Firms' Information Environments and Board Independence

Abstract

A feature of recent regulatory developments, such as CLERP 9 in Australia and Sarbannes Oxley in the United States, is that they prescribe uniform governance mechanisms for all firms, a 'one size fits all' approach. However, there is scant empirical evidence of whether this is efficient, and in the extant empirical literature there is only equivocal guidance on the more general question of how firm characteristics impact the selection of governance mechanisms. Addressing, at least in part this issue, this study evaluates the impact of the firms' information environment and the ability of accounting information to capture this on the demand for independent boards of directors as a governance mechanism. Price to book (P/B) and price to earnings (P/E) are used to evaluate the firms' information environment and the extent to which it is captured by accounting information. Evidence is provided of joint P/B, P/E firm classification capturing significant differences in board independence across firms. Importantly, supplementing P/B with P/E identifies significant differences in board independence within high and low P/B firms. Furthermore, evidence is provided of a strong, positive correlation between board size and board independence suggesting that independent directors are added to boards rather than used to supplant inside directors. This brings into question the appropriateness of regulation uniformly prescribing corporate governance mechanisms.