What makes a board independent? Australian evidence

The purpose of this paper is to determine what aspects of board independence, in terms of board structure and characteristics of non-executive directors (NEDs), are associated with effective monitoring of management, as evidenced through lower levels of earnings management. This paper examines the effectiveness of board independence requirements under the 2003 Australian Stock Exchange (ASX) Principles of Good Corporate Governance and Best Practice Recommendations (POGCG) for a sample of 231 firms listed on the ASX in the financial year 2005. The associations of board composition, share ownership and compensation of NEDs with the level of earnings management are estimated. To explore the characteristics of NEDs that are important for effective monitoring, NEDs are separated into "grey" (affiliated) directors and independent directors and compensation is separated into variable and fixed components. The results of the paper indicate a positive relation between earnings management and share ownership of NEDs, particularly that of grey directors. There is a negative relation between NED compensation and the level of earnings management, particularly the fixed compensation component for independent directors.23 page(s