694

Corporate Governance: An International Review, 2009, 17(6): 694–709

Governance Mechanisms and Firm Value:

The Impact of Ownership Concentration
and Dividends
Lukas Y. Setia-Atmaja*

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This study examines whether ownership concentration affects board and audit committee
independence, and whether the impact of board and audit committee independence on firm value is moderated by
ownership concentration and dividend payouts.
Research Findings/Insights: Using panel data on a sample of Australian publicly listed firms over the period 2000–2005
(1,530 firm-year observations), the study finds that ownership concentration has a negative impact on board independence,
but no impact on audit committee independence. Results also suggest that board independence enhances firm value and that
performance impact of board independence is stronger in closely-held firms and/or firms having low dividend payouts. A
marginally positive impact of audit committee independence, especially among closely-held firms, is also found.
Theoretical/Academic Implications: This study suggests that the impact of governance mechanisms is moderated by
companies’ ownership structure and dividend policies. It extends research on the effectiveness of governance mechanisms
by distinguishing two types of agency problems and using a simultaneous equations model. The findings underline the
important governance role that independent boards and audit committee can play in a country that has high ownership
concentration and high levels of private benefits of control.
Practitioner/Policy Implications: The results of this study strengthen the idea that independent directors can also play a key
role in the governance of closely-held firms. As such, for investors, as far as agency costs are concerned, investments in
closely-held firms that have a higher proportion of independent directors on the board and audit committee are sensible.
Closely-held firms should be aware of the investor’s need for more independent directors, especially when dividends
are low.

Keywords: Corporate Governance, Ownership Concentration, Dividend, Agency Theory

INTRODUCTION committee may assist the board of directors by providing

oversight on financial reporting and accounting controls that

B oards of directors can play a significant role in control-

ling agency problems, which is the heart of corporate
governance, particularly in monitoring executive manage-
ment (Fama & Jensen, 1983). The normative literature
suggests that a board can monitor its firm more closely and
take appropriate governance actions if it has enough inde-
pendent directors to ensure effective monitoring (Jensen,
1993). The literature also underlines the critical role that
audit committee can play in corporate governance. Audit
*Address for correspondence: Prasetiya Mulya Business School, Finance, RA Kartini,
Cilandak Barat, Jakarta, Indonesia, 12430, Jakarta, 12430, Indonesia. E-mail: lukas@
pmbs.ac.id
could alleviate information asymmetry between insiders
and outsiders (Klein, 1998).
The impact of many key governance mechanisms depends
considerably on companies’ ownership structure (Bebchuk
& Hamdani, 2009). It is widely believed that ownership con-
centration may have a significant impact on corporate gov-
ernance by mitigating or exacerbating agency problems. For
example, agency problems can be reduced by the presence
of blockholders with greater incentive and more power to
monitor management (Shleifer & Vishny, 1986). Neverthe-
less, minority shareholders’ wealth expropriation can
also be prevalent in closely-held firms (Shleifer & Vishny,
1997). The literature (e.g., Anderson & Reeb, 2004; Raheja,

© 2009 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2009.00768.x
GOVERNANCE MECHANISMS AND FIRM VALUE
2005; Westphal, 1998) suggests that independent directors
can play an important role in protecting the expropriation of
minority shareholders by controlling shareholders among
closely-held firms.
The literature also suggests that dividends can alleviate
agency problems. Dividends serve to reduce agency prob-
lems between owners (or large controlling shareholders)
and managers (or minority shareholders) by reducing the
amount of free cash flow that might otherwise be expropri-
ated (Jensen, 1986; La Porta, Lopez-de-Silanes, Shleifer, &
Vishny, 2000) and forcing insiders to raise funds in the
capital markets more frequently, thus subjecting themselves
to outside scrutiny (Easterbrook, 1984; Rozeff, 1982). Raheja
(2005) suggests board and audit committee independence
should increase as private benefits to insiders (agency prob-
lems) increase. As such, dividends and ownership concen-
tration should moderate the performance effect of the board
of directors and audit committee.
This paper attempts to deliver incremental insights on
corporate governance by addressing five main research
questions: (1) Does ownership concentration affect the deci-
sions on board independence and audit committee indepen-
dence?; (2) Do closely-held firms with a less independent
board or audit committee underperform those with a more
independent board or audit committee?; (3) Does the impact
of board or audit committee independence on firm perfor-
mance differ between closely-held and widely-held firms?;
(4) Does the impact of board or audit committee indepen-
dence on firm performance differ between low and high
dividend payout firms?; and (5) Does the impact of board or
audit committee independence on firm performance differ
between closely-held firms having low dividend payouts
and other firms?
This paper utilizes panel data on a sample of Australian
publicly listed firms over the period 2000–2005. There are
two key motivations for undertaking research on the
relationships among internal governance mechanisms,
ownership, dividends, and firm value in Australia. First,
although Australia has strong legal shareholder protection
(La Porta, Lopez-de-Silanes, & Shleifer, 1999), the Austra-
lian market is characterized by larger private benefits of
control (Lamba & Stapledon, 2001; Nenova, 2003)1 and a
higher concentration of ownership (La Porta et al., 1999)
compared to other strong law country markets. A cross-
country study by Dahya, Dimitrov, and McConnell (2008)
suggests that in countries with weak legal shareholder pro-
tections a dominant shareholder could offset the value dis-
count associated with weak legal shareholder protection by
appointing an independent board. This research therefore
offers an opportunity to further examine the key role own-
ership concentration can play in determining a firm’s
internal governance mechanisms and their effectiveness
especially in the presence of strong legal protection and
high private benefits of control. Second, after the introduc-
tion of the dividend imputation tax system in 1987, the
incentives for Australian firms to pay dividends have
increased (Cannavan, Finn, & Gray, 2004).2 This makes it
possible to test the moderation effect of dividends on the
performance impact of governance mechanisms in environ-
ments where tax is supposedly the main reason for paying
dividends.
© 2009 Blackwell Publishing Ltd
695
This study finds that ownership concentration has a sig-
nificant negative impact on board independence. There are
two possible explanations for these results. Controlling
shareholders may prefer less independent boards to facili-
tate acts at their discretion (the rent extraction argument).
Alternatively, the presence of blockholders with powerful
incentives to monitor managers substitutes the monitoring
role played by independent directors on the board (the sub-
stitution argument). Indeed, this study finds that closely-
held firms underperform widely-held firms, which provides
support for the rent extraction argument. This study,
however, finds little evidence that ownership concentration
affects audit committee independence.
This study also finds that board independence enhances
firm value, especially in closely-held firms that have lower
dividend payouts. A marginally positive relationship
between firm value and audit committee independence is
also found, especially among closely-held firms. Given that
the agency problems between controlling and minority
shareholders in closely-held firms can be more severe than
those between owners and managers in widely-held firms
(Villalonga & Amit, 2006) and that blockholders may exac-
erbate the agency problems by not paying or only paying low
dividends (La Porta et al., 2000), the results highlight the key
role that independent directors on the board and audit com-
mittee can play in protecting minority shareholders from
expropriation by controlling shareholders, and support for
the notion that board or audit committee independence
should increase as private benefits to insiders increase
(Raheja, 2005). The results could serve to justify initiatives to
encourage board independence and audit committee inde-
pendence in a country where private benefits of control are
relatively high.
This study contributes to the literature in two important
ways. First, it examines the moderating effect of ownership
structure (i.e., closely-held versus widely-held firms) and
dividends on the impact of corporate governance mecha-
nisms (i.e., independent directors on the board of directors
and audit committee). It therefore sheds light on the effec-
tiveness of internal governance mechanisms in controlling
agency problems under the two different types of owner-
ship structures and dividend policies. Second, the study
adds to the literature by examining the impact of corporate
governance mechanisms using simultaneous equation ap-
proach. It therefore acknowledges that corporate governance
decisions are endogenously determined in response to
agency problems inherent in organizations (Agrawal &
Knoeber, 1996; Hermalin & Weisbach, 2003).
The rest of the paper is structured as follows. The next
section discusses related literature and develops hypoth-
eses. Data and methodology are discussed, after which the
results are analyzed and discussed, and conclusions drawn.
LITERATURE REVIEW AND
HYPOTHESIS DEVELOPMENT
Internal Governance Mechanisms and Firm Value
Over the last three decades, the idea of independent direc-
tors has become important, particularly with stock market
Volume 17 Number 6 November 2009
696
regulators and many corporate governance advocates
(Farrar, 2001). Indeed, financial economists generally sug-
gest that the representation of independent directors on
boards increases the effectiveness of boards in monitoring
managers and exercising control on behalf of shareholders
(e.g., Fama & Jensen, 1983; Weisbach, 1988). The most widely
discussed question regarding board composition is there-
fore whether having more independent directors on the
board enhances firm performance. A number of studies have
been conducted in the US on this issue. For example, a study
by Baysinger and Butler (1985) found that the proportion
of independent directors was positively correlated with
accounting measures of performance. In contrast, Bhagat
and Black (2001), Hermalin and Weisbach (1991), and Klein
(1998) have found that a higher percentage of independent
directors on the board does not have a significant impact
on accounting measures of firm performance. A study by
Agrawal and Knoeber (1996) show that the proportion of
independent directors has a negative relationship to market
measures of performance.
Conflicting evidence on a direct relationship between
board composition and firm performance has also been
reported from Australia. Lawrence and Stapledon (1999)
found that independent directors do not appear to have
added value to firms in the period 1985–1995. A similar
result is reported by Cotter and Silvester (2003), who
examine the largest 200 companies in 1997. In contrast,
Bonn, Yoshikawa, and Phan (2004) reported that a higher
proportion of independent directors on the board leads to
stronger firm performance.
Why are the findings on the relationship between board
composition and firm performance inconclusive? One pos-
sible explanation is that most of the corporate governance
variables are endogenous. For example, firm performance is
both a result of the decisions made by previous directors
and, itself a factor that potentially affects the choice of
subsequent directors. Studies of boards often neglect this
issue and therefore produce confusing results (Hermalin &
Weisbach, 2003).
An important role of boards is to establish sub-committees
to deal with specific matters. One such committee is the
audit committee. The audit committee’s principal function is
to review the firm’s financial statement, audit process, and
internal accounting controls. This helps mitigate the agency
problem by providing unbiased accounting information,
thus reducing the information asymmetry between insiders
and outsiders. Principle 4 of the 2003 ASX Best Practices
Recommendations3 includes a recommendation that all
members of the audit committee should be non-executive
directors and that the committee should comprise a majority
of independent directors as well as is chaired by an inde-
pendent director who is not chairperson of the board. Com-
panies within the S&P/ASX All Ordinaries Index must
comply with this recommendation.
The empirical evidence on the relationship between
audit committee composition and firm value, however, is
also inconclusive. A number of studies (e.g., Hsu, 2008;
Klein, 1998; Reddy, Locke, Scrimgeour, & Gunasekarage,
2008) find that audit committee independence has insignifi-
cant impact on firm value. In contrast, DeFond, Hann,
and Hu (2005) find significant positive abnormal returns
Volume 17 Number 6 November 2009
CORPORATE GOVERNANCE
around the appointment of “accounting” financial expert-
independent directors to the audit committee. More
recently, Hsu (2008) and Chan and Li (2008) report that
firm performance is positively associated with audit com-
mittee financial expertise.
Several studies have also provided evidence on the gov-
ernance role of an audit committee in Australia. For
example, Koh, Laplante, and Tong (2007) examine the twin
roles of accountability and value enhancement of corporate
governance in the context of financial reporting. The authors
find that independent active audit committees and indepen-
dent boards are important governance mechanisms and
value enhancing. Cotter and Silvester (2003), however, find
no support for a positive relationship between audit com-
mittee independence and firm value. Meanwhile, Psaros and
Seamer (2004) report that the audit committee independence
of Australia’s largest 250 companies appears to have dete-
riorated between 1998 and 2001.
The positive impact of an audit committee on firm value
may come from the role of the audit committee in constrain-
ing earnings management. A number of studies provide
support for this notion. For example, Davidson, Goodwin-
Stewart, and Kent (2005) show that a majority of non-
executive directors on the audit committee is associated with
a lower likelihood of earnings management. Hsu and Koh
(2005) find that a long-term oriented institution can act as a
corporate governance mechanism to mitigate aggressive
earnings management, while Chan, Faff, Mather, and
Ramsay (2007) documented a positive relationship between
the likelihood and frequency of firms issuing management
earnings forecasts and audit committee independence.
Stewart and Munro (2007) show that the existence of an
audit committee is associated with a reduction in perceived
audit risk. Finally, Krishnamoorthy, Wright, and Cohen
(2002) and Chen, Carson, and Simnett (2007) suggest that
audit committee plays an important role in enhancing finan-
cial reporting quality.
Independent Directors, Audit Committee and
Ownership Concentration
The relation between ownership concentration and boards
of directors can be explained by agency theory. Jensen and
Meckling (1976) suggest that agency problems will be lower
when the interests of agents (i.e., managers) and principals
(i.e., shareholders) are more aligned through higher mana-
gerial share ownership. Agency problems between owners
and managers relate to managerial consumption of per-
quisites, shirking, misallocation of company funds, and
entrenchment (Shleifer & Vishny, 1997). The presence of
blockholders may also enhance corporate governance. Since
blockholders hold a significant percentage of firm equity,
they have an incentive to collect information and monitor
management (Shleifer & Vishny, 1986) as well as have
enough voting power to force management to act in the
interest of shareholders (La Porta et al., 1999). Therefore, the
classic owner-manager conflict described by Berle and
Means (1932) should be lower in closely-held firms than in
widely-held firms.
The literature, however, suggests that combining owner-
ship and control allows concentrated shareholders to
© 2009 Blackwell Publishing Ltd
GOVERNANCE MECHANISMS AND FIRM VALUE 697

exchange profits for private rents (e.g., Bebchuk, 1999; board and audit committee independence (Research Ques-
Bebchuk & Kahan, 1990:1090; Faccio, Lang, & Young, 2001; tion 1) is developed:
Fama & Jensen, 1983; Shleifer & Vishny, 1997) define
Hypothesis 1a. Board independence is significantly lower
private benefits as “any value captured by those controlling
among closely-held than widely-held firms in Australia.
the company after the control contest and not shared
among shareholders at large.” For example, the opportu- Hypothesis 1b. Audit committee independence is significantly
nity to engage in self-dealing and in taking corporate lower among closely-held than widely-held firms in Australia.
opportunities is regarded as private benefits of control.
Since ownership concentration can influence board and
Furthermore, Shleifer and Vishny (1997) and La Porta et al.
audit committee independence, it can be argued that own-
(2000) suggest that minority shareholder expropriation
ership concentration may moderate the role of board and
relates to insiders using the firm’s profits to their benefit
audit committee independence in corporate governance.
rather than returning them to other shareholders. For
Studies that examine the monitoring role of independent
example, insiders can simply steal or sell assets in the firms
directors in firms with different ownership provide incon-
they control to another firm they own at below market
clusive evidence. For instance, Anderson and Reeb (2004)
prices. They can also divert corporate opportunities from
find that among large US corporations, family firms outper-
the firm, appoint unqualified family members in manage-
formed non-family firms only when family firms have a rela-
rial positions, or overpay executives.
tively strong board (i.e., have more independent directors on
As such, ownership concentration can either mitigate or
the board). More recently, Dahya et al. (2008) study the rela-
exacerbate agency problems and consequently may affect
tionship between firm value and the proportion of indepen-
the composition and effectiveness of the internal gover-
dent directors in firms with a dominant shareholder across
nance mechanisms. For example, to facilitate their opportu-
22 countries. They found a positive relationship, especially
nistic behavior large controlling shareholders may prefer
in countries with weak legal shareholder protections, which
boards and audit committees that have fewer independent
suggests that a dominant shareholder could offset the value
directors.
discount associated with weak legal shareholder protection
Agency theorists also suggest independent directors can
by appointing an independent board.
serve to protect minority shareholders against expropria-
How can independent directors be an effective gover-
tion by large shareholders. Raheja (2005) hypothesizes that
nance device in the presence of a dominant shareholder
the optimal number of independent directors on the board
such as families? Dahya et al. (2008) argue that although the
increases as the private benefits to insiders increase.
dominant shareholders can remove independent directors
Indeed, Westphal (1998) suggests that since governance
just as easily they appoint them, they should consider the
mechanisms in closely-held firms are limited, minority
costs of replacement of independent directors. The authors
shareholders potentially rely on their boards and their
also suggest that independent directors have an incentive
committees to limit the controlling shareholder’s oppor-
to monitor a dominant shareholder as long as a market
tunism. Meanwhile, Anderson and Reeb (2004) argue that
for independent directors occurs (Fama & Jensen, 1983)
interests of minority shareholders are best protected when
and that independent directors can drive their power to
independent directors have greater power relative to
monitor a dominant shareholder legally, contractually, or
controlling blockholders. An agency theory perspective
implicitly.
thereby suggests that controlling blockholders seeking to
Erickson, Park, Reising, and Shin (2005), however,
extract rent for their private benefits are unlikely to
examine the relation between board composition and firm
assemble boards or audit committees that can limit their
value in the presence of significant ownership concentration
control of firms, implying that a negative relation exists
using publicly traded Canadian firms. They find that greater
between ownership concentration and board and audit
board independence does not have a positive influence on
committee independence.
firm value and that poorly performing firms increase the
Empirical studies show that ownership concentration
proportion of outside directors in subsequent periods.
has a significant impact on board and audit committee
Based on Anderson and Reeb (2004) and Dahya et al.
independence. For example, Anderson and Reeb (2004)
(2008), this study develops the following hypotheses to
report that family blockholders in large US firms prefer to
examine whether closely-held firms with a less independent
limit independent director presence on the board. Kim,
board or audit committee underperform closely held firms
Kitsabunnarat-Chatjuthamard, and Nofsinger (2007) find
with more independent board or audit committee (Research
that ownership concentration and board independence
Question 2):
are negatively related in 14 European countries. Cotter and
Silvester (2003) report that board independence of Austra- Hypothesis 2a. Among Australian closely-held firms, board
lian firms is associated with low management ownership independence is positively related to firm performance.
and an absence of blockholders. Setia-Atmaja, Tanewski,
Hypothesis 2b. Among Australian closely-held firms, audit
and Skully (2009) indicate that family controlled firms have
committee independence is positively related to firm
lower independent boards than non-family firms in Aus-
performance.
tralia. Méndez and Garcia (2007) show the existence of
lower audit committee activity when the ownership struc- In addition, to test whether the impact of board or audit
ture is concentrated in the hands of large shareholders. committee independence on firm performance differs
Based on this empirical evidence, the following hypoth- between closely-held and widely-held firms (Research
eses to answer whether ownership concentration affects Question 3), this study develops the following hypotheses:

© 2009 Blackwell Publishing Ltd Volume 17 Number 6 November 2009

698
Hypothesis 3a. The impact of board independence on firm per-
formance is stronger in closely-held than widely-held firms.
Hypothesis 3b. The impact of audit committee independence on
firm performance is stronger in closely-held than widely-held
firms.
The Role of Dividends in Corporate Governance
The important role that dividend policy can play in corpo-
rate governance is derived basically from the notion that
dividend policy can assist dispersed (or minority) share-
holders in monitoring managers (or large controlling
shareholders). Dividends serve to reduce agency pro-
blems between owners (or large controlling shareholders)
and managers (or minority shareholders) by reducing the
amount of free cash flow that might otherwise be expropri-
ated (Jensen, 1986) and forcing insiders to raise funds in the
capital markets more frequently, thus subjecting themselves
to outside scrutiny (Easterbrook, 1984; Rozeff, 1982).
Easterbrook (1984) suggests that as all agency problem
controls are costly, substitution among them should be
expected. Alternatively, Agrawal and Knoeber (1996) suggest
that complementary monitoring mechanisms can also exist
to control monitoring and expropriation issues. Heraclous
(2001) notes that firms will adopt a corporate governance
structure to cope with the environment, and choose among
alternative governance mechanisms such as boards and divi-
dends. Consistent with these arguments, Setia-Atmaja et al.
(2009) report that Australian family firms have a different
governance structure, compared to their non-family counter-
parts. In particular, family controlled firms have higher divi-
dend payouts and have significantly lower levels of board
independence compared to non-family firms. More impor-
tantly, the authors find that dividends are more effective
governance mechanisms in mitigating the expropriation of
minority shareholders’ wealth by families, whereas inde-
pendent directors are a more effective device to control
owner-manager conflict in non-family firms.
In addition, La Porta et al. (2000) posit that dividends can
be used by controlling shareholder in closely-held firms to
establish a reputation for moderation in expropriating
minority shareholders’ wealth. Firms that pay higher divi-
dends therefore should have lower agency conflicts than
those paying lower or no dividends. Therefore, it can be
argued that dividends may moderate the role of board and
audit committee independence in corporate governance.
This study hypothesizes that independent directors on the
board or audit committee should play a more important
governance role in firms that encounters higher moral
hazard problems. The following hypotheses are used to test
whether the impact of board or audit committee indepen-
dence on firm performance differs between higher and
lower dividend paying firms (Research Question 4):
Hypothesis 4a. The impact of board independence on firm per-
formance is stronger in firms having low dividend payouts than
other firms.
Hypothesis 4b. The impact of audit committee independence on
firm performance is stronger in firms having low dividend
payouts than other firms.
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CORPORATE GOVERNANCE
From previous discussion, it can be argued that both own-
ership concentration and dividends may determine the level
of agency problems and therefore moderate the governance
role of independent directors on the board or audit com-
mittee. The following hypotheses are utilized to answer
whether the impact of board or audit committee indepen-
dence on firm performance differ between closely-held firm
having low dividend payouts and other firms (Research
Question 5).
Hypothesis 5a. The impact of board independence on firm per-
formance is significantly stronger in closely-held firms having
low dividend payouts than other firms.
Hypothesis 5b. The impact of audit committee independence on
firm performance is significantly stronger in closely-held firms
having low dividend payouts than other firms.
DATA AND METHODOLOGY
Sample
The study examines annual panel data over a six-year period
from 2000 to 2005, an important period in Australia during
which it experienced vigorous debate of corporate gover-
nance with the redevelopment of the Corporate Law Eco-
nomic Reform Program (Audit Reform and Corporate
Disclosure) Bill in 2003 and the introduction of the ASX
Corporate Governance Council Implementation Review
Groups’ principles on corporate governance in 2004. The
sample comprises firms that were listed on the Australian
Stock Exchange (ASX) as of June 30, 1998 (i.e., 1,214 firms,
includes data from 1998 and 1999).4 Financial firms (218
firms) are excluded because their dividend policies are influ-
enced by government regulations (e.g., La Porta et al., 2000).
The sample is further restricted to firms with annual reports
available for 2000–2005 (i.e., 140 firms were excluded) and
those firms that are eligible to pay dividends (i.e., 540 firms
were excluded).5 This removes the possibility that zero divi-
dends simply result from a firm’s inability to pay dividends.
The final sample comprises 316 firms or 1,530 firm-year
observations over a six-year period. Table 1 summarizes the
sampling procedure.
Primary Variable Measures
This study defines board independence as the proportion of
independent directors on the board (denoted as Board-Ind)
(Anderson & Reeb, 2004), whereas the independence of the
audit committee is measured using a dummy variable with
a value of one if the percentage of independent director is
equal or more than 50 per cent and zero otherwise (denoted
as AC-Ind) (Chan & Li, 2008). This paper defines indepen-
dent directors as “individuals whose only business relation-
ship to the firm is their directorship” (Anderson & Reeb,
2004:219). The 2003 ASX Corporate Governance Council’s
definition of independent directors is not used in this study
as the sample starts from 2000. Independent directors are
identified through the corporate governance and directors’
statements as well as information on related party transac-
tions in annual reports obtained from Connect – 4 and
DatAnalysis databases, and then individually analyzed.
© 2009 Blackwell Publishing Ltd
GOVERNANCE MECHANISMS AND FIRM VALUE
TABLE 1
Sample Distribution
Description Total
Sampling frame 1,214
Excluded
Financial firmsa 218
Firms with missing Annual Report 140
Firms ineligible to pay dividends 540
Total excluded 898
Final sample 316
Delisted firms 14
Active firms 302
a
These include banks (GICS industry group 4010), diversified
financial (GICS industry group 4010), and real estate investment
trust (GICS sub industry group 40401010) firms.
Consistent with prior research (e.g., Faccio et al., 2001; La
Porta et al., 2000), the dividend payout ratio is measured as
total ordinary dividends divided by net income before
extraordinary items (denoted as dividend).6 This study uses
the natural logarithm of Tobin’s Q to measure firm value
(denoted as Tobin’s Q). The actual definition of Tobin’s Q is
market value of the firm divided by replacement cost of
assets. However, as replacement cost of assets information
(the denominator) is not available in Australia, this study
defines Tobin’s Q as the market value of equity plus the book
value of all liabilities and preference shares scaled by total
assets.7
With regard to ownership concentration, this study cat-
egorizes firms as closely-held or widely-held based on
whether a single shareholder controls at least 20 per cent of
the equity. Twenty per cent of the voting rights is considered
to be sufficient for effective control and is used in prior
ownership studies (Faccio et al., 2001; La Porta et al., 1999).
Twenty per cent is also the control threshold adopted in
Australia’s takeover regulations.8 Dummy variable Closely-
held (equals 1 for closely-held firm and 0 for widely-held
firm) is used in the regression and simultaneous analyses.
Data to construct Closely-held is collected from “substantial
shareholding” disclosures in companies’ annual reports.
Under the Australian Corporations Act 2001, substantial
shareholders (i.e., investors who own 5 per cent or larger of
equity) have to disclose their shareholdings in the company
annual report. This includes any direct interests (i.e., shares
registered in her/his name) as well as other relevant interest.
If a firm has at least one such shareholder controlling 20 per
cent or more equity, it is categorized as a closely-held firm.
For example, in the 2003 annual report of Oakton Limited,
Paul Holyoake reports a 38.86 per cent shareholding. Thus,
Oakton Ltd. is categorized as a closely-held company. In
contrast, the 2002 annual report of Coles Myer Ltd. reports
two substantial shareholders – Myer Family Investment Pty
Ltd. and Maple Brown Abbot Ltd. who own 5.03 per cent
and 5 per cent shares, respectively. Coles Myer Ltd is there-
fore classified as a widely-held firm.
© 2009 Blackwell Publishing Ltd
699
Model
The following model is used to test Hypotheses 1a and 1b.
Board -Ind or AC -Ind = f ( closely -held , dividend , debt ,
firm size , CEO , firm age , free cash flows, lag
profitability , growth opportunity , industry , year ) (1)
The dependent variable is Board-Ind or AC-Ind. Closely-held is
the key variable of interest in both equations. In addition,
several control variables are incorporated. Description of all
variables in the regression models is presented in Appendix.
Dividend and debt – Independent directors, debt, and divi-
dends can be used as substitute or complementary gover-
nance tools (Agrawal & Knoeber, 1996; Easterbrook, 1984;
Jensen, 1986). Firm size – Boone, Fields, Karpoff, and Raheja
(2007) argue that board independence increases as firms
grow in size over time. Lehn, Patro, and Zhao (2004) argue
that larger firms demand more independent directors
because they encounter more significant agency problems.
CEO – Prior studies (e.g., Hermalin & Weisbach, 1998)
suggest that board independence diminishes as CEO’s influ-
ence increases. Firm age – Hermalin and Weisbach (1998)
indicate that younger firms tend to have a lower proportion
of independent directors on the board because the scope and
complexity of these firms are lower than in older firms. Free
cash flow – Agency theory predicts a positive association
between free cash flow and board independence or audit
committee independence. This control variable has been
used by Lehn et al. (2004) and Coles, Daniel, and Naveen
(2008). Lag (Profitability) – Hermalin and Weisbach (2003)
suggest that prior year profitability may affect the decision
on board composition. Growth opportunity – Coles et al.
(2008) argue that board independence or audit committee
independence is negatively related to the firm’s growth,
because independent directors are less effective in monitor-
ing firms with high growth potential. In addition, a two-way
fixed effects model is included. The first fixed effect (indus-
try dummy variables based on two digit GICS codes) con-
siders any variation in the dependent variable due to
industry differences, while the second fixed effect (i.e., year
dummy) removes any secular effects among the indepen-
dent variables.
Random effects regressions are used to estimate
Equation 1. A random effects technique is employed to
address the possibility of a spurious relationship between
the dependent and independent variables. This may arise
due to the exclusion of unmeasured explanatory variables
that nevertheless still affect firm behavior. The ownership
concentration (dummy) variable used in this study tends
to be relatively stable over the study period. This is con-
sistent with the notion that controlling shareholders gener-
ally maintain control over their firms for long periods.
Thus, the random effects model is considered more appro-
priate than fixed effects model and hence is used in this
study.
Prior studies were concerned with endogeneity prob-
lems between governance mechanisms and firm value and,
thus, used a simultaneous equations model in their analysis
(e.g., Agrawal & Knoeber, 1996; Hermalin & Weisbach,
1991). In this study, a system of two equations that address
Volume 17 Number 6 November 2009
700
board independence (or audit committee independence)
and firm value is developed to test Hypotheses 2a and
2b.
Board -Ind or AC -Ind = f (Tobin’s Q , dividend , debt ,
firm size , CEO , firm age , free cash flows,
lag -profitability , growth opportunity , industry , year ) (2a)
Tobin’s Q = f ( Board -Ind or AC -Ind , dividend , debt ,
firm size , investment , profitability , lag -profitability ,
firm age , industry , year ) (2b)
The endogeneous variables are Board-Ind or AC-Ind and
Tobin’s Q. In addition, several control variables are incor-
porated in the Tobin’s Q equation. Dividend and Debt –
Dividend and debt helps to alleviate agency problems and
reduces extraction of private benefits of control as manag-
ers are forced to commit operating cash flows towards
fixed charges and are subject to monitoring by external
parties (Easterbrook, 1984; Jensen, 1986). Firm size – Larger
firms tend to have fewer growth opportunities (Morck,
Shleifer, and Vishny, 1988). Investment – Firms with lower
investment tend to have fewer growth opportunities
(Morck et al., 1988). Profitability and Lag-Profitability – On
the basis of simple valuation model, it is reasonable to
expect that accounting profitability (measured by return on
assets) is positively related to Tobin’s Q (Beiner, Drobetz,
Schmid, & Zimmermann, 2004). Firm age – Mikkelson,
Partch, & Shah (1997) suggest that the number of years of
operating history is a significant determinant of post-listing
performance.
Equations 2a and 2b are then estimated by using three-
stage least squares (3SLS) regressions for a sample of closely-
held firms.
To test Hypotheses 3a and 3b, this study utilizes the fol-
lowing equations:
Board -Ind or AC -Ind = f (Tobin’s Q , closely -held , dividend ,
debt , firm size , CEO , firm age , free cash flows,
lag -profitability , growth opportunity , industry , year ) (3a)
Tobin’s Q = f ( Board -Ind or AC -Ind , closely -held ,
closely -held ∗ Board -Ind or closely -held ∗ AC -Ind ,
dividend , debt , firm size , investment ,
profitability , lag -profitability , firm age ,
industry , year ) (3b)
To test Hypotheses 4a and 4b, a dummy variable Div-Dum is
included in Equation 3b. Div-Dum equals one if firms have
low dividend payouts (i.e., dividend payout ratio is below
sample average) and zero otherwise. The interaction variable
between Div-Dum and Board-Ind or AC-Ind is also incorpo-
rated. Closely-held and its interaction variables are removed
from Equation 3b.
Finally, to test Hypotheses 5a and 5b, a three way
interaction variable: closely-held * Div-Dum * Board-Ind or
closely-held * Div-Dum * AC-Ind is included in Equation 3b,
replacing closely-held * Board-Ind or closely-held * AC-Ind.
Volume 17 Number 6 November 2009
CORPORATE GOVERNANCE
RESULTS
Descriptive Statistics and Univariate Test
Descriptive statistics for all variables used in the model are
presented in Table 2. On average, firms report a dividend-
to-earnings ratio of 47.3 per cent. The average number of
directors on the board is approximately 6 and around 43.2
per cent of the board members are independent directors
(i.e., 2.8 independent directors on the board). About 58.7 per
cent of audit committeess have a majority of independent
directors. Around 54.9 per cent of firms are closely-held. The
average blockholding (i.e., shareholders with more than 5
per cent equity stake) is 44.6 per cent, which suggests that
Australian firms have relatively concentrated ownership.
Table 3 reports differences in governance mechanisms,
ownership, and financial characteristics between closely
and widely-held firms. On average, closely-held firms are
smaller, have less investment and lower dividend to earn-
ings ratio (42.9 per cent versus 52.5 per cent) compared to
widely-held firms. Closely-held firms also have a signifi-
cantly lower proportion of independent directors (34.7 per
cent versus 53.3 per cent), lower percentage of independent
audit committee (49.8 per cent versus 69.6 per cent), higher
percentage of CEO chairman (20.1 per cent versus 9.7 per
cent), and smaller boards (5.8 versus 6.3 directors) compared
to widely-held firms.
Table 4 reports various Pearson product moment correla-
tion coefficients among variables used in this study. It
indicates that correlations among independent or firm char-
acteristic variables are generally low. The maximum magni-
tude of the correlation coefficient among the independent
variables is around .46 (i.e., the correlation between firm size
and board independence). This study also calculates vari-
ance inflation factors (VIFs) and finds that all independent
variables in Equations 1, 2a, and 2b have VIFs less than 2 (i.e.,
between 1.03 and 1.45). The overall results suggest that mul-
ticollinearity is not a potential threat when conducting mul-
tiple regression analyses.
The Association between Ownership Concentration
and Governance Mechanisms
Column 1 of Table 5 reports the random effects estimation of
ownership concentration and board independence (Equa-
tion 1). There appears a significant negative impact of own-
ership concentration on board independence, suggesting
that closely-held firms prefer less independent boards.
Column 2 of Table 5 presents the random effects logit esti-
mation of ownership concentration and audit committee
independence. It shows that the coefficient on AC-Ind is
negative, but not significant at the conventional level.
The results therefore provide support for H1a, but not
for H1b. The possible explanation for the board indepen-
dence result is that controlling shareholders in closely-held
firms tend to avoid independent directors who can limit
their opportunistic behavior (Anderson & Reeb, 2004).
Alternatively, blockholders and independent directors may
be substitute mechanisms in controlling agency problems
(Easterbrook, 1984; Jensen & Meckling, 1976). Therefore
this research further examines the relationship between
© 2009 Blackwell Publishing Ltd
GOVERNANCE MECHANISMS AND FIRM VALUE 701

TABLE 2
Descriptive Statistics

Variable Mean Median Std. Dev. Min. Max.

Board Structure
% of independent directors .43 .42 .24 0 1
% of independent audit .58 – – – –
committeea
Number of directors 6.08 6.00 2.10 3 15
Ownership Structure
% closely-held firmsa .54 – – – –
% of substantial holdings .44 .44 .23 0 1
Dividend Policy
Dividend-to-Earnings .47 .48 .46 0 5.41
Firm Characteristics
Total debt/Assets .22 .22 .17 0 1.448
Total assets 1.15 (A$ billion) 1.12 (A$ billion) 3.59 (A$ billion) .90 (A$ billion) 5.52 (A$ billion)
% of CEO chairmana .15 – – – –
Firm age 34.02 21.00 28.24 3 168
Free cash flow/Assets .03 .02 .15 -1.00 1.10
Capital expenditure/Assets .06 .03 .07 0 .58
Lag (Profitability) .03 .03 .13 -2.11 .75
Growth opportunity .44 .41 1.10 -.86 8.60
Number of observations 1,530 1,530 1,530 1,530 1,530
a
This indicates proportion of firms, rather than the mean proportion for associated variable.

TABLE 3
Univariate Tests

Variable Closely-held firms Widely-held firms t-statistic

Dividends/earnings .42 .52 2.89***

% of independent directors .34 .53 15.03***
% of independent audit committeea .49 .69 7.95***
Number of directors 5.86 6.34 4.39***
% of substantial holdings .58 .27 33.95***
Total debt/Assets .22 .23 1.25
Total assets (A$ billion) .62 1.78 6.35***
% of CEO chairman* .20 .09 5.69***
Firm age 3.19 3.23 .97
Free cash flow/Assets .03 .02 .38
Capital expenditure/Assets .05 .07 5.81***
Lag (Profitability) .03 .04 1.75*
Growth opportunity .40 .49 1.73*
Sample size 840 690
a
This indicates proportion of firms, rather than the mean proportion for associated variable.
***p < .001, **p < .01, *p < .05.

ownership concentration and firm value (Tobin’s Q). Spe- found that closely-held firms significantly underperform
cifically, Equation 2b, which incorporates the closely-held widely-held firms, and hence providing support for the
variable, is estimated using random effects regression. expropriation argument. In addition, board independence
While the result is not presented to preserve space, it is is found to be positively associated with firm size and

© 2009 Blackwell Publishing Ltd Volume 17 Number 6 November 2009

 702

Volume 17
Number 6
TABLE 4
Correlations

Tobin’s Board- AC-Ind Closely- Div- Dividend Debt Firm CEO Firm Free Profit- Lag Growth
Q Ind held Dum size Age cash ability (Profit- Opp.
flow ability)

November 2009
Tobin’s Q
Board-Ind .21***
AC-Ind .20*** .76***
Closely-held -.19*** -.36*** -.27***
Div-Dum .22*** -.33*** .34*** -.09***
Dividend .14*** .29*** .27*** -.10*** .62**
Debt -.01 .08** .02 -.03 -.01 -.00
Firm size .19*** .46*** .40*** -.27*** .39*** -.29*** .25***
CEO -.10*** -.20*** -.23*** .14*** -.04 -.05* -.02 -.15***
Firm age -.04** .15*** .16*** .02 .17*** .11*** -.04 .22*** -.07**
Free cash flow .04 .04* .03 -.00 .09*** .06* -.08** .07*** -.18 .06*
Profitability .34*** .04* .04 -.03 .17*** .04* -.20** .02 .03 .01 .19***
Lag(Profitability) .19*** .08*** .07** -.04 .27*** .17*** -.07* .10*** -.00*** .05*** .09*** .26
Growth Opp. .03 -.06** -.05* -.04 -.11*** -.10*** -.06* -.08** -.07*** -.15*** -.00 -.06** -.06**
Investment .19*** .03 .03 -.14*** -.07*** -.10*** -.07* .02 -.02 -.05* .07 .10*** .10*** .03

Notes: This table reports Pearson correlation coefficients for all variables in the regression models.
***p < .001, **p < .01, *p < .05.
CORPORATE GOVERNANCE

© 2009 Blackwell Publishing Ltd

GOVERNANCE MECHANISMS AND FIRM VALUE 703

TABLE 5
Random Effects Estimations of Board Independence, Audit Committee Independence, and Ownership Concentration

Variable Dependent variable: Board-Ind t-statistic Dependent variable: AC-Ind t-statistic

Closely-held -.05*** -4.26 -.57 -1.26

Dividend .03*** 4.02 1.48** 2.45
Debt -.01 -.35 .05 .01
Firm size .04*** 8.32 6.92*** 8.33
CEO -.06*** -3.45 -.39 -.69
Firm age .01 .78 .15 .48
Free cash flow .00 .31 .34 .26
Lag (Profitability) .03 1.36 -.55 -.41
Growth opportunity -.00 -.67 -.45* -1.92
Constant -.34*** -3.54 -127.63*** -8.44
Industry dummy Included Included
Year dummy Included Included
Adjusted R2 .30
Wald Chi-Square 80.54

Notes: This table reports results of (1) random effects regressions of the relationship between board independence and ownership
concentration, and (2) random effects tobit regressions of the relationship between audit committee independence and ownership
concentration for the entire sample of 1,530 firm-year observations. The dependents variable is Board-Ind or AC-Ind. t-statistics are reported
in parentheses.
***p < .001, **p < .01, *p < .05.

dividends and negatively related to the presence of a CEO
chairman.
Governance Mechanisms and Value of
Closely-held Firms
Table 6 reports the 3SLS estimations of board independence
or audit committee independence and firm value relation-
ship among closely-held firms. In Column 1, the coefficient
on Board-Ind is positive and significant, suggesting that
among Australian closely-held firms, more independent
boards lead to higher firm value. The result provides support
for H2a. In Column 2, however, the result fails to provide
support for H2b (i.e., the coefficient on AC-Ind is positive,
but not significant at the conventional level).
Moderation Effect of Ownership Concentration
Table 7 presents the 3SLS estimations of board indepen-
dence and firm value relationship for the entire sample. In
Column 1, the coefficient on Board-Ind is positive and sig-
nificant at the conventional level, suggesting that indepen-
dent directors on the board and audit committee enhance
firm value.
Are these positive relationships moderated by ownership
concentration? The result presented in Column 2 of Table 7
suggest that the impact of board independence on perfor-
mance is stronger for closely-held than widely-held firms.
That is, the coefficient on the interaction term between
closely-held and Board-Ind (which measures the differential
impact of board independence on Tobin’s Q for closely-held
and widely-held firms) is positive (i.e., t = 2.10, p < .05). In
contrast, the coefficient on Board-Ind (which measures the
impact of board independence on performance for widely-
held firms) is statistically not significant at the conventional
level (i.e., t = -1.16, p > .05). The results suggest that the posi-
tive relationship between board independence and Tobin’s
Q (Column 1 of Table 7) is derived from closely-held firms.
The results, thereby, underline the important role that inde-
pendent directors can play in corporate governance of
closely-held firms and provide support for H3a.
Table 8 presents the 3SLS estimations of audit committee
independence and firm value relationship for the entire
sample. In Column 1, the coefficient on AC-Ind is positive
and marginally significant (i.e., t = 1.78, p < .10), suggesting
that independent directors on the audit committee enhance
firm value.
When ownership concentration is considered, result in
Column 2 of Table 8 suggests that the impact of audit com-
mittee independence on Tobin’s Q differs between closely-
held and widely-held firms. That is, the coefficient on the
interaction term between closely-held and AC-Ind (which mea-
sures the differential impact of audit committee indepen-
dence on Tobin’s Q for closely-held and widely-held firms) is
positive and marginally significant (i.e., t = 1.77, p < .10).
Hence, the result provides marginal support for H3b.
Moderation Effect of Dividends and
Ownership Concentration
In Column 1 of Table 9, the 3SLS estimations suggest that the
positive relationship between board independence and
Tobin’s Q is moderated by dividends.
In particular, the coefficient on the interaction term
between Div-Dum and Board-Ind (which measures the dif-

© 2009 Blackwell Publishing Ltd Volume 17 Number 6 November 2009

704 CORPORATE GOVERNANCE

TABLE 6
3SLS Estimations of Board Independence, Audit Committee Independence, and Tobin’s Q of Closely-held Firms

Variable Dependent variable: Tobin’s Q t-statistic Dependent variable: Tobin’s Q t-statistic

Board-Ind 1.90** 3.56 – –

AC-Ind – – 2.03 1.50
Dividend -.04 -.58 -.03 -.05
Debt .24* 2.12 .22 1.38
Firm size .00 .17 -.34 -1.33
Investment 1.61*** 5.54 1.81** 2.83
Profitability 1.23*** 6.00 1.35*** 4.00
Lag-Profitability .08 .51 -.08 -.34
Firm age -.05† -1.78 -.07† -1.73
Constant -.77*** -3.10 5.56 1.26
Industry dummy Included Included
Year dummy Included Included

Notes: This table reports results of three-stage least squares (3SLS) regressions of the relationship between (1) firm value measured by
Tobin’s Q and board independence, and (2) Tobin’s Q and audit committee independence using a sub-sample of closely-held firms (815
firm year observations). The endogenous variables are Tobin’s Q and Board-Ind or AC-Ind. Only estimation on Tobin’s Q equation is
reported. Estimation on board independence or audit committee independence equation is not reported. t-values are shown in paren-
theses.
***p < .001, **p < .01, *p < .05, †p < .10.

TABLE 7
3SLS Estimations of Board Independence and Tobin’s Q: The Moderation Effect of Ownership Concentration

Variable Dependent variable: Tobin’s Q t-statistic Dependent variable: Tobin’s Q t-statistic

Board-Ind 1.07*** 5.10 -2.23 -1.16

Closely-held - - -1.80† -2.00
Closely-held*Board-Ind - - 3.65* 2.10
Dividend .01 .48 .07 1.09
Debt .13 1.52 .04 .53
Firm size -.00 -.19 .08 1.52
Investment 1.07*** 6.15 1.04*** 5.03
Profitability 1.76*** 12.00 1.31*** 9.10
Lag-Profitability .22* 2.12 .17* 2.05
Firm age -.08*** -4.88 -.01 -.43
Constant -.31 -1.58 -.47 -1.63
Industry dummy Included Included
Year dummy Included Included

Notes: This table reports results of three-stage least squares (3SLS) regressions of the relationship between firm value measured by
Tobin’s Q and board independence (Board-Ind). Moderation effect of ownership concentration is considered. The endogeneous variables
are Tobin’s Q and Board-Ind. Only estimation on Tobin’s Q equation is reported. Estimation on board independence or audit committee
independence equation is not reported. t-values are shown in parentheses.
***p < .001, **p < .01, *p < .05, †p < .10.

ferential impact of board independence on Tobin’s Q for
closely-held and widely-held firms) is positive (i.e., t = 3.40,
p < .05). It implies that performance impact of board inde-
pendence is stronger among firms having low dividend
payouts than the other firms (i.e., supporting H4a).
Furthermore, results presented in Column 2 of Table 9
suggests that the positive relationship between board
independence and Tobin’s Q is moderated by both
dividends and ownership concentration. That is, the
coefficient on the three way interaction term between

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GOVERNANCE MECHANISMS AND FIRM VALUE 705

TABLE 8
3SLS Estimations of Audit Committee Independence and Tobin’s Q: The Moderation Effect of
Ownership Concentration

Variable Dependent variable: Tobin’s Q t-statistic Dependent variable: Tobin’s Q t-statistic

AC-Ind 4.39† 1.78 .49 .65

Closely-held – – -.07 -.21
Closely-held*AC-Ind – – .09† 1.77
Dividend -.35 -1.09 .06 1.04
Debt -.35 -1.09 .07 .73
Firm size -.74 -1.36 -.03 -.45
Investment 1.49* 2.17 1.16*** 5.58
Profitability 2.31*** 5.77 1.84*** 10.12
Lag-Profitability .13* 2.00 .19* 2.34
Firm age -.07 -.20 -.06*** -3.56
Constant 11.93 1.35 .52 .46
Industry dummy Included Included
Year dummy Included Included

Notes: This table reports results of three-stage least squares (3SLS) regressions of the relationship between firm value measured by
Tobin’s Q and audit committee independence (AC-Ind). Moderation effect of ownership concentration is considered. The endogeneous
variables are Tobin’s Q and AC-Ind. Only estimation on Tobin’s Q equation is reported. Estimation on board independence or audit
committee independence equation is not reported. t-values are shown in parentheses.
***p < .001, **p < .01, *p < .05, †p < .10.

TABLE 9
3SLS Estimations of Board Independence and Tobin’s Q: The Moderation Effect of Dividends and
Ownership Concentration

Variable Dependent variable: Tobin’s Q t-statistic Dependent variable: Tobin’s Q t-statistic

Board-Ind .41 1.03 -.12 -.15

Div-Dum -.65*** -3.53 -.40* -2.49
Div-Dum*Board-Ind 1.24*** 3.40 – –
Closely-held – – -.30† -1.69
Closely-held*Div-Dum*Board-Ind – – 1.16* 2.16
Debt .04 .52 .07 .82
Firm size -.01 -.93 .03 1.07
Investment .86*** 5.44 1.37*** 5.94
Profitability 1.19*** 8.27 1.63*** 10.67
Lag-Profitability .27* 2.51 .22* 2.01
Firm age -.08*** -4.23 -.06* -2.22
Constant .29† 1.81 -.27 1.20
Industry dummy Included Included
Year dummy Included Included

Notes: This table reports results of three-stage least squares (3SLS) regressions of the relationship between firm value measured by
Tobin’s Q and board independence (Board-Ind). Moderation effect of dividends and ownership concentration is considered. The endog-
enous variables are Tobin’s Q and Board-Ind. Only estimation on Tobin’s Q equation is reported. Estimation on board independence
equation is not reported. t-values are shown in parentheses.
***p < .001, **p < .01, *p < .05, †p < .10.

closely-held, Div-Dum, and Board-Ind (which measures the suggests that the performance impact of board indepen-
differential impact of board independence on Tobin’s Q dence is stronger among closely-held firms that pay lower
for closely-held firms having low dividend payouts and dividends than among the other firms (i.e., supporting
the other firms) is positive (i.e., t = 2.16, p < .05). It H5a).

© 2009 Blackwell Publishing Ltd Volume 17 Number 6 November 2009

706 CORPORATE GOVERNANCE

TABLE 10
3SLS Estimations of Board Independence and Tobin’s Q: The Moderation Effect of Dividends and Ownership
Concentration

Variable Dependent variable: Tobin’s Q t-statistic Dependent variable: Tobin’s Q t-statistic

AC-Ind .86 .94 -.12 -.15

Div-Dum -.25 -.57 -.40* -2.49
Div-Dum*AC-Ind .24 .38 – –
Closely-held – – -.10 -1.39
Closely-held*Div-Dum*AC-Ind – – .08 .28
Debt .06 .52 .09 1.03
Firm size -.13 -1.36 -.03 -.49
Investment 1.23*** 4.23 1.23*** 6.25
Profitability 1.86*** 9.24 1.88*** 11.92
Lag-Profitability .14 .95 .22* 2.12
Firm age -.06*** -2.69 -.06*** -3.69
Constant 2.30† 1.71 .64 .57
Industry dummy Included Included
Year dummy Included Included

Notes: This table reports results of three-stage least squares (3SLS) regressions of the relationship between firm value measured by
Tobin’s Q and audit committee independence (AC-Ind). Moderation effect of dividends and ownership concentration is considered. The
endogenous variables are Tobin’s Q and AC-Ind. Only estimation on Tobin’s Q equation is reported. Estimation on audit committee
independence equation is not reported. t-values are shown in parentheses.
***p < .001, **p < .01, *p < .05, †p < .10.

With regard to audit committee independence, results in
Table 10 suggest that the marginally positive relationship
between audit committee independence and Tobin’s Q
previously found (see Column 1 of Table 8) is not moderated
by dividends or dividends and ownership concentration
altogether.
In Column 1 of Table 10, the coefficient on the interaction
term between Div-Dum and AC-Ind is positive but not sig-
nificant (i.e., t = .38, p > .05), while in Column 2 of Table 10,
the coefficient on the interaction term between closely-held,
Div-Dum, and AC-Ind is positive but not significant (i.e.,
t = .28, p > .05). This study, thereby, fails to provide support
for H4b and H5b.
not different from those reported in Tables 5–8. Third, to
remove the possibility that firms with positive retained earn-
ings, but negative net earnings, were unable to pay divi-
dends due to cash shortages, the analysis was repeated using
a subset of firms with only non-negative net earnings (con-
sequently, the sample size was reduced to 1,355 observa-
tions). The results are consistent with earlier analyses.
Finally, the sensitivity of the findings in the presence of
outliers and influential observations is tested by truncating
the largest one to 5 per cent probability levels for each tail of
the distribution of the model variables. In general, the results
are not substantially different from earlier analyses.

Robustness Tests DISCUSSION AND CONCLUSIONS

Several additional analyses were conducted to test the
robustness of the results. First, to examine whether the
results in Tables 5–8 are sensitive to the cut-off used for
closely-held firms, this study takes a 10 per cent and 15 per
cent cut-off, instead of 20 per cent. The results are not
significantly different from those reported in Tables
5–8. Second, to examine whether the results in Table 5
are sensitive to alternate measurements, Equation (1) was
re-estimated using alternate proxy for ownership concentra-
tion. Specifically, the aggregate ownership of shareholders
holding at least 5 per cent of equity and the ownership of the
largest 20 shareholders was used. The results are not differ-
ent from those reported in Table 5. An alternate proxy for
audit committee independencewas also used. Instead of
using a dummy variable, the proportion of independent
directors in the audit committee was used. The results are
While conventional wisdom is asking for increased indepen-
dence on boards and audit committees, little empirical evi-
dence has been presented with regard to the impact of
ownership concentration and dividend policy on the effec-
tiveness of independent directors. This study therefore pro-
vides incremental insights by examining the relationships
between ownership concentration and governance mecha-
nisms as well as the effectiveness of governance mechanisms
in the presence of blockholders and high or low dividend
payouts. Using a sample of publicly traded firms in Australia
over the period 2000–2005, this study provides several inter-
esting results.
This paper finds that ownership concentration does have a
significant negative impact on board independence. That is,
compared to widely-held firms, closely-held firms have
lower proportion of independent directors on the boards.

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GOVERNANCE MECHANISMS AND FIRM VALUE
There are two possible interpretations for the results. First,
controlling shareholders prefer less independent boards to
facilitate actions at their discretion (the rent extraction argu-
ment). Second, the presence of blockholders with more
incentive and power to monitor managers substitutes the
monitoring role of independent directors (the substitution
argument). Indeed, this paper finds that closely-held firms
underperform widely-held firms, and hence provides
support for the rent extraction argument (Shleifer & Vishny,
1997). This study, however, fails to find evidence that own-
ership concentration has any impact on audit committee
independence.
The study also finds that board independence and audit
committee independence are positively associated with firm
value which suggests that Australian publicly listed firms
could enhance their performance by increasing the propor-
tion of independent directors on their boards or by having
more independent audit committees. Compared with prior
studies in Australia, results on board independence are con-
sistent with Bonn et al. (2004), who studied firms in 1999, but
inconsistent with Lawrence and Stapledon (1999), who
found that independent directors are not related to firm
value in the period 1985–1995. Results on audit committee
independence are consistent with Chan and Li (2008), but
inconsistent with Klein (1998). Both are US studies.
More importantly, this paper finds that the impact of board
independence on firm value is moderated by ownership
concentration and dividend policy. In particular, the 3SLS
results indicate that closely-held firms with a less indepen-
dent board underperform those with a more independent
board. The results also suggest that the performance effect of
board independence is stronger among firms having low
dividend payouts or closely-held firms having low dividend
payouts than among other firms. This study also finds that the
performance effect of audit committee independence is mar-
ginally stronger among closely-held than widely-held firms.
This study, however, fails to find evidence that performance
effect of audit committee independence is moderated by
dividends. Given that the controlling-minority shareholder
agency problems in closely-held firms may be more severe
than the owner-manager agency problems in widely-held
firms (Villalonga & Amit, 2006) and that blockholders may
exacerbate the agency problems by paying lower dividends
(La Porta et al., 2000), the overall findings highlight the key
role that independent directors on the board and audit com-
mittee can play in protecting minority shareholders from
expropriation by controlling shareholders in closely-held
firms. The results provide support for the notion that board or
audit committee independence should increase as private
benefits to insiders increase (Raheja, 2005).
The study has some limitations. The research considers
only boards of directors or audit committees in the analysis. It
does not consider other internal mechanisms such as mana-
gerial compensation and external mechanisms, such as the
labor market for managers, or takeover activities. While not
all blockholders are the same, this research treats them as a
homogeneous grouping (i.e., firms are delineated into
closely-held versus widely-held). In addition, it should be
noted that board composition may or may not signal actual
independent behavior. Only a field study would verify this
further.
© 2009 Blackwell Publishing Ltd
707
These findings have several important implications. For
investors, the findings reveal that, as far as agency costs are
concerned, investments in closely-held firms that have more
independent boards are sensible. For corporate decision
makers, the results imply that controlling shareholders
should be aware of the need for more independent directors
on the board, as investors consider them as an effective
governance mechanism to control agency problems between
controlling and minority shareholders. For policy makers,
the finding that firm performance is significantly influenced
by board independence in closely-held firms could serve to
justify initiatives to encourage more independent directors
on boards.
ACKNOWLEDGEMENTS
The author is a Research Fellow, Monash University, Austra-
lia, and Senior Lecturer, Prasetiya Mulya Business School,
Indonesia. The author would like to acknowledge George
Tanewski, Michael Skully, Christine Brown, Jorge Farinha,
Barry Oliver, Gary Twite, Elisabete Vieira, and seminar par-
ticipants at the European Financial Management Association
2007 and the Asian Finance Association 2007 annual meet-
ings for their useful comments and suggestions. He would
also like to express his gratitude to the anonymous review-
ers for their insightful comments. The financial support from
the Australian Government (AusAid) and Prasetiya Mulya
Business School, Indonesia, is gratefully acknowledged.
NOTES
1. In a study on the determinants of corporate ownership struc-
ture, Lamba and Stapledon (2001) report a significant positive
relationship between ownership structure and the level of
related party transactions. They also reveal private benefits of
control are available in a large proportion of Australian publicly
listed firms (p. 26). In a cross-country study on the value of
corporate voting rights and control, Nenova (2003) reports sig-
nificantly higher mean and median values of control-block votes
for Australia compared to other common law countries such as
Canada, Hong Kong, South Africa, the UK, and the US, suggest-
ing that controlling shareholders of Australian firms are able to
extract private benefits of control from minority shareholders.
2. The Australian imputation tax system allows companies to pay
dividends that carry imputation credits for income tax paid by
the company (known as franked dividends). Imputation credits
can be used to reduce income tax paid by resident shareholders.
3. A revised version of the ASX Corporate Governance Council’s
Principles and Best Practice Recommendations were issued in
2007. The Australian Stock Exchange (ASX) became the Austra-
lian Securities Exchange in 2006.
4. Additional lag data from 1998 and 1999 were required to cor-
roborate both independent director status of firms between 2000
and 2005, and to augment some of the financial data analyses.
5. When a firm makes losses and has negative retained profits in a
given year, it is legally unable to pay dividends (Section 254T,
Australian Corporations Act 2001).
6. This study excludes observations with negative earnings to
avoid negative dividend payout ratios. If net earnings are nega-
tive, the dividend payout ratio can be negative, which implies
incorrectly that these firms’ payout ratio is low. This treatment
does not bias the results as it only effects less than 1 per cent of
the total number of observations.
Volume 17 Number 6 November 2009
708 CORPORATE GOVERNANCE

7. This proxy is highly correlated with the actual definition of
Tobin’s Q and has been widely used in US studies (e.g., Demsetz
& Villalonga, 2001). In Australia, Craswell, Taylor, and Saywell
(1997) also use the market-to-book (equity) ratio as a proxy for
Tobin’s Q.
8. Chapter Six of the Australian Corporations Act contains a
general prohibition on acquiring more than 20 per cent of the
voting rights in a publicly listed company (see Lamba & Staple-
don, 2001).

APPENDIX
Variable Description

Endogenous variables
Board-Ind The proportion of independent directors on the board.
AC-Ind A binary variable that equals one if the percentage of independent director on an audit
committee is equal to or greater than 50 per cent, zero otherwise.
Tobin’s Q The natural log of market to book value of assets ratio.
Ownership structure
Closely-held A binary variable that equals one if a firm has a blockholder holding at least 20 per cent of
the firm’s shares, zero otherwise.
Dividend variables
Dividend Ordinary dividend divided by net earnings before extraordinary items.
Div-Dum A binary variable that equals one if firms have low dividend payouts (i.e., dividend payout
ratio is below sample average), zero otherwise.
Control variables
Debt The book value of debt divided by assets.
Firm Size The natural logarithm of total assets.
CEO A binary variable that equals one if the CEO is also the chairman of board, zero otherwise.
Firm Age The natural logarithm of the number of years since the firm’s incorporation.
Free Cash Flow The difference between net earnings before extraordinary items and capital expenditure
scaled by assets.
Profitability Earnings after tax scaled by assets (ROA).
Lag (Profitability) Previous year’s ROA.
Growth Opportunity The arithmetic average of growth in revenue in the previous five years.
Investment Capital expenditure scaled by assets.
Industry A dummy variable, based on two digit GICS codes, which equals one for “opaque industries”
and zero for “transparent industries.”

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Lukas Y. Setia-Atmaja is Senior Lecturer at the Prasetiya
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from Monash University, Australia, in 2007 and has pub-
lished in journals such as the Journal of Business Finance and
Accounting and Corporate Ownership and Control.
Volume 17 Number 6 November 2009