external monitoring by institutional investors are
increasingly determinant of the extent of agency costs inherent in larger firms. Based on
an index measure for overall internal governance structure, it can be concluded that
superior internal governance significantly lowers the level of agency costs, and that
internal governance and external shareholding influences are substitute mechanisms in
their effect on the creation of agency costs for company shareholders.
These findings have implications for shareholders and managers of firms and for
corporate regulators concerned about the performance, structure and integrity of the
corporate sector. The conclusion that agency costs may be more pervasive in the
Australian capital market has potential consequences for investors risk and cost of
capital requirements and, more importantly, the ability of listed companies to attract
domestic and international investment capital. From a governance-reform perspective, it
is suggested that the adoption by listed companies of major corporate governance
initiatives proposed by the ASX Corporate Governance Council has the capacity to
reduce agency cost levels, resulting in improved performance outcomes for listed firms
and their shareholders. The results in this paper indicate, however, that corporate
governance reform should be considered from an overall structural perspective, rather
than necessarily expecting individual governance changes to have substantial agency cost
and performance effects. This is consistent with findings in the recent empirical
governance literature focusing on the relationship between performance and risk
measures and wider governance index constructions. The finding that internal governance
structure and external ownership influences are substitute agency-mitigation mechanisms
emphasises the consideration of the motives and actions of major corporate shareholders
and parent company owners, and evidence of the desirable monitoring and agency cost
effects of institutional ownership is supportive of greater incorporation of the role of
institutional investors into Australian corporate governance reform initiatives, similar to
what has occurred with the various manifestations of the UK corporate governance code.

28

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investigation of share ownership and corporate performance, in: R.G. Hubbard, ed.,

32

Asymmetric Information, Corporate Finance, and Investment, (University of Chicago

Press, Chicago), 149-180.

33

Table 1
Hypothesis expectations for the relationship between independent variables and agency
cost proxies

Independent variable
Leverage ratio
Dividend yield
Board independence
CEO-chair duality
Board size
Board remuneration
Executive option use
Director ownership
Square of director ownership
Institutional ownership
External ownership
Square of external ownership
Standard deviation
Firm size

Dependent Variable
Asset utilisation ratio
Asset liquidity ratio
Qagency dummy
Free cash flow / Total assets
Positive
Positive
Positive
Negative
Negative
Positive
Positive
Positive
Negative
Positive
Positive
Negative
Positive
Negative

34

Negative
Negative
Negative
Positive
Positive
Negative
Negative
Negative
Positive
Negative
Negative
Positive
Negative
Positive

Table 2
Descriptive statistics for the dependent and independent variables
Mean

Median

Standard
Deviation

Minimum

Maximum

Panel A: Overall Period from 1992 to 2002

Asset utilisation ratio
0.8549
0.6670
Asset liquidity ratio
0.0969
0.0504
FCF / Total assets
0.0419
0.0531
Qagency dummy
0.6251
1.0000
Tobins Q ratio
1.2521
1.1124

0.6727
0.1336
0.1238
0.4843
0.6133

0.0002
0.0000
-1.6351
0.0000
0.1042

4.8041
0.9984
0.8263
1.0000
4.3543

Leverage ratio
Dividend yield
Board independence
CEO-chair duality
Board size
Board remuneration ($000)
Executive option use
Director ownership
Institutional ownership
External ownership
Standard deviation
Total revenue ($Million)

0.2179
0.0423
0.2316
0.3881
2.6143
5,654.5
0.4984
0.1411
0.1290
0.2826
0.0197
3,459.9

0.0006
0.0000
0.0000
0.0000
2.0000
25.000
0.0000
0.0000
0.0000
0.0000
0.0045
0.2100

2.6740
0.5758
1.0000
1.0000
20.0000
98,700.0
1.0000
0.7871
0.7518
0.9787
0.3843
29,305.0

0.4932
0.0399
0.5405
0.1846
7.9296
2,713.7
0.4577
0.0606
0.2296
0.2449
0.0232
1,902.0

0.5099
0.0376
0.5714
0.0000
8.0000
1,419.0
0.0000
0.0017
0.2230
0.1174
0.0181
638.1

Panel B: Annual mean values from 1992 to 1997

1992
1993
1994

1995

1996

1997

Asset utilisation ratio

Asset liquidity ratio
FCF / Total assets
Qagency dummy
Tobins Q ratio

0.8431
0.0828
0.0503
0.5660
1.1100

0.8195
0.0936
0.0571
0.6355
1.2531

0.7992
0.0967
0.0458
0.6415
1.2787

0.8453
0.0940
0.0361
0.5370
1.2255

0.8649
0.0994
0.0520
0.6509
1.2826

0.8650
0.1040
0.0159
0.7745
1.3648

Leverage ratio
Dividend yield
Board independence
CEO-chair duality
Board size
Board remuneration ($000)
Executive option use
Director ownership
Institutional ownership
External ownership
Standard deviation

0.4687 0.4754
0.0390 0.0347
0.4927 0.4875
0.2075 0.1869
8.1132 7.9533
1,641.1 1,453.4
0.2924 0.2804
0.0728 0.0699
0.2042 0.2497
0.2686 0.2638
0.0219 0.0225

0.4717
0.0375
0.5029
0.1792
7.8962
1,878.5
0.3774
0.0637
0.2237
0.2618
0.0212

0.4822
0.0392
0.5174
0.1481
8.0463
2,012.6
0.3981
0.0513
0.2334
0.2599
0.0217

0.4744 0.4827
0.0363 0.0362
0.5389 0.5436
0.1321 0.1471
8.2075 8.0686
2,312.0 2,604.5
0.5189 0.5196
0.0610 0.0604
0.2211 0.2223
0.2620 0.2452
0.0224 0.0199

35

Total revenue ($Million)

1,420.8 1,448.8

1,470.3

1,588.2

1,667.8

Panel C: Annual mean values from 1998 to 2002

1998
1999
2000

2001

2002

Asset utilisation ratio

Asset liquidity ratio
FCF / Total assets
Qagency dummy
Tobins Q ratio

0.8819
0.0982
0.0352
0.6392
1.2127

0.8893
0.0949
0.0444
0.6000
1.2869

0.9073
0.0988
0.0483
0.5765
1.2450

0.8511
0.1140
0.0310
0.5946
1.2505

0.8553
0.0937
0.0408
0.6571
1.2767

Leverage ratio
Dividend yield
Board independence
CEO-chair duality
Board size
Board remuneration ($000)
Executive option use
Director ownership
Institutional ownership
External ownership
Standard deviation
Total revenue ($Million)

0.5168 0.5160
0.0448 0.0381
0.5638 0.5688
0.1649 0.1889
7.8557 7.8889
2,923.2 3,153.9
0.5567 0.5444
0.0633 0.0518
0.2070 0.2467
0.2304 0.2231
0.0261 0.0241
2,020.5 2,137.7

0.5339
0.0498
0.5841
0.2471
7.6706
3,655.7
0.5882
0.0520
0.2348
0.2243
0.0253
2,450.7

0.5336
0.0516
0.5932
0.2568
7.5676
4,629.4
0.5541
0.0492
0.2339
0.2343
0.0264
2,665.0

0.4972
0.0364
0.6073
0.2143
7.7143
5,353.4
0.5000
0.0670
0.2477
0.1900
0.0265
3,002.2

1,815.5

The Asset utilisation ratio is total revenue divided by total assets, Asset liquidity ratio is the sum of cash
and marketable securities divided by total assets, FCF / Total assets is the ratio of free cash flow divided by
total assets, Qagency dummy is an indicator variable coded as one if the Tobins q ratio is greater than 1.00
otherwise zero, Tobins Q ratio is the sum of the market capitalisation of equity plus the book value of
preference shares plus the book value of long-term debt all divided by total assets, Leverage ratio is total
debt divided by total assets, Dividend yield is dividends per share divided by end-of-year share price, Board
independence is the number of independent directors divided by the total number of board directors, CEOchair duality is an indicator variable coded as one if the CEO is also the board chairperson otherwise zero,
Board size is the total number of board members, Board remuneration is the sum of total benefits paid to all
board members, Executive option use is an indicator variable coded as one if there are outstanding options
on issue to executive directors at the end of the financial year otherwise zero, Director ownership is the
proportion of total firm equity capital (excluding shares attributable to underlying share bonus, incentive
and option plans) owned by directors, Institutional ownership is the proportion of total firm equity capital
owned by all institutional shareholders within the Top 20 firm shareholders, External ownership is the sum
of all individual non-institutional and non-director shareholdings exceeding 5% of total firm equity capital,
Standard deviation is the standard deviation of daily share returns in the financial year, and Total revenue is
total revenue at the end of the financial year.

36

Table 3
Pairwise correlation coefficients for the independent variables for the overall period from 1992 to 2002
Leverage
Divyield
Indboard
Ceochair
Brdsize
Brdpay
Optuse
Dirown
Instown
Extown
Stddev
Firmsize

Leverage Divyield
1.000
-0.112
1.000
0.064
-0.002
-0.115
-0.002
0.029
-0.014
0.211
-0.001
0.171
-0.082
0.057
-0.185
-0.013
0.028
0.006
0.082
0.186
-0.047
-0.165
0.082

Indboard

Ceochair Brdsize

Brdpay

Optuse

Dirown

Instown

Extown

Stddev

1.000
-0.305
0.138
0.076
0.233
-0.259
0.420
-0.438
-0.116
0.253

1.000
-0.063
0.036
-0.058
0.359
-0.102
-0.009
0.113
-0.165

1.000
0.272
-0.023
0.135
-0.188
-0.149
0.525

1.000
0.029
0.133
-0.260
-0.006
0.220

1.000
-0.140
-0.164
0.102
-0.176

1.000
-0.484
-0.183
0.231

1.000
0.128
-0.141

1.000
-0.196

1.000
0.488
0.216
-0.104
0.118
-0.177
-0.240
0.436

Leverage is the leverage ratio, Divyield is the dividend yield, Indboard is the degree of board independence, Ceochair is the indicator variable for the existence of
CEO and board chairperson duality, Brdsize is board size which is measured as the natural logarithm of the total number of board members, Brdpay is board
remuneration which is measured as the natural logarithm of total benefits paid to directors, Optuse is the indicator variable for the existence of share option
incentives for executive directors, Dirown is the level of director ownership, Instown is the level of institutional ownership, Extown is the level of external
substantial shareholder ownership, Stddev is the standard deviation of daily share returns, and Firmsize is firm size which is measured as the natural logarithm of
annual total revenue.

37

Table 4
Fixed effects regression model results of the determinant of agency costs for sample
companies over the period from 1992 to 2002. The dependent variable proxy for agency
costs is the Asset utilisation ratio. There are four categories of independent variables
financial attributes, governance attributes, ownership attributes and control and year
dummy variables.
Model 1
Independent variable
Constant
Leverage
Dividend yield
Board independence
CEO-chair duality
Board size
Board remuneration
Executive option use
Director ownership
Square of director ownership
Institutional ownership
External ownership
Square of external ownership
Standard deviation of returns
Firm size
Goodness of fit (R2)
Model F-statistic
Fixed effects significance

Model 2

Coefficient

t-statistic

Coefficient

t-statistic

-1.374
0.034
0.996
0.161
0.077
-0.158
-0.055
0.016
0.254

-4.22***
0.55
4.77***
2.34**
2.46**
-3.37***
-3.36***
0.69
2.13**

-0.140
-0.060

-1.23
-0.78

0.942
0.159

2.18**
12.71***

-1.349
0.019
1.007
0.166
0.088
-0.154
-0.059
0.017
0.230
-0.031
-0.160
0.371
-0.666
0.845
0.160

-4.15***
0.30
4.84***
2.40**
2.80***
-3.29***
-3.59***
0.75
0.78
-0.07
-1.41
2.41**
-3.21***
1.97**
12.82***

0.257
11.470***
50.410***

*** **

0.247
11.050***
50.880***

, and * denote significance at the 1%, 5% and 10% levels respectively.

Year dummy variables are included in the regression models, however, their coefficients are not reported in
Table 4.
The dependent variable is the Asset utilisation ratio which is calculated as total revenue divided by total
assets, Leverage ratio is total debt divided by total assets, Dividend yield is dividends per share divided by
end-of-year share price, Board independence is the number of independent directors divided by the total
number of board directors, CEO-chair duality is an indicator variable coded as one if the CEO is also the
board chairperson otherwise zero, Board size is the natural logarithm of the total number of board
members, Board remuneration is the natural logarithm of the sum of total benefits paid to all board
members, Executive option use is an indicator variable coded as one if there are outstanding options on
issue to executive directors at the end of the financial year otherwise zero, Director ownership is the
proportion of total firm equity capital (excluding shares attributable to underlying share bonus, incentive
and option plans) owned by directors, Institutional ownership is the proportion of total firm equity capital
owned by all institutional shareholders within the Top 20 firm shareholders, External ownership is the sum
of all individual non-institutional and non-director shareholdings exceeding 5% of total firm equity capital,
Standard deviation is the standard deviation of daily share returns in the financial year, and Firm size is the
natural logarithm of total revenue at the end of the financial year.

38

Table 5
Fixed effects regression model results of the determinant of agency costs for sample
companies over the period from 1992 to 2002. The dependent variable proxy for agency
costs is the Asset liquidity ratio. There are four categories of independent variables
financial attributes, governance attributes, ownership attributes and control and year
dummy variables.
Model 1
Independent variable
Constant
Leverage
Dividend yield
Board independence
CEO-chair duality
Board size
Board remuneration
Executive option use
Director ownership
Square of director ownership
Institutional ownership
External ownership
Square of external ownership
Standard deviation of returns
Firm size
Goodness of fit (R2)
Model F-statistic
Fixed effects significance

Model 2

Coefficient

t-statistic

Coefficient

t-statistic

1.075
-0.030
0.547
0.008
0.024
0.009
-0.015
-0.002
0.141

8.85***
-1.23
6.71***
0.30
1.97**
0.47
-2.31**
-0.27
3.02***

-0.115
-0.008

-2.59**
-0.27

0.020
-0.041

0.12
-8.38***

1.065
-0.031
0.549
0.011
0.023
0.007
-0.015
-0.002
0.273
-0.214
-0.113
-0.022
0.028
0.009
-0.041

8.75***
-1.27
6.74***
0.40
1.88*
0.41
-2.29**
-0.28
2.35**
-1.23
-2.55**
-0.37
0.34
0.05
-8.30***

0.165
8.280***
10.240***

*** **

0.167
7.650***
10.220***

, and * denote significance at the 1%, 5% and 10% levels respectively.

Year dummy variables are included in the regression models, however, their coefficients are not reported in
Table 5.
The dependent variable is the Asset liquidity ratio which is calculated as the sum of cash and marketable
securities divided by total assets, Leverage ratio is total debt divided by total assets, Dividend yield is
dividends per share divided by end-of-year share price, Board independence is the number of independent
directors divided by the total number of board directors, CEO-chair duality is an indicator variable coded as
one if the CEO is also the board chairperson otherwise zero, Board size is the natural logarithm of the total
number of board members, Board remuneration is the natural logarithm of the sum of total benefits paid to
all board members, Executive option use is an indicator variable coded as one if there are outstanding
options on issue to executive directors at the end of the financial year otherwise zero, Director ownership is
the proportion of total firm equity capital (excluding shares attributable to underlying share bonus,
incentive and option plans) owned by directors, Institutional ownership is the proportion of total firm equity
capital owned by all institutional shareholders within the Top 20 firm shareholders, External ownership is
the sum of all individual non-institutional and non-director shareholdings exceeding 5% of total firm equity
capital, Standard deviation is the standard deviation of daily share returns in the financial year, and Firm
size is the natural logarithm of total revenue at the end of the financial year.

39

Table 6
Fixed effects regression model results of the determinant of agency costs for sample
companies over the period from 1992 to 2002. The dependent variable proxy for agency
costs is the Free cash flow (FCF) / Total assets ratio. There are four categories of
independent variables financial attributes, governance attributes, ownership attributes
and control and year dummy variables.
Model 1
Independent variable
Constant
Leverage
Dividend yield
Board independence
CEO-chair duality
Board size
Board remuneration
Executive option use
Director ownership
Square of director ownership
Institutional ownership
External ownership
Square of external ownership
Standard deviation of returns
Firm size
Goodness of fit (R2)
Model F-statistic
Fixed effects significance

Model 2

Coefficient

t-statistic

Coefficient

t-statistic

0.460
-0.184
-0.194
-0.020
0.007
-0.006
-0.047
0.026
0.054

2.74**
-5.75***
-1.80*
-0.56
0.43
-0.23
-5.59***
2.18**
0.88

0.062
0.012

1.06
0.31

-0.096
0.018

-0.43
2.79***

0.522
-0.178
-0.208
-0.035
0.011
0.001
-0.048
0.026
-0.655
1.150
0.055
0.079
-0.134
-0.037
0.016

3.14***
-5.61***
-1.96**
-1.00
0.67
0.02
-5.71***
2.22**
-4.32***
5.08***
0.94
1.00
-1.26
-0.17
2.53**

0.099
4.620***
1.800***

*** **

0.124
5.440***
1.770***

, and * denote significance at the 1%, 5% and 10% levels respectively.

Year dummy variables are included in the regression models, however, their coefficients are not reported in
Table 6.
The dependent variable is the FCF / total assets ratio which is calculated as free cash flow divided by total
assets, Leverage ratio is total debt divided by total assets, Dividend yield is dividends per share divided by
end-of-year share price, Board independence is the number of independent directors divided by the total
number of board directors, CEO-chair duality is an indicator variable coded as one if the CEO is also the
board chairperson otherwise zero, Board size is the natural logarithm of the total number of board
members, Board remuneration is the natural logarithm of the sum of total benefits paid to all board
members, Executive option use is an indicator variable coded as one if there are outstanding options on
issue to executive directors at the end of the financial year otherwise zero, Director ownership is the
proportion of total firm equity capital (excluding shares attributable to underlying share bonus, incentive
and option plans) owned by directors, Institutional ownership is the proportion of total firm equity capital
owned by all institutional shareholders within the Top 20 firm shareholders, External ownership is the sum
of all individual non-institutional and non-director shareholdings exceeding 5% of total firm equity capital,
Standard deviation is the standard deviation of daily share returns in the financial year, and Firm size is the
natural logarithm of total revenue at the end of the financial year.

40

Table 7
Fixed effects logit regression model results of the determinant of agency costs for sample
companies over the period from 1992 to 2002. The dependent variable proxy for agency
costs is the management performance indicator variable (Qagency) based on firm Tobins
Q ratios. There are four categories of independent variables financial attributes,
governance attributes, ownership attributes and control and year dummy variables.
Model 1
Independent variable

Coefficient

z-statistic

Leverage
-0.610
Dividend yield
-11.647
Board independence
1.830
CEO-chair duality
-0.146
Board size
0.339
Board remuneration
0.363
Executive option use
0.168
Director ownership
0.018
Square of director ownership
Institutional ownership
4.566
External ownership
2.121
Square of external ownership
Standard deviation of returns -6.314
Firm size
-0.456
Likelihood ratio (LR) statistic

Model 2

-0.83
-3.20***
2.12**
-0.38
0.60
1.86*
0.57
0.01
3.10***
2.32**
-1.03
-3.03***
72.280***

*** **

Coefficient
-0.602
-11.750
1.833
-0.181
0.340
0.368
0.147
1.127
-1.478
4.650
0.707
2.349
-5.999
-0.453

z-statistic
-0.82
-3.23***
2.12**
-0.47
0.60
1.89*
0.50
0.31
-0.29
3.15***
0.39
0.92
-1.00
-3.00***

73.130***

, and * denote significance at the 1%, 5% and 10% levels respectively.

Year dummy variables are included in the regression models, however, their coefficients are not reported in
Table 7.
The dependent variable is the Qagency indicator variable which is coded as one if the Tobins q ratio is
greater than 1.00 otherwise zero, Leverage ratio is total debt divided by total assets, Dividend yield is
dividends per share divided by end-of-year share price, Board independence is the number of independent
directors divided by the total number of board directors, CEO-chair duality is an indicator variable coded as
one if the CEO is also the board chairperson otherwise zero, Board size is the natural logarithm of the total
number of board members, Board remuneration is the natural logarithm of the sum of total benefits paid to
all board members, Executive option use is an indicator variable coded as one if there are outstanding
options on issue to executive directors at the end of the financial year otherwise zero, Director ownership is
the proportion of total firm equity capital (excluding shares attributable to underlying share bonus,
incentive and option plans) owned by directors, Institutional ownership is the proportion of total firm equity
capital owned by all institutional shareholders within the Top 20 firm shareholders, External ownership is
the sum of all individual non-institutional and non-director shareholdings exceeding 5% of total firm equity
capital, Standard deviation is the standard deviation of daily share returns in the financial year, and Firm
size is the natural logarithm of total revenue at the end of the financial year.

41

Table 8
Difference of means (medians) tests for the agency cost proxy variables for small and
large firm sub-samples
Dependent variable
Asset utilisation ratio
Asset liquidity ratio
FCF / Total assets
Tobins Q ratio

Small Firms

Large Firms

0.6387 (0.4724)
0.1295 (0.0716)
0.0278 (0.0426)
1.3236 (1.1174)

T-Statistic

1.0716 (0.9146) -11.012***

0.0642 (0.0400)
8.162***
0.0559 (0.0595) -3.702***
1.1805 (1.1055)
3.807***

***

Wilcoxon
Z-Statistic
-11.784***
6.137***
-4.165***
1.499

denotes significance at the 1% level.

The Asset utilisation ratio is total revenue divided by total assets, Asset liquidity ratio is the sum of cash
and marketable securities divided by total assets, FCF / Total assets is the ratio of free cash flow divided by
total assets, and Tobins Q ratio is the sum of the market capitalisation of equity plus the book value of
preference shares plus the book value of long-term debt all divided by total assets.

42

Table 9
Fixed effects regression model results of the determinant of agency costs for sample companies over the period from 1992 to 2002. The
dependent variable proxies for agency costs are 1) Asset utilisation ratio, 2) Asset liquidity ratio, 3) Free cash flow (FCF) / Total assets ratio and
4) Qagency indicator variable. There are five categories of independent variables financial attributes, internal governance index, ownership
attributes, governance and ownership interaction attributes and control and year dummy variables.

Constant
Leverage
Dividend yield
Internal governance
Director ownership
Institutional ownership
External ownership
GovDirector ownership
GovInstitutional ownership
GovExternal ownership
Standard deviation of returns
Firm size
Goodness of fit (R2)
Model F/LR statistic
Fixed effects significance
*** **

Asset utilisation ratio

Asset liquidity ratio

Coefficient t-statistic

Coefficient t-statistic

-2.308
0.048
0.877
0.087
0.081
0.441
0.031
0.035
-0.223
-0.054
1.075
0.145

-8.45***
0.78
4.14***
2.61***
0.35
1.86*
0.25
0.47
-2.47**
-1.14
2.46**
11.73***

0.209
10.320***
56.050***

1.088
-0.029
0.525
-0.017
-0.127
-0.160
-0.026
0.094
0.021
0.006
0.035
-0.045

10.37***
-1.19
6.49***
-1.43
-1.39
-1.50
-0.47
3.44***
0.65
0.35
0.21
-9.46***

0.169
8.920***
10.340***

FCF / Total assets

Qagency dummy

Coefficient t-statistic Coefficient z-statistic

-0.071
-0.197
-0.234
-0.001
-0.128
0.045
0.123
0.070
0.020
-0.036
-0.034
0.009

-0.51
-6.15***
-2.16**
-0.05
-1.04
0.32
1.66*
1.91*
0.44
-1.50
-0.15
1.45

0.074
3.480***
1.490***

, and * denote significance at the 1%, 5% and 10% levels respectively.

Year dummy variables are included in the regression models, however, their coefficients are not reported in Table 9.

-0.551
-10.372
0.841
-4.019
7.676
4.840
1.346
-1.083
-1.098
-7.224
-0.444

-0.76
-2.88***
2.03**
-1.32
2.24**
2.41**
1.42
-1.00
-1.73*
-1.16
-3.08***

80.770***

The Asset utilisation ratio is total revenue divided by total assets, Asset liquidity ratio is the sum of cash and marketable securities divided by total assets, FCF / Total assets
is the ratio of free cash flow divided by total assets, Qagency dummy is an indicator variable coded as one if the Tobins q ratio is greater than 1.00 otherwise zero, Leverage
ratio is total debt divided by total assets, Dividend yield is dividends per share divided by end-of-year share price, Internal governance is a rank variable representative of
stronger internal corporate governance structure based on the sum of five binary attributes, Director ownership is the proportion of total firm equity capital (excluding shares
attributable to underlying share bonus, incentive and option plans) owned by directors, Institutional ownership is the proportion of total firm equity capital owned by all
institutional shareholders within the Top 20 firm shareholders, External ownership is the sum of all individual non-institutional and non-director shareholdings exceeding 5%
of total firm equity capital, GovDirector ownership is the interaction between internal governance and director ownership, GovInstitutional ownership is the interaction
between internal governance and institutional ownership, GovExternal ownership is the interaction between internal governance and external ownership, Standard deviation
is the standard deviation of daily share returns in the financial year, and firm size is the natural logarithm of total revenue at the end of the financial year.

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