ASIC actions canaries for poor corporate governance

Description
The purpose of this study is to investigate whether companies subject to an Australian
Securities and Investment Commission (ASIC) action have poorer corporate governance than other
companies. Evidence from the USA suggests such a relationship but the issue has not been
investigated for Australian firms.

Accounting Research Journal
ASIC actions: canaries for poor corporate governance?
Raymond da Silva Rosa J ennifer Filippetto Ann Tarca
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To cite this document:
Raymond da Silva Rosa J ennifer Filippetto Ann Tarca, (2008),"ASIC actions: canaries for poor corporate
governance?", Accounting Research J ournal, Vol. 21 Iss 1 pp. 67 - 86
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ASIC actions: canaries for poor
corporate governance?
Raymond da Silva Rosa, Jennifer Filippetto and Ann Tarca
UWA Business School (M250), The University of Western Australia,
Nedlands, Australia
Abstract
Purpose – The purpose of this study is to investigate whether companies subject to an Australian
Securities and Investment Commission (ASIC) action have poorer corporate governance than other
companies. Evidence from the USA suggests such a relationship but the issue has not been
investigated for Australian ?rms.
Design/methodology/approach – The paper considers a matched sample of 240 companies,
including 120 which were subject to 143 actions relating to; interpretation of accounting
standards; the continuous disclosure regime; and other governance matters during the period
1998-2004.
Findings – We ?nd that companies subject to ASIC actions are less likely to comply with the
Australian stock exchange (ASX) best practice governance recommendations and that the main area of
difference relates to separation of the roles of the CEO and board chair.
Research limitations/implications – We were able to investigate only 3 of 10 items in the ASX
recommendations due to data availability. The sample of ASIC companies is not randomly drawn,
thus our results are not generalisable the wider population of listed companies. Capital market
consequences of ASIC actions, such as effect on share price, bid-ask spread, analyst following and cost
of capital, are not considered and could be investigated in future research.
Practical implications – The results suggest that, in relation to publicised cases, ASIC is
effective in targeting more poorly governed companies, a positive signal for Australian capital
markets.
Originality/value – Few papers investigate ASIC’s publicised cases and no prior study has
linked ASIC cases and corporate governance practices. The ?ndings will be of interest to Australian
capital market participants, some of whom question the bene?ts of corporate governance
recommendations.
Keywords Auctions, Best practice, Corporate governance
Paper type Research paper
Coal mine canaries made redundant: “More than 200 canary birds are being phased out of
Britain’s mining pits, according to new plans by the government. Modern technology is being
favoured over the long-serving yellowfeathered friend of the miner in detecting harmful gases
which may be present underground. Newelectronic detectors will replace the bird because they
are said to be cheaper in the long run and more effective in indicating the presence of pollutants
in the air otherwise unnoticed by miners.” (BBC News, 30 December 1986).
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1030-9616.htm
The authors wish to thank Philip Brown, Richard Cockburn, H.Y. Izan, Brendan O’Connell,
Peter Pope and seminar participants at the Australian Stock Exchange (ASX) in Sydney, Australian
Securities and Investment Commission (ASIC) in Melbourne, Lancaster University, UTS 2006
Summer School, AFAANZ 2007 Gold Coast Conference, Australian National University, Curtin
University and University of Western Australia for helpful feedback. We acknowledge the ?nancial
support of the UWA Business School and the research assistance of Melissa Moy.
Canaries for poor
corporate
governance?
67
Accounting Research Journal
Vol. 21 No. 1, 2008
pp. 67-86
qEmerald Group Publishing Limited
1030-9616
DOI 10.1108/10309610810891355
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1. Introduction
The aim of this study is to investigate the extent to which companies attracting the
attention of the Australian corporate regulator, the Australian Securities and
Investment Commission (ASIC), have poorer governance than other companies. The
quality of company governance is a crucial issue in capital markets, given the
information asymmetry between managers and providers of capital ( Jensen and
Meckling, 1976). An underlying assumption is that company “outsiders” can bene?t
from better governance, if robust governance systems restrain managers’
opportunistic behaviour and better protect outsiders’ interests. Consequently,
companies have for many years adopted management structures which are seen as
representing good governance and have publicised their practices through media such
as annual reports.
Corporate collapses in the period 2000-2002 including Enron and World.Com in
the USA and HIH and One.tel in Australia drew regulators’ attention to corporate
governance practices. Legislation such as the Sarbanes Oxley Act in the USA and
the Corporate Law Economic Reform Program (CLERP 9) in Australia made some
governance practices mandatory, including director responsibility for internal control
systems (USA) and ?nancial statements (Australia) and use of an audit committee
(Hitt, 2002; Blake Dawson Waldron, 2004). In addition, the Australian Stock Exchange
(ASX 2003) released Principles of Good Corporate Governance and Best Practice
Recommendations comprising 28 recommendations related to 10 corporate governance
principles (Appendix). Some market participants have questioned the bene?t of
increased regulation and a formal corporate governance code, claiming it to be a
“box-ticking” exercise of dubious bene?t. Further, the focus on corporate governance
has imposed further costs on Australian companies, with some Boards complaining of
excessive time spent on compliance matters (Buf?ni, 2003; Eyers, 2004).
Our study presents evidence which is relevant to the debate about the bene?ts of
corporate governance recommendations. We gather all publicly available material
about ASIC actions over the period 1 January 1998-31 December 2004 in relation to
breaches of the Corporations Act 2001 (Cth) relating to ?nancial reporting and
governance matters. We identify 120 companies and 143 cases relating to:
.
interpretation of accounting standards;
.
the continuous disclosure regime; and
.
other governance matters.
For the 120 ASIC companies, we select a group of control companies matched by date,
size and industry. Comparing the ASIC and control companies, we ?nd that those
subject to ASIC actions are more likely to have poorer governance practices.
Speci?cally, the companies are more likely to have the chief executive of?cer (CEO) as
board chair. When an audit committee is present, it is likely to have fewer non-executive
members and a non-independent chair. Multivariate analysis shows that, after
controlling for the signi?cant impact of company size on the likelihood of being subject
an ASIC action, ASIC companies have lower corporate governance scores and are less
pro?table than control companies. They are also less likely to have a Big 4 auditor[1].
Prior evidence about the bene?ts of sound corporate governance practices has
been mixed. Some studies show little relationship between governance structures
and ?nancial performance (Baysinger and Butler, 1985; Bhagat and Black, 2002;
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Hermalin and Weisbach, 1991; Klein, 1998). More recently, Beekes and Brown (2006)
demonstrated that better governed companies provide more informative and timely
disclosures. We add to the literature by considering a different aspect of the question
of the importance of governance. Rather than investigating the relationship of
performance outcomes and governance practices, we consider whether poor behaviour
by companies is associated with weaker governance. Dechow et al. (1996) investigate
whether companies subject to SEC[2] enforcement actions exhibit poorer governance
and Peasnell et al. (2001) explore the attributes of the UK companies attracting
the attention of the Financial Reporting Review Panel (FRRP). In the same vein,
we consider Australian companies. We use ASIC actions to represent unacceptable
corporate behaviour, including opportunistic use of accounting standards,
failure to release price sensitive information in a timely manner and lack of
compliance with procedural requirements, such as lodging information and holding
meetings. We recognise that our “bad behaviour” sample is biased since it contains
only companies for which we identify an ASIC action related to a breach of the
Corporations Act. Further, ASIC actions are not necessarily comprehensive. ASIC
monitoring activities are selective and investigate different companies and industries
at various times. ASIC cases re?ect only those the regulator has required to be made
public. Nevertheless, the cases represent those that ASIC has selected to highlight to
the ?nancial community. They demonstrate unacceptable behaviour from the
regulator’s viewpoint, in terms of compliance with law and accounting standards, and
as such are illuminating examples.
The contribution of our paper is to provide evidence about the regulation of the
Australian capital market and the governance attributes of companies involved in
publicised ASIC actions. Much of ASIC’s work is, of necessity, behind closed doors.
While there is considerable activity which does not reach the public domain, there are
many cases where ASIC does take public action against companies for breach of the
Corporations Act and in relation to interpretation of accounting standards. It has
been proposed that an effective corporate governance framework in a country
should promote transparent and ef?cient markets, be consistent with the rule of law
and clearly articulate the division of responsibilities among supervisory regulators and
enforcement authorities (OECD, 2004). Our study extends existing literature by
providing evidence about the role taken by an enforcement body, in this case ASIC,
within the context of the national corporate governance framework. The Australian
setting is of interest because it features a developed capital market, where external
parties provide an important source of ?nance. ASIC is a well established security
regulator with considerable expertise, yet it differs in important ways from both the
USA’s SEC and the UK’s FRRP (Brown and Tarca, 2007). Evidence about ASIC’s
effectiveness is of interest both in Australia and in other jurisdictions seeking to
develop active capital markets and regulatory bodies.
We show that for both continuous disclosure matters and accounting
interpretations, ASIC is effective in seeking remedial action from companies which
are more poorly governed. This is a positive signal for Australian capital markets. We
do not know how often ASIC “gets it right” in terms of interpretation accounting
standards and in identifying companies in breach of the law because of non-disclosure
of some of ASIC’s activities. However, the study does show that ASIC is effectively
identifying and taking action against companies, which are more poorly governed.
Canaries for poor
corporate
governance?
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We do not know the extent to which poor governance will lead to future problems in
the companies identi?ed, however the ASIC actions provide a credible signal to capital
markets that can be used by analysts and investors.
The remainder of the paper is organised as follows. The next section presents
relevant prior literature and develops our hypothesis. Section three presents data and
method and section four, the results. The ?nal section concludes.
2. Background and hypothesis
Larcker et al. (2004) de?ne corporate governance as a set of mechanisms that in?uence
the decisions made by managers when there is a separation of ownership and control.
Best practice recommendations for corporate governance have emerged in capital
markets, following reports such as the 1987 Treadway Commission in the USA (COSO,
1999) and the Cadbury Committee (1992), the Greenbury Report (1995), the Hampel
Committee (1998) and Turnbull Report (1999) in the UK. Recommendations relate to
board size and independence, separation of the CEO and board chair, director
competence and composition and function of the audit, remuneration and nomination
committees, among other matters.
Many studies have investigated the relationship between best practice governance
mechanisms and company performance. Conventional wisdom may expect companies
with good corporate governance to perform better, but empirical evidence is mixed.
Baysinger and Butler (1985), Bhagat and Black (2002), Hermalin and Weisbach (1991)
and Klein (1998) all report a lack of association between accounting performance
measures and the percentage of independent directors on the board. Results of
Australian studies are similar (Grace et al., 1995; Calleja, 1999). An explanation of these
?ndings is offered by Wilson who states: “. . .?nancial performance is affected by so
many variables that isolating any of the principles of good corporate governance and
tying it to performance produces few meaningful results”.
Nevertheless, Beekes and Brown (2006) demonstrate a relationship between
governance quality and the informativeness of ?rm disclosures for Australian
companies. They include several measures of informativeness (including document
counts, properties of analysts’ forecasts and a “timeliness” metric which re?ects the
average speed of price discovery throughout the year). Subsequent studies of Canadian
?rms provide similar results (Beekes et al., 2005).
Another best practice recommendation relates to separation of the roles of CEO and
board chair. Jensen (1993) argues that serious information problems can limit the
effectiveness of board members if the role of CEO and chairman are exercised by the
same individual. Jensen (1993), Yermack (1996), Dechow et al. (1996) and Klein (1998)
examine the separation of CEO and chairman, based on the view that agency problems
are higher when the same person holds both positions. Yermack (1996) ?nds that ?rms
are more valuable when the CEO is not the chairman and Klein (1998) reports a positive
relationship between earnings management and the CEOholding the chairman position.
Studies also investigate the effectiveness of board committees, which are part of
recommended best practice. Klein (1998) demonstrates that more independent board
and audit committees are better able to perform their oversight function. DeFond and
Jiambalvo (1991) ?nd that accounting errors are more likely among companies without
an audit committee and Wright (1996) reports that the quality of ?nancial statements is
signi?cantly related to independence of the audit committee. In contrast, Beasley
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examines convicted fraud and non-fraud companies and ?nds no difference in the
composition of the audit committee.
Chtourou et al. (2001) posit that the presence of an independent nomination
committee is important for board effectiveness and monitoring ability, as it takes away
the CEO’s power in nominating new members to the board. Jensen (1993) asserts that
the nomination process is often dominated by powerful CEOs who select directors
under their in?uence. Yermack (1996) provides support for this conjecture. He ?nds
that CEOs who are involved in director selection are less likely to choose directors who
will monitor management aggressively.
Several studies have considered the characteristics of ?rms subject to SEC
enforcement actions. Dechow et al. (1996) ?nd that ?rms subject to SEC enforcement
actions are less likely to have an audit committee, more likely to have a founder as CEO
who is also board chair, more likely to have a board dominated by insiders and less
likely to have an external block-holder monitoring management. In relation to audit
committees, McMullen and Raghunandan (1996) and Wright (1996) ?nd that the
proportion of independent directors serving on the audit committee is negatively
associated with the probability of a SEC enforcement action. Further, McMullen and
Raghunandan (1996) ?nd that SEC actioned ?rms are less likely to have frequent
meetings, suggesting less activity and monitoring by the committee. Agrawal and
Chadha (2005) report that audit committees of companies that restate earnings are less
likely to have an independent director with ?nancial expertise than control companies.
The US studies discussed above suggest a link between poor governance and the
likelihood of fraud and being subject to enforcement action by the SEC. It is not
surprising that ?rms guilty of contravening the law and breaching accounting
standards exhibit weaker governance mechanisms. Such mechanisms are expected to
promote behaviour that assists the ?rm meet its objectives (Keasey and Wright, 1993)
and it seems unlikely that ?rm objectives would not include legal compliance. Taken
on face value, one would not expect non-compliance with law and accounting
standards to be a favourable signal about corporate behaviour. However, in its
enforcement role, a regulator such as ASIC canvases a wide range of matters.
An individual company could engage ASIC’s attention over the interpretation of an
accounting standard, for example, without necessarily being a poorly governed
company. However, when a range of cases relating to a number of areas of law are
considered, it seems reasonable to expect that, overall, the companies subject to ASIC
investigations are more likely to have poorer governance. The research proposition can
be stated formally as:
Companies subject to an ASIC action have poorer corporate governance practices than
companies not subject to an ASIC action.
3. Data and research method
3.1 Sample companies
The sample companies are ASX listed companies actioned by ASIC for prima facie
non-compliance with at least one of the following aspects of the Corporations Act:
.
accounting provisions;
.
continuous disclosure provisions; or
.
other corporate governance matters.
Canaries for poor
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The period commences with the formation of ASIC. Companies were identi?ed through
public announcements made by ASIC or the companies between 1 July 1998 and
31 December 2004. Table I provides a summary of ASIC actions over the period. The
information was hand-collected from ASIC media releases, company ?nancial
statements and company announcements to the ASX[3]. The relevant documents were
obtained from the ASIC website, the Fin Analysis database of company ?nancial
statements, and the ASX website[4]. ASIC does not make public details about
all companies that come under its scrutiny. One implication is that some control
companies may have been subject to a discreet ASIC action, which reduces the power
of our test.
3.2 ASIC actions
Table I shows a total of 143 enforcement actions were identi?ed. Of these, 81 related to
accounting matters, for example, incorrectly recognising revenue (38), failure to
adequately disclose information about the value of options in annual reports (22), failure
to lodge annual reports (13) or non-compliance with AASB 1047 Disclosing the impact of
adopting Australian equivalents to international ?nancial reporting standards (8).
In addition, a total of 55 breaches of the continuous disclosure provisions were identi?ed
and seven more enforcement actions were for other corporate governance matters. The
actions relate to 120 companies. Eighteen companies were subject to multiple actions
over the sample period: 14 companies were actioned two times, three were actioned three
times and one was subject to four actions.
The data shows that ASIC targets speci?c provisions of the Corporations Act at
particular times, presumably for ef?ciency reasons. For instance, in 2001 ASIC focused
on disclosure practices, particularly among high-technology companies[5]. Table I
shows 26 (47 per cent of total) continuous disclosure enforcement actions occurred in
2001 with ten of them relating to companies in the technology sector. In 2003 and 2004
ASIC increased its surveillance of accounting related matters (Brown and Tarca, 2007).
In 2003 all 1,225 listed companies’ annual reports were reviewed, followed by 440
annual reports in 2004. In comparison, only 80 and 140 annual reports were examined
in 2000 and 2001. Table I shows the outcome of the extended surveillance program,
with 55 (69 per cent of total) accounting enforcement actions occurring in 2003 and
2004. Other speci?c ASIC targets are observed in the data. For example, in 2003 ASIC
Year Accounting Continuous Disclosure Other Total
1998 1 4 2 7
1999 6 6 0 12
2000 4 3 2 9
2001 1 26 1 28
2002 14 12 1 27
2003 35 3 1 39
2004 20 1 0 21
Total 81 55 7 143
Note: This table shows ASIC enforcement over the period 1 July 1998-31 December 2004 in three
groups, relating to accounting matters, breaches of continuous disclosure provisions and other
corporate governance matters
Table I.
ASIC enforcement
actions 1998-2004
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issued guidelines about disclosure related to valuation of options included in directors’
emoluments[6]. Subsequently, 22 enforcement actions followed for companies that did
not disclose the necessary information. In 2002, ASIC targeted the failure of companies
to lodge ?nancial reports and in 2004, ASIC scrutinised annual reports for failure to
comply with AASB 1047 Disclosing the impact of adopting Australian equivalents to
international ?nancial reporting standards.
Attention to speci?c provisions means that enforcement actions do not provide a
representative view of the propensity of companies to overstep various aspects of the
Corporations Act. In recent years, ASIC has publicised the focus of surveillance prior to
its commencement (Brown and Tarca, 2007). A subsequent enforcement action in a
targeted area suggests a serious divergence of opinion between a company’s view of its
required conduct and that held by ASIC.
3.3 Control companies
In this study, each ASIC company is matched with a control company using the
following protocol:
.
The set {X} comprising the population of ASX listed companies that has annual
reports with all the requisite data covering the period in which details of the
respective sample company’s enforcement action was made public is identi?ed.
Aspect Huntley’s Fin Analysis database is the source.
.
Companies within set {X} that belong to the same two-digit global industry
classi?cation standard (GICS) as the respective sample company are identi?ed
and the rest discarded.
.
The company within set {X} closest in market value of equity is selected as the
control company for the ASIC company.
Following Dechow et al. (1996), we match on industry because corporate governance
structures may differ across sectors. For instance, companies in the information
technology and materials sector have a disproportionately high number of younger
companies, which may have less well-developed corporate governance mechanisms.
As discussed above, ASIC targets particular industries for more intensive surveillance
in some years, providing another reason to match by industry. Company are
size-matched as far as possible as size may be related to the quality of a company’s
governance structure. For example, da Silva Rosa et al. (2004) ?nd that IPO companies
typically have fewer board members than the number required to apply the
ASX’s recommendations.
3.4 Measurement of corporate governance
Sample companies’ governance structures were measured using the ASX’s corporate
governance recommendations, which include 10 principles and 28 recommendations on
how the principles might be acted upon. Compliance by ASX listed companies is not
mandatory but companies must explain in their annual reports any failure to comply
with the recommendations, often termed the “if not, why not?” provision. The ASX
code provides an appropriate measure of attributes of a potentially high-quality
governance system. The recommendations were developed with input from the
corporate sector and are consistent with best practice recommendations in other
jurisdictions such as the USA and UK.
Canaries for poor
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Based on data availability in companies’ annual reports, we measure compliance
with respect to the recommendations for principles. (2) Structure the board to add
value, (4) Safeguard integrity in ?nancial reporting, and (9) Remunerate fairly and
responsibly (Appendix). These principles are selected because measurement of
compliance with their associated ASX recommendations is practical and also because
board structure, ?nancial reporting and remuneration are aspects of corporate
governance that are highly salient in the literature[7]. Our premise is that measures
of companies’ compliance with this core set of principles are highly correlated
with measures of their relative compliance with the complete set of ASX’s
28 recommendations. Given the prominence of the three principles selected, it is
reasonable to assume that companies failing to comply with the core
recommendations may not comply with recommendations associated with the other
seven principles.
We collect data for 10 items, based on principles 2, 4 and 9 (Table II). Data collected is
analysed separately and in a composite measure based on six items (1, 2, 3, 4, 5 and 10;
items 6-9 are excluded fromthe composite measure because they are dependent on item5
and are only applicable to companies that have established an audit committee).
Item ASX principle Measure
Composite
measure
1 A majority of the board should be independent
directors (Principle 2.1)
Proportion of non-executive
directors 0-1
2 The chairperson should be an independent director
(Principle 2.2)
Score 1 if chair is
non-executive director 0 or 1
3 The roles of chairperson and chief executive of?cer
should not be exercised by the same individual
(Principle 2.3)
Score 1 if the chair is not the
chief executive of?cer
0 or 1
4 The board should establish a nomination committee
(Principle 2.4)
Score 1 if a nomination
committee is established 0 or 1
5 The board should establish an audit committee
(Principle 4.2)
Score 1 if an audit
committee is established 0 or 1
6 The audit committee should consist of only
non-executive directors (Principle 4.3)
Number of non-executive
directors NA
7 The audit committee should consist of a majority of
independent directors (Principle 4.3)
Proportion of non-executive
directors on audit
committee NA
8 The chair of the audit committee is independent and
not the board chair (Principle 4.3)
Score 1 if chair of the audit
committee is not the board
chair NA
9 The audit committee should consist of at least three
members (Principle 4.3)
Number of members
NA
10 The board should establish a remuneration
committee (Principle 9.2)
Score 1 if a remuneration
committee is established 0 or 1
Total maximum score range 0-6
Notes: This table shows the ten items from the ASX Corporate governance principles (Appendix) for
which data were collected in this study. Items 1, 2, 3, 4, 5 and 10 were included in a composite corporate
governance score for each company. NA, not applicable. Items 6, 7, 8 and 9 were not included in the
composite measure as they are sub-categories of item 5
Table II.
Corporate governance
items
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The composite measure is calculated by awarding a score of one for each item, to a
maximum of six.
3.5 model
Binary logistical regression is used to explore the relationship between corporate
governance measures and whether or not a company is subject to an ASIC action.
The primary model is as follows:
ProbðASICÞ ¼ b
0
þb
1
CGCOMP þb
2
SIZE þb
3
PROFIT þb
4
GROWTH þ b
5
BIG4
þ b
6
PRE2003 þ1
where, ASIC: 1, if the company is subject to an ASIC action; 0, otherwise; CGCOMP,
corporate governance score on six items; SIZE, natural log of market capitalisation;
PROFIT, net pro?t after tax/total assets; GROWTH, book value of equity to market
value of equity; BIG4: 1, if company has Big 4 Auditor; 0, otherwise; PRE-2003: 1, if ASIC
action predates issue of ASXprinciples; Additional corporate governance measures are:
BOARDIND, board independence (percentage of non-executive directors on the board);
CEOCOB: 1, if the chairman of the board is the CEO; 0, otherwise; COBNED: 1, if the
chairman of the board is a non-executive director; 0, otherwise; NOMCOM: 1, if company
has a nomination committee; 0, otherwise; AUDITCOM: 1, if company has an audit
committee; 0, otherwise; REMCOM: 1, if company has a remuneration committee;
0, otherwise.
4. Results
4.1 Descriptive statistics
We ?nd that there are signi?cant differences between the ASIC sample and the control
group on corporate governance measures and company attributes (Table III). Panel A
reports data for continuous variables and Panel B dichotomous variables. ASIC
companies score signi?cantly lower on the composite corporate governance measure
(CGCOMP). Of the 10 items in Table II, ASIC companies have less favourable measures
for eight of them. They include whether: the CEO is board chair (COBNED), the chair is
a non-executive director (COBNED)[8], the company has a audit or remuneration
committee (AUDITCOM, REMCOM) and four further items related to the audit
committee, namely, the number and proportion of non-executive directors
(AUDITNED and AUDITIND), the number of members (AUDITMEMBERS) and
whether the chair is a non-executive director (AUDITCHAIR). The ASIC and control
samples are not signi?cantly different on two items, being the proportion of
non-executive directors on the board (BOARDIND) and whether the company has a
nomination committee (NOMCOM).
The ASIC and control companies are signi?cantly different on several other
dimensions. ASIC companies are less likely to be audited by a Big 4 auditor. Recall that
the two samples were matched as far as possible by industry and size, however full size
matching was not possible due to the composition of companies in the Australian
market. In fact, ASIC companies are smaller and less pro?table (based on net pro?t
after tax/total assets). In addition, they are less pro?table if the effect of the ASIC action
is disregarded (that is, the effect of the ASIC action is added back to net pro?t after tax).
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The ?nding in relation to pro?tability suggests less pro?table companies may be more
susceptible to the kinds of omissions and behaviours that lead to an ASIC enforcement
action. Companies with lower pro?ts may be less inclined to update ?nancial
information on a timely basis because of concerns about market reaction to that
information. For instance, Network Foods Ltd was reprimanded for not releasing
material information to the market when there was a change from a pro?t to a loss.
Companies with a less favourable pro?t position may also be more likely to make
questionable accounting policy choices to improve their reported ?nancial position.
Peasnell et al. (2001) report that the UK companies subject to adverse rulings by the
Financial Reporting Review Panel (FRRP) are average performers experiencing
temporary performance dif?culties, rather than being perennial underachievers.
A similar pattern is not observed among the ASIC companies. Change in performance,
as measured by both return on assets and return on equity, is calculated for the year
prior (t 2 1) and the year subsequent (t þ 1) to the ASIC action year (t ¼ 0). We ?nd no
signi?cant differences in pro?tability between the prior and subsequent periods
(untabulated). ASIC companies may be “underachievers” compared to the control
companies, however there is no evidence of signi?cant change in performance around
the time of the ASIC action.
4.2 Multivariate analysis
The binary logistic regression models reported in Table IV provide support for our
hypothesis that ASIC companies have poorer corporate governance practices than
ASIC CONTROL
N ¼ 120 N ¼ 120
Mean Mean
Panel A: Continuous variables Mann-Whitney Z
CGCOMP score for 6 items (min ¼ 0, max ¼ 6) 3.429 4.062 2.881
* * *
percentage of independent directors 62.9 68.6 1.546
percentage of independent directors – audit committee 55.9 67.2 1.752
*
Number of independent directors – audit committee 1.733 2.192 2.588
* * *
Number of members of audit committee 2.100 2.658 2.705
* * *
SIZE (log of market capitalisation) 928,962,729 1,020,522,474 0.095
* * *
GROWTH (book value equity/market value of equity) 0.795 0.962 1.253
PROFIT (Net pro?t after tax/total assets) 21.338 20.209 3.998
* * *
PROFIT restated for no ASIC action 21.203 20.222 2.940
* * *
Panel B: Dichotomous variables x
2
No. of companies out of 120 with:
CEO ¼ board chair 25 4 17.297
* * *
Chair ¼ Non-executive 82 93 2.553
*
Nomination committee 21 27 0.938
Audit committee 84 98 4.456
* *
Independent chair – audit committee 68 95 13.94
* * *
Remuneration committee 57 71 3.218
* *
Big 4 auditor 56 75 6.068
* *
ASIC action before 2003 51 51 NA
Notes: CGCOMP score based on six items from the ASX corporate governance principles. NA, not
applicable; signi?cants are at
*
p , 0.10,
* *
p , 0.05,
* * *
p , 0.01 (two-tailed tests)
Table III.
Descriptive statistics
for the ASIC and control
companies
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other companies. model 1 is signi?cant overall, with explanatory power (Nagelkerke
R
2
) ¼ 0.169 and 64.7 per cent correctly predicted. In model 1, CGCOMP is signi?cant
and negative ( p , 0.01), indicating lower corporate governance scores among ASIC
companies. As expected, ASIC companies are less pro?table. ASIC actions are more
likely after the introduction of the ASX code, consistent with the regulator expanding
its level of activity around this time (Brown and Tarca, 2007). Separate regression
models (not tabulated) for cases before introduction of the ASX Code (n ¼ 103) and
after (n ¼ 137) provides results which are consistent with those reported in model 1.
ASIC companies are less likely to be audited by a Big 4 auditor. Size is positively
related to the likelihood of an ASIC action. It could be argued that smaller
companies are more likely to be involved in an ASIC action, as they are less likely
to have the resources to ensure compliance with Corporations Act requirements.
The results do not support this conjecture. One potential explanation is that ASIC
Model 1 Model 2
Variable (sign) Coef?c. Wald Coef?c. Wald
SIZE (2) 0.5504 9.9170
a
0.5497 8.5834
a
PROFIT (2) 20.4253 5.6281
* * *
20.4139 4.9189
* * *
GROWTH (2) 0.0074 0.0048 0.0392 0.1297
BIG 4 AUDITOR (2) 20.5549 3.1280
* *
20.5914 3.3250
* *
PRE-2003 (?) 0.1942 0.4447 0.1915 0.4001
CGCOMP (2) 20.3720 9.3021
* * *
BOARDIND (2) 20.6426 0.6107
CEOCOB (2) 22.2579 12.3541
* * *
COBNED (2) 0.5226 1.5881
NOMCOM (2) 20.1550 0.1353
AUDITCOM (2) 20.6649 2.5037
*
REMCOM (2) 20.2682 0.5234
CONSTANT (?) 22.7032 4.9779
* *
21.3395 0.8021
Nagelkerke R
2
0.169 0.224
Percentage of correctly predicted 64.7 68.1
Model x
2
32.29 43.81
Model p-value ,0.001 ,0.001
Number of companies 240
1 ¼ ASIC action 120
0 ¼ Control group 120
Notes: This table reports the results of binary logistic regression models investigating the
relationship of the probability that a company is subject to an ASIC enforcement action and
its corporate governance. model 1 includes a composite corporate governance score based six items
(CGCOMP) from the ASX corporate governance principals. model 2 includes the six individual items
comprising CGCOMP. SIZE ¼ log of market capitalisation at year end, PROFIT ¼ net pro?t after
tax/total assets, GROWTH ¼ book value/market value of equity, BIG 4 AUDITOR 1 ¼ company has
Big 4 auditor, 0 otherwise, PRE-2003 1 ¼ date of ASIC action predates ASX Code, 0 otherwise,
BOARDIND % non-executive directors on board, CEOCOB 1 ¼ Board chair is chief executive of?cer,
0 otherwise, COBNED Board chair is non-executive director, 0 otherwise, NOMCOM 1 ¼ company has
nomination committee, 0 otherwise, AUDITCOM 1 ¼ company has audit committee, 0 otherwise,
REMCOM 1 ¼ company has nomination committee 0 otherwise. Wald test signi?cant at
*
p , 0.10,
* *
p , 0.05,
* * *
p , 0.01 (one-tailed tests except for the intercept term).
a
The coef?cient is signi?cant
but has the opposite sign
Table IV.
Regression models
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deliberately targets some larger companies. Elliott (2003) states that Mr Knott
(former chairman of ASIC) has been criticised for appearing to target cases because
they involved high pro?le names – like Nicholas Whitlam, Rodney Adler and
John Eliott. However, Mr Bosch (chairman of 1995 Bosch Report) said this was an
important strategy for ASIC:
I wouldn’t want the successor [ASIC chairman] to take the pressure off the big end of
town. The big cases like Elliott get noticed and lead people to think that this could happen
to them.
Alternative measures for size (log of total revenue, log of total assets), pro?tability
(return on equity) or additional variables representing leverage (debt/equity,
debt/assets) are also used in regression models (untabulated). The signi?cance of the
alternative variables is consistent with the results reported model 1. Leverage is not
signi?cant. The corporate governance composite measure remains signi?cant in the
additional models, supporting the inferences drawn from our primary analysis.
Dummy variables for industry (energy and manufacturing, ?nance and services) were
also included but were not signi?cant. Further discussion of industry differences is
included below.
Both models 1 and 2 show company lower pro?tability among companies with
ASIC actions. The result is consistent with the conjecture discussed above, that
companies under pressure in terms of results may be more likely to make aggressive
accounting policy choices and to be less transparent in their disclosures, which in turn
attract the attention of the regulator. The result is consistent with US studies
suggesting earnings management is more prevalent among ?rms with poorer
governance, speci?cally where the CEO is also board chair (Klein, 1998).
Table III shows differences between the ASIC and control group in ?rm attributes
including size and pro?tability. As a robustness check, we exclude the 15 most
pro?table and the 15 least pro?table ?rms from the ASIC and control samples, giving a
sub-sample of 210 ?rms. In the sub-sample, ?rms in the two groups are not
signi?cantly different in size or pro?tability. However, consistent with the full sample,
mean scores for the CGCOMP measure are signi?cantly different, as are the variables
for AUDITNED and AUDITMEMBERS. Multivariate analysis (models 1 and 2) using
the sub-sample provides results, which are consistent with the full sample (results not
tabulated). Thus, we conclude that the relationship of ASIC actions and corporate
governance is not a result of underlying differences between the two groups of ?rms
relating to size or pro?tability.
Overall, the results suggest that there are signi?cant differences between companies
subject to an ASIC action and the matched control companies and that corporate
governance practices are a signi?cant factor in explaining these differences. However,
caution is required in interpreting model 1 as the constant term is signi?cant,
indicating omitted explanatory variables.
To investigate the results further, we include individual measures of corporate
governance in model 2 instead of the composite measure. We ?nd that size,
pro?tability and Big 4 auditor have signi?cant coef?cients. Among the corporate
governance variables, CEOCOB and AUDITCOM are signi?cant and negative
( p , 0.01 and 0.10, respectively). Explanatory power of the model is 22.4 per cent and
predictive power is 68.1 per cent.
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When comparing ASIC and control companies, model 2 shows separation of the
roles of CEO and board chair to be the most important individual distinguishing
governance attribute. The result is consistent with the ?ndings of Dechow et al. (1996)
and supports the recommended Anglo-American corporate regulatory practice of
separation of the CEO and chairman roles.
Model 2 includes only the audit committee variable because of multicollinearity
between the variables related to the audit committee[9]. To explore the audit committee
variables (Table II, items 6-9) further, we consider each separately in regression models
(untabulated). We ?nd that ASIC companies were less likely to have a non-executive
director as chair ( p , 0.01) and to have fewer members on the audit committee
( p , 0.04). Frequency of meeting is also signi?cant ( p , 0.01). Most companies in our
sample tended to have two meetings, suggesting that audit committees typically meet
before the release of the half yearly and annual reports. However, some companies had
an extraordinarily high number of meetings. For example, Uecomm and The Gribbles
Group had nine and eight audit committee meetings, respectively, as well as further
18 and 22 board meetings. This may be indicative of a board that is in damage control
and meeting frequently to address its problems. However, our result is contrary to
McMullen and Raghunadan (1996) who observe fewer meeting among SEC actioned
companies.
Two other audit committee variables are not signi?cant, namely the number and
proportion of non-executive directors (untabulated). The result is consistent with
Beasley (1996) who ?nds no difference in the composition of the audit committee
between samples of fraud and non-fraud companies. However, our results do not follow
US studies by McMullen and Raghunandan (1996) and Wright (1996) who ?nd that the
proportion of independent directors serving on the audit committee was negatively
associated with the probability of a SEC enforcement action.
Establishing a nomination and remuneration committee has been shown to be
relevant in past research (Yermack, 1996) but the nomination and remuneration
committee variables are not signi?cant in model 2. Nomination committees were
observed for 27 companies (22.5 per cent) in the control group and 21 companies
(17.5 per cent) in the ASIC group. The insigni?cant result in model 2 may re?ect the
small number of companies with a nomination committee. The annual reports for
companies in both groups revealed that generally companies prefer to consider
nomination candidates in the course of normal board meetings. Remuneration
committees were observed for in the control group for 71 companies (59 per cent) and in
the ASIC group for 57 companies (48 per cent).
Notably, board independence is not a distinguishing factor between companies
subject to an ASIC action and the control sample. The result is contrary to US
studies such as Dechow et al. (1996). A potential explanation for the inconsistency is
that our measure of director independence is inaccurate. The ASX corporate
governance guidelines describe several attributes and tests for candidates to qualify
as independent directors. However, the requisite information to identify directors as
such is not always available in the data sources we consulted. Therefore,
non-executive directors are classi?ed as independent in our study, notwithstanding
that some may have associations that render them non-independent (“grey directors”
in US literature). Wright (1996) shows that in the US low ?nancial reporting quality
companies have approximately a 50 per cent higher incidence of “grey directors”.
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It may be that companies subject to an ASIC action have a higher proportion of
“grey directors” on the board relative to truly independent directors. However, our
data does not permit further examination of this issue. Alternative measures
relating to board composition (the number of directors and whether membership
was in the optimum range of six to nine) were considered but were not signi?cant
in the models (untabulated).
In summary, several of the governance variables identi?ed in our analysis are
signi?cantly associated with the probability of being subject to an ASIC action. They
include recommendations to separate the role of CEO and chairman, to have an
independent chair for the audit committee and to have at least three members on the
audit committee. We note that our results differ at times to those of US studies.
A possible explanation is the lack of generalisability of results of studies of
enforcement actions because they focus on a speci?c relatively small group of
companies which differ between countries and time periods.
4.3 Companies reprimanded more than once
As noted above, 14 companies were the subject of multiple actions. It could be that
companies with more than one instance of ASIC enforcement action have lower
levels of compliance with the ASX recommendations than companies involved in
only one ASIC action. However, there is no evidence that this is the case.
Mann-Whitney tests (untabulated) show no signi?cant differences for the composite
governance score (CGCOMP) for multiple-action and single-action ASIC companies.
In relation to the individual corporate governance items, the only item of difference
is frequency of board meetings. Multiple-action companies held signi?cantly more
meetings than single action companies ( p ¼ 0.003). There is some evidence that
multiple-action companies are less pro?table (ROE and ROA are signi?cantly lower,
p ¼ 0.02 and 0.075, respectively, one-tailed tests). The result is consistent with the
earlier discussion about the relationship of likelihood of ASIC action and
pro?tability. The majority of the multiple-action cases occurred subsequent to the
introduction of the ASX principles in 2003, re?ecting increased surveillance activity
by ASIC from 2002 onwards.
4.4 Industry classi?cation
Given that ASIC on occasion targets particular industries to enhance the effectiveness
of its surveillance, we also consider whether corporate governance scores vary by
industry. Our tests show few signi?cant differences between industry groups.
Kruskal-Wallis tests show no difference between mean corporate governance scores by
industry in the control sample and a difference only at the 10 per cent level in the ASIC
group (Table V). Mann-Whitney tests compare mean scores by industry between the
ASIC and control sample. Companies’ scores in the materials and consumer
discretionary sectors in the control group are signi?cantly higher, but only at the
10 per cent level (Table V). Thus, industry membership does not appear to be an
explanatory factor for the differences in corporate governance scores.
5. Conclusion
This study considers the relevance of corporate governance recommendations by
investigating whether companies subject to ASIC enforcement actions have weaker
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corporate governance structures than a sample of control companies matched on date,
size and industry. Consistent with our hypothesis, we ?nd that ASIC companies are
more likely to have lower corporate governance scores, based on a composite
governance measure. In relation to speci?c aspects of corporate governance, it appears
that separation of the role of CEO and board chair is of primary importance. Other
relevant factors relate to the audit committee: having an independent chair and more
members. Board independence and presence of a remuneration and nomination
committee were not signi?cant explanatory variables. We are limited in the extent we
can draw conclusions in relation to nomination committees as the majority of ASIC and
sample companies did not have these committees. In addition, our results suggest that
poor performance (low pro?tability) is an important explanatory factor for the
likelihood of a company breaching the Corporations Act, consistent with arguments
that companies under pressure in relation to performance results are those more likely
to adopt aggressive accounting policies and to be less transparent in releasing
information to the market.
We provide a test of the relevance of best practices recommendations, which is of
interest given the controversy surrounding them. We provide empirical evidence that
the recommendations are not just a “box ticking” exercise and that compliance with
them is a positive signal. Further, we show that some companies do not comply with
much best practice governance recommendations, both before and after they were
endorsed in Australia in 2003. The recommendations re?ect the consensus of the
business community, who were involved in their formulation. Non-compliance implies
that some companies do not perceive a bene?t from compliance and represents an
opportunity for further research.
GICS Sector ASIC
Mean score
CGCOMP CONTROL
Mean score
CGCOMP Mann-Whitney Z
Energy 3 2.10 3 3.92 1.091
Materials 19 2.81 19 3.44 1.770
*
Industrials 16 3.22 16 4.08 1.528
Consumer discretionary 25 3.61 25 5.89 1.747
*
Consumer staples 6 4.70 6 4.11 0.722
Health care 6 3.97 6 3.96 1.121
Financials 18 3.75 18 4.53 1.125
Information technology 19 3.10 19 4.06 1.446
Telecommunication services 8 3.92 8 3.71 0.053
Utilities
a
0 0
Total number of companies 120 120
Kruskal-Wallis 13.504 8.497
p ¼ 0.096 0.386
Notes: This table presents the GICS sector analysis for ASIC and control group companies. The mean
corporate governance score (based on six items) is presented for each sector and compared between the
ASIC and control samples using Mann Whitney tests. Kruskal-Wallis tests compare industry groups
within the ASIC and the control samples. N, number of companies in each sector.
*
signi?cant at
p , 0.10 (two-tailed test).
a
No company from the utility sector was subject to an ASIC enforcement
action
Table V.
Comparison of corporate
governance score by
industry sector
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Corporate governance structures consist of both internal (to the company) and
external mechanisms which seek to minimise the problems arising from the agency
relationship. External mechanisms include the market for corporate control, legal and
regulatory rules, investor monitoring as well as labour and competitive product
markets. Much research focuses on internal corporate governance mechanisms, such
as the board of directors and board committees. This study adds to the literature based
on Australian companies, by considering the activities of one the key external
corporate governance mechanisms, the securities market regulator.
The results suggest that the Australian corporate regulator is effective in
identifying breaches of the Corporations Act by companies with poorer governance.
Research shows that in both the USA and UK, being subject to an enforcement action
by a regulator is not a positive signal for a company (Dechowet al., 1996; Fearnley et al.,
2000). Similar research has not been conducted in Australia. Our evidence con?rms
the “red ?ag” nature of ASIC actions, since it suggests that targeted companies are
more likely to have weaknesses in their governance structures. These results may be
relevant to investors and analysts. Our ?ndings may also be of interest to market
participants because we show that, at least some of the time, ASIC is focusing its
attention where it is needed, on more poorly governed companies.
The study is subject to several limitations. We were able to investigate only three of
the ten items in the ASX recommendations due to data availability. Therefore, the
measures of company governance are only partial and could change if more elements
were included. In addition, the sample of ASIC companies is not randomly drawn, thus
our results are not generalisable the wider population of listed companies. However,
ASIC targets a range of companies and a variety of issues so a cross-section of
companies is included in the sample. Nevertheless, the results must be interpreted with
caution. We do not imply that all companies which attract the attention of ASIC are
poorly governed but overall we provide evidence which supports ASIC’s selection of
enforcement cases.
There are several areas for further research. We do not consider the capital market
consequences of ASIC actions, such as effect on share price, bid-ask spread, analyst
following and cost of capital. In particular, research could examine whether companies
with better governance have less adverse market effects following attention from the
regulator. Other aspects of the ASX recommendations could also be investigated, using
data sourced directly from companies. In addition, there is scope to investigate the
impact of the ASX recommendations in the Australian market using a larger sample of
companies and a longer time period.
Notes
1. KPMG, PricewaterhouseCoopers, Deloitte and Ernst & Young.
2. The Securities and Exchange Commission, the US security market regulator.
3. More details for each company and ASIC action are available on request from the contact
author.
4. www.asic.gov.au; www.aspecthuntley.com.au/af/?nshome?xtm-licensee ¼ ?nanalysis; and
www.asx.com.au
5. The attention on technology companies followed the “internet bubble crash”, a worldwide
fall in technology company stock prices in April 2001.
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6. ASIC Media Release 03-147.
7. Ideally, we would measure the extent of compliance with all 28 recommendations. However,
all the requisite data are in either not in the public domain or not practically accessible.
8. The ASIC sample includes 13 companies where the chair is neither a non-executive director
nor the CEO. The control sample includes 23 companies in this category.
9. Phi tests show signi?cant correlations between audit committee, audit committee
independence, audit committee chair independence and number of audit committee
members. Phi tests are appropriate to investigate correlations between dummy variables
(Coakes and Steed, 2003).
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Appendix. ASX principles of good corporate governance and best practice
recommendations
Principle 1: Lay Solid foundations for management and oversight
1.1 Formalise and disclose the functions reserved to the board and those delegated to
management.
Principle 2: Structure the board to add value
2.1 A majority of the board should be independent directors
*
.
2.2 The chairperson should be an independent director
*
.
2.3 The roles of chairperson and chief executive of?cer should not be exercised by the same
individual
*
.
2.4 The board should establish a nomination committee
*
.
2.5 Provide the information indicated in Guide to reporting on Principle 2.
Principle 3: Promote ethical and responsible decision-making
3.1 Establish a code of conduct to guide the directors, the chief executive of?cer (or equivalent),
the chief ?nancial of?cer (or equivalent) and any other key executives as to:
3.1.1 The practices necessary to maintain con?dence in the company’s integrity.
3.1.2 The responsibility and accountability of individuals for reporting and investigating
reports of unethical practices.
3.2 Disclose the policy concerning trading in company securities by directors, of?cers and
employees.
3.3 Provide the information indicated in Guide to reporting on Principle 3.
Principle 4: Safeguard integrity in ?nancial reporting
4.1 Require the chief executive of?cer (or equivalent) and the chief ?nancial of?cer (or equivalent)
to state in writing to the board that the company’s ?nancial reports present a true and fair
view, in all material respects, of the company’s ?nancial condition and operational results and
are in accordance with relevant accounting standards.
4.2 The board should establish an audit committee
*
.
4.3 Structure the audit committee so that it consists of
*
:
.
only non-executive directors;
.
a majority of independent directors;
.
an independent chairperson, who is not chairperson of the board; and
.
at least three members.
4.4 The audit committee should have a formal charter.
4.5 Provide the information indicated in Guide to reporting on Principle 4.
Principle 5: Make timely and balanced disclosure
5.1 Establish written policies and procedures designed to ensure compliance with ASX Listing
Rule disclosure requirements and to ensure accountability at a senior management level for
that compliance.
5.2 Provide the information indicated in Guide to reporting on Principle 5.
Principle 6: Respect the rights of shareholders
6.1 Design and disclose a communications strategy to promote effective communication with
shareholders and encourage effective participation at general meetings.
6.2 Request the external auditor to attend the annual general meeting and be available to answer
shareholder questions about the conduct of the audit and the preparation and content of the
auditor’s report.
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Principle 7: Recognise and manage risk
7.1 The board or appropriate board committee should establish policies on risk oversight and
management.
7.2 The chief executive of?cer (or equivalent) and the chief ?nancial of?cer (or equivalent) should
state to the board in writing that:
7.2.1 the statement given in accordance with best practice recommendation 4.1 (the integrity
of ?nancial statements) is founded on a sound system of risk management and internal
compliance and control which implements the policies adopted by the board.
7.2.2 the company’s risk management and internal compliance and control system is
operating ef?ciently and effectively in all material respects.
7.3 Provide the information indicated in Guide to reporting on Principle 7.
Principle 8: Encourage enhanced performance
8.1 Disclose the process for performance evaluation of the board, its committees and individual
directors, and key executives.
Principle 9: Remunerate fairly and responsibly
9.1 Provide disclosure in relation to the company’s remuneration policies to enable investors to
understand:
9.1.1. The costs and bene?ts of those policies.
9.1.2. The link between remuneration paid to directors and key executives and corporate
performance.
9.2 The board should establish a remuneration committee
*
.
9.3 Clearly distinguish the structure of non-executive directors’ remuneration from that of
executives.
9.4 Ensure that payment of equity-based executive remuneration is made in accordance with
thresholds set in plans approved by shareholders.
9.5 Provide the information indicated in Guide to reporting on Principle 9.
Principle 10: Recognise the legitimate interests of shareholders
10.1 Establish and disclose a code of conduct to guide compliance with legal and other
obligations to legitimate stakeholders.
Note:
*
Recommendations investigated in this study
Corresponding author
Ann Tarca can be contacted at [email protected]
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