Director Share Ownership and Corporate Performance - Evidence from Australia

Corporate Governance: An International Review

Volumn 6, Issue 4, 1998, Pages 233-248

  Farrer, Jonathan ^a   Ramsay, Ian M ^a  

^a UNIVERSITY OF MELBOURNE   (Australia)

Author keywords

[No Author keywords available]

Indexed keywords

EID: 0542445565     PISSN: 09648410     EISSN: None     Source Type: Journal    
DOI: 10.1111/1467-8683.00112     Document Type: Article

References (80)

1. Jeni Porter, 'The High Cost of Buying In', Sydney Morning Herald, 26 April 1993.
2. Ibid. For example, BHP's 1996 Annual Report states at page 30 that "Directors are each required to own at least 1,000 shares in the Company".
3. Independent Working Party into Corporate Governance (Frederick Hilmer, chair), Strictly Boardroom: Improving Governance to Enhance Company Performance (1993) para 3.17-3.18.
4. Statement by a director of that board, Lawrence Tucker: Ted Bunker, Investors' Daily, 7 July 1993, cited in Charles Elson, 'The Duty of Care, Compensation, and Stock Ownership' (1995) 63 University of Cincinnati Law Review 649, 691.
5. Statement by a director of that board, Lawrence Tucker: Ted Bunker, Investors' Daily, 7 July 1993, cited in Charles Elson, 'The Duty of Care, Compensation, and Stock Ownership' (1995) 63 University of Cincinnati Law Review 649, 691.
6. Michael Jensen and Kevin Murphy, 'CEO Incentives - It's Not How Much You Pay, But How' (1990) 68:3 Harvard Business Review 138, 142 found that CEOs are rarely dismissed for poor performance.
7. Carl Bogus, 'Excessive Executive Compensation and the Failure of Corporate Democracy' (1993) 41 Buffalo Law Review 1, 38.
8. See AWA Ltd v Daniels (1992) 7 ACSR 759 for a detailed discussion of the operation of s 232(4).
9. See s 232(2) Corporations Law; Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821; Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285.
10. Elson, above n 4, 689.
11. AWA Ltd v Daniels (1992) 7 ACSR 759, 867.
12. See, for example, Committee on the Financial Aspects of Corporate Governance, Report (1992); Toronto Stock Exchange Committee on Corporate Governance in Canada, Where Were the Directors? Guidelines for Improved Corporate Governance in Canada (1994);
13. See, for example, Committee on the Financial Aspects of Corporate Governance, Report (1992); Toronto Stock Exchange Committee on Corporate Governance in Canada, Where Were the Directors? Guidelines for Improved Corporate Governance in Canada (1994);
14. Working Group of the Australian Institute of Company Directors, et al, Corporate Practices and Conduct (3rd ed, 1995).
15. For an overview of the debate on the value of independent directors and a synthesis of the empirical evidence, see G.P. Stapledon and J. Lawrence, 'Board Composition, Structure and Independence in Australia's Largest Listed Companies' (1997) 21 Melbourne University Law Review 150.
16. See above n 11, paras 5.11 and 5.12.
17. Ibid, para 5.11.
18. Australian Investment Managers' Association, Corporate Governance: A Guide for Investment Managers in Corporations (2nd ed, 1997), 24.
19. Ibid.
20. Michael Jensen and William Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure' (1976) 3 Journal of Financial Economics 305.
21. Ibid, 309.
22. This example is similar to one given by Jensen and Meckling, ibid, 312.
23. Ibid, 348-349.
24. Myron Scholes, 'Stern Stewart Roundtable on Managerial Incentive Compensation and Shareholder Value' (1992) 5:2 Journal of Applied Corporate Finance 110, 123.
25. Ibid.
26. Finance theory suggests a positive relationship between a company's risk and returns: Harry Markowitz, 'Portfolio Selection' (1952) Journal of Finance 77.
27. For United States evidence on the relationship between directors' and officers' share ownership and the likelihood of a successful takeover, see Wayne Mikkelson and Megan Partch, 'Managers' Voting Rights and Corporate Control' (1989) 25 Journal of Financial Economics 263.
28. See generally Geof Stapledon, 'Disincentives to Activism by Institutional Investors in Listed Australian Companies' (1996) 18 Sydney Law Review 152.
29. See Eugene Fama and Michael Jensen, 'Separation of Ownership and Control' (1983) 26 Journal of Law and Economics 301 for an overview of this entrenchment hypothesis. However, this entrenchment argument may be criticised on the basis that director ownership may not reflect the level of entrenchment. For example, Randall Morck, Andrei Schleifer and Robert Vishny, 'Management Ownership and Market Valuation: An Empirical Analysis' (1988) 20 Journal of Financial Economics 293, 294 suggest that some directors, by virtue of their tenure with the company, status as a founder, or even their personality, may be entrenched with relatively small ownership stakes.
30. See Eugene Fama and Michael Jensen, 'Separation of Ownership and Control' (1983) 26 Journal of Law and Economics 301 for an overview of this entrenchment hypothesis. However, this entrenchment argument may be criticised on the basis that director ownership may not reflect the level of entrenchment. For example, Randall Morck, Andrei Schleifer and Robert Vishny, 'Management Ownership and Market Valuation: An Empirical Analysis' (1988) 20 Journal of Financial Economics 293, 294 suggest that some directors, by virtue of their tenure with the company, status as a founder, or even their personality, may be entrenched with relatively small ownership stakes.
31. The agency argument is empirically confirmed by Hamid Mehran, 'Executive Compensation Structure, Ownership, and Firm Performance' (1995) 38 Journal of Financial Economics 163, 175. Support for the entrenchment argument comes from Andrei Schleifer and Robert Vishny, 'Management Entrenchment: The Case of Manager-Specific Investments' (1989) 25 Journal of Financial Economics 123.
32. The agency argument is empirically confirmed by Hamid Mehran, 'Executive Compensation Structure, Ownership, and Firm Performance' (1995) 38 Journal of Financial Economics 163, 175. Support for the entrenchment argument comes from Andrei Schleifer and Robert Vishny, 'Management Entrenchment: The Case of Manager-Specific Investments' (1989) 25 Journal of Financial Economics 123.
33. Morck, Schleifer and Vishny, above n 26; Diane Schooley and Dwayne Barney, 'Using Dividend Policy and Managerial Ownership to Reduce Agency Costs' (1994) 17 Journal of Financial Research 363.
34. Morck, Schleifer and Vishny, above n 26; Diane Schooley and Dwayne Barney, 'Using Dividend Policy and Managerial Ownership to Reduce Agency Costs' (1994) 17 Journal of Financial Research 363.
35. See Morck, Schleifer and Vishny, above n 26, 298-299 for an overview of the piecewise linear regression technique used. Tobin's Q is a commonly used performance measure and is defined in Section 5.2.
36. John McConnell and Henry Servaes, 'Additional Evidence on Equity Ownership and Corporate Value' (1990) 27 Journal of Financial Economics 595.
37. Other United States studies finding evidence of a positive relationship between the percentage ownership of shares by directors (or directors and officers) and corporate performance include Idalene Kesner, 'Directors' Stock Ownership and Organizational Performance: An Investigation of Fortune 500 Companies' (1987) 13 Journal of Management 499; and Karl Hudson, John Jahera and William Lloyd, 'Further Evidence on the Relationship Between Ownership and Performance' (1992) 27 Financial Review 227.
38. Other United States studies finding evidence of a positive relationship between the percentage ownership of shares by directors (or directors and officers) and corporate performance include Idalene Kesner, 'Directors' Stock Ownership and Organizational Performance: An Investigation of Fortune 500 Companies' (1987) 13 Journal of Management 499; and Karl Hudson, John Jahera and William Lloyd, 'Further Evidence on the Relationship Between Ownership and Performance' (1992) 27 Financial Review 227.
39. Allen Craswell, Richard Saywell and Stephen Taylor, 'Ownership Structure and Corporate Performance: Australian Evidence' (1997) 5 Pacific-Basin Finance Journal 301.
40. Elson, above n 4, 704-706. See also two studies cited extensively by Elson: David McLaughlin, The Director's Stake in the Enterprise' (1994) Directors and Boards 53; and Robert Stobaugh, 'Director Compensation: A Lever to Improve Corporate Governance' (1993) Director's Monthly 1.
41. Elson, above n 4, 704-706. See also two studies cited extensively by Elson: David McLaughlin, The Director's Stake in the Enterprise' (1994) Directors and Boards 53; and Robert Stobaugh, 'Director Compensation: A Lever to Improve Corporate Governance' (1993) Director's Monthly 1.
42. Ann Yerger, 'CEO's Stock Holdings Said Key to Performance' (1993) 10:6 IRRC Corporate Governance Bulletin 15.
43. Section 609(1) Corporations Law.
44. Although the basic rule is contained in s 31 of the Corporations Law, ss 30-45 should also be noted when deciding if an interest falls within the meaning of 'relevant interest'.
45. Sections 32 and 33 Corporations Law.
46. See ss 31 and 51(1)(b) Corporations Law. Also note the exemption for some trustees contained in s 39 Corporations Law.
47. See s 34(c) Corporations Law.
48. Sec Ian Renard and Joseph Santamaria, Takeovers and Reconstructions in Australia (Butterworths looseleaf service, 1996) para 431.
49. Ibid.
50. Where a director's shareholding was not given in the 1995 annual report because they had left the company subsequent to balance date, that director's shareholding as stated in the 1994 annual report was used. Also note that additional testing was conducted to incorporate convertible securities and options over unissued shares, which are not relevant interests, into the analysis.
51. See Craswell, Saywell and Taylor, above n 32; Andrew Defina, Thomas Harris and Ian Ramsay, 'What is Reasonable Remuneration for Corporate Officers? An Empirical Investigation Into the Relationship Between Pay and Performance in the Largest Australian Companies' (1994) 12 Company and Securities Law Journal 341, 349.
52. See Craswell, Saywell and Taylor, above n 32; Andrew Defina, Thomas Harris and Ian Ramsay, 'What is Reasonable Remuneration for Corporate Officers? An Empirical Investigation Into the Relationship Between Pay and Performance in the Largest Australian Companies' (1994) 12 Company and Securities Law Journal 341, 349.
53. The Australian Stock Exchange also publishes total shareholder returns over the past year for each company. The preference for using a three year return in this study is supported by the Hilmer Working Party's observation that directors should strive for sustained, above average performance, which they define as "longer-term patterns of results than those achieved in a single year": Independent Working Party into Corporate Governance (Frederick Hilmer, chair), Strictly Boardroom: Improving Governance to Enhance Company Performance (1993) para 3.17.
54. Australian Investment Managers' Association and Australian Institute of Company Directors, Executive Share Option Schemes Guidelines (1995) para 5.
55. 'In' refers to the natural logarithm.
56. Indeed, one report suggests that about half of the Australian companies applying performance criteria to the exercise of options use GEPS as their criteria: Mark Lawson, 'Half Our Share Schemes Not Linked to Performance', Australian Financial Review, 14 June 1996.
57. This is consistent with views expressed in various corporate governance reports: Independent Working Party into Corporate Governance (Frederick Hilmer, chair), Strictly Boardroom: Improving Governance to Enhance Company Performance (1993) para 3.16; Report of a Study Group Chaired by Sir Richard Greenbury, Directors' Remuneration (1995) para 6.39-6.40.
58. This is consistent with views expressed in various corporate governance reports: Independent Working Party into Corporate Governance (Frederick Hilmer, chair), Strictly Boardroom: Improving Governance to Enhance Company Performance (1993) para 3.16; Report of a Study Group Chaired by Sir Richard Greenbury, Directors' Remuneration (1995) para 6.39-6.40.
59. See footnote 45 and the accompanying quote.
60. See Section 3.1 and the John Prescott example in Section 4.3.
61. Morck, Schleifer and Vishny, above n 26, 298-9 used 5% and 25% because the former is the level of ownership in the United States beyond which mandatory disclosure to the Securities and Exchange Commission is required and the latter is, in their view, the ownership range beyond which a hostile bid for the company cannot succeed.
62. To some extent this confirms the other Australian evidence which suggests that executive share schemes are often not linked to performance: Lawson, above n 47.
63. The findings of Defina, Harris and Ramsay, above n 43, 351 suggest a positive relationship between the size of a company and CEO remuneration.
64. See Section 3.2.
65. The results for high levels of director ownership may provide some support for the recommendation contained in the Draft Report of the Toronto Stock Exchange Committee on Corporate Governance in Canada that a director who, because of his or her shareholding, can control or influence the control of the company, should not be treated as an independent director. See above nn 13-14 and accompanying text. As previously noted, the Committee reversed this recommendation in its Final Report.
66. McConnell and Servaes, above n 30.
67. Bernard Black, 'Stern Stewart Roundtable on Managerial Incentive Compensation and Shareholder Value' (1992) 5:2 Journal of Applied Corporate Finance 110, 124-5.
68. Ibid; Elson, above n 4, 695.
69. Patrick McGurn, 'Board Reforms Top Activists' Agendas' (1995) 12:3 IRRC Corporate Governance Bulletin 6.
70. Ibid, 9.
71. The proposals have been backed by the Investor's Rights Association of America: ibid, 7. McGurn says that the institutional community "tends to support paying directors in stock", but has not favoured some of the proposals which have sought to pay directors a fixed sum, such as 2,000 shares per year, regardless of the market value of those shares: ibid, 7.
72. The proposals have been backed by the Investor's Rights Association of America: ibid, 7. McGurn says that the institutional community "tends to support paying directors in stock", but has not favoured some of the proposals which have sought to pay directors a fixed sum, such as 2,000 shares per year, regardless of the market value of those shares: ibid, 7.
73. Australian Investment Managers' Association, Corporate Governance: A Guide for Investment Managers in Corporations (2nd ed, 1997), 24.
74. Scholes, above n 21, 123. See Section 3.1.
75. See Jonathan Farrer and Tony Cusack, 'Dividends, Shares and the Options: DRP Alternatives' (1995) 3 Journal of the Securities Institute of Australia 20 for an overview of the factors that may impact upon the discount rate chosen.
76. Scholes, above n 21, 123.
77. Independent Working Party into Corporate Governance (Frederick Hilmer, chair), Strictly Boardroom: Improving Governance to Enhance Company Performance (1993) paras 4.21-4.23; Australian Investment Managers' Association and Australian Institute of Company Directors, Executive Share Option Schemes Guidelines (1995) para 5; Australian Investment Managers' Association, Corporate Governance: A Guide for Investment Managers in Corporations (2nd ed, 1997), 24; Report of a Study Group Chaired by Sir Richard Greenbury, Directors' Remuneration (1995) para 6.41.
78. Independent Working Party into Corporate Governance (Frederick Hilmer, chair), Strictly Boardroom: Improving Governance to Enhance Company Performance (1993) paras 4.21-4.23; Australian Investment Managers' Association and Australian Institute of Company Directors, Executive Share Option Schemes Guidelines (1995) para 5; Australian Investment Managers' Association, Corporate Governance: A Guide for Investment Managers in Corporations (2nd ed, 1997), 24; Report of a Study Group Chaired by Sir Richard Greenbury, Directors' Remuneration (1995) para 6.41.
79. Independent Working Party into Corporate Governance (Frederick Hilmer, chair), Strictly Boardroom: Improving Governance to Enhance Company Performance (1993) paras 4.21-4.23; Australian Investment Managers' Association and Australian Institute of Company Directors, Executive Share Option Schemes Guidelines (1995) para 5; Australian Investment Managers' Association, Corporate Governance: A Guide for Investment Managers in Corporations (2nd ed, 1997), 24; Report of a Study Group Chaired by Sir Richard Greenbury, Directors' Remuneration (1995) para 6.41.
80. Independent Working Party into Corporate Governance (Frederick Hilmer, chair), Strictly Boardroom: Improving Governance to Enhance Company Performance (1993) paras 4.21-4.23; Australian Investment Managers' Association and Australian Institute of Company Directors, Executive Share Option Schemes Guidelines (1995) para 5; Australian Investment Managers' Association, Corporate Governance: A Guide for Investment Managers in Corporations (2nd ed, 1997), 24; Report of a Study Group Chaired by Sir Richard Greenbury, Directors' Remuneration (1995) para 6.41.