ACCOUNTING, ECONOMICS AND FINANCE. School Working Papers Series 2004 SWP 2004/04

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1 FACULTY OF BUSINESS AND LAW School of ACCOUNTING, ECONOMICS AND FINANCE School Working Papers Series 24 SWP 24/4 Board Composition Changes After an Initial Public Offering William Dimovski* and Robert Brooks** *School of Accounting, Economics and Finance, Deakin University **Research Development Unit, RMIT Business The working papers are a series of manuscripts in their draft form. Please do not quote without obtaining the author s consent as these works are in their draft form. The views expressed in this paper are those of the author and not necessarily endorsed by the School. URL:

2 Board Composition Changes After an Initial Public Offering. William Dimovski* and Robert Brooks** * School of Accounting, Economics and Finance, Deakin University ** Research Development Unit, RMIT Business Keywords: Stakeholders, IPOs Correspondence to: Bill Dimovski, School of Accounting, Economics and Finance, Deakin University, Geelong, Victoria, Australia, Phone: , Fax , wd@deakin.edu.au - 2 -

3 ABSTRACT This paper follows Luoma and Goodstein (1999) who find increased stakeholder representation on the boards of U.S. companies. This study describes the changes in board composition by director type (stakeholder or shareholder) and by gender (male or female) of large Australian companies after listing. We find a substantial increase in the number of directors holding shares in the firms in which they hold their directorships and that essentially directors putting their own capital at risk is an important element in the Australian capital market. We also report a slight decrease in the proportion of female directors post listing

4 1. Introduction The management literature over the last twenty years has argued that companies would benefit by understanding the needs and expectations of their non shareholder stakeholders, such as customers, employees, suppliers, and public representatives [see for example Agle, Mitchell and Sonnenfeld (1999), Freeman (1984) and Clarkson (1995)]. As companies recognise the range of non shareholder stakeholders, the issue arises as to how companies can more appropriately cater for the interests of such stakeholders. Evan and Freeman (1993), Freeman and Evan (199) and Jones and Goldberg (1982) argue that stakeholders could be directly represented on the board of directors. Luoma and Goodstein (1999) argue that if direct stakeholder representation on the boards of companies is useful, there is likely to be an increase in non shareholder stakeholder representation. They study 224 NYSE companies over the period 1984 to 1994 and do indeed find increased stakeholder board representation. Dimovski and Brooks (forthcoming) study 27 initial public offerings (IPOs) in Australia over the period 1994 to 1997 and conclude that the IPO market in Australia does not require non shareholder stakeholder representation on the board. While suppliers, suppliers with options to purchase shares, employees and employees with options to purchase shares were represented on the boards of these IPOs, there were only 5 of 1393 non financially interested public stakeholder directors in their sample

5 The purpose of this paper is to document changes to the composition of the boards of these Australian companies as they mature after listing. This paper examines if the Luoma and Goodstein (1999) findings apply in the Australian IPO market. We investigate the composition of the boards of 54 of the 27 new IPO companies during 1994 to 1997 that are later recorded as a top 5 company (by market capitalization) listed on the Australian Stock Exchange in 22. The plan of this paper is as follows. Section 2 briefly reviews some of the stakeholder literature. In section 3 we report our empirical findings. Section 4 contains some concluding comments. 2. Some Previous Stakeholder Research and Hypotheses Freeman (1984), in some early work, argued that corporations should consider stakeholder needs and expectations because they were likely to influence the types of corporate strategies developed by those organisations. Freeman (1984) identified three stakeholder categories. They were the shareholder stakeholders, the economic stakeholders (such as customers, suppliers, debt providers and employees) and the third were the influencer stakeholders (such as governments, trade unions and consumer organisations). Clarkson (1995) suggested a stakeholder classification of primary stakeholders (those the company depends on for it's survival) and secondary stakeholders (those the company - 5 -

6 doesn't depend on for its survival). Primary stakeholders would include shareholders, investors, employees, customers, suppliers and the government. A third taxonomy is presented by Luoma and Goodstein (1999). They suggest that perhaps only non shareholder stakeholders need to be classified. Primary non shareholder stakeholders are essentially those the company has a business relationship with, such as customers, suppliers and financiers. Public non shareholder stakeholders are those the company doesn t have a business relationship with but would nevertheless be interested in the activities of the organisation (such as government officials, academics and community representatives). While Evan and Freeman (1993), Freeman and Evan (199) and Jones and Goldberg (1982) all suggest the importance of non shareholder stakeholders at board level, Luoma and Goodstein (1999) studied board composition of U.S. NYSE firms to see if board seats were actually occupied by non shareholder stakeholders. They found that while the proportion of private stakeholder directors (customers, suppliers, financiers) to total directors remained at 5% in each of the years 1984, 1989 and 1994, the proportion of public stakeholder directors (government officials, academics and community representatives) to total directors was a statistically significant growth from 9% to 1% to 11% in each of those years. This study investigates the composition of large Australian company boards at the time of the IPO and subsequently as they establish themselves into a top 5 company (by market capitalization). While the pre-ipo owners of the firm must select the board of the - 6 -

7 IPO firm at the time of preparing the prospectus, Mak and Roush (2) argue that it is in the interests of the pre-ipo owners to select a board with an ability to reduce any potential agency costs and hence any excess IPO underpricing. As the IPO company matures, following Luoma and Goodstein (1999), we might expect that the proportion of non shareholder directors to increase. 3. Empirical Findings There were 27 initial public offerings (IPOs) over 1994 to 1997 that successfully listed on the Australian Stock Exchange. Of these, 64 were identified as a top 5 company in the 22 year in terms of their market capitalisation. Of the 64, 1 were property and equity trust IPOs that had a management company managing the affairs of the trust, rather than a board of directors and have been excluded from the sample. This reduced the sample size to 54. Connect 4 databases were used to determine board composition data in each of the prospectuses and in the 22 Annual Reports. Each director s interest (including shareholding and option interests), director profiles (including occupation and affiliation) and gender were noted. Alternate directors were not included. of each company that had a shareholding interest were identified (direct or through one of their personally affiliated trusts or companies) and classified as shareholder directors. Using Luoma and Goodstein s (1999) classification of private stakeholder directors, directors who were non equity holding customers, employees and suppliers were also identified. Similarly, we identify the non equity holding public stakeholder directors of government representatives and academics. A number of - 7 -

8 directors in our sample group were also non equity interested professional directors. These too were classified as public stakeholder directors. Table 1 reports the results of board composition by director type. The three columns following director type report the numbers of directors in each director type and their percentages of the total numbers of directors for the 54 IPOs. Of the 54 IPOs, 1 were mining companies and 44 industrial companies. There were 319 directors in total, of which 51 were mining company directors and 268 industrial company directors. The number of shareholder directors (132) as a percentage of the number of total directors (319) was 41.4% overall with (36 of 51) 7.6% being shareholder directors in the mining companies and (96 of 319) 35.8% being shareholder directors in the industrials. Similarly, the number of supplier directors (2) as a percentage of the number of total directors (319) was 6.3% overall with (5 of 51) 9.8% being supplier directors in the mining companies and (15 of 319) 5.6% being supplier directors in the industrials. The number of employees with options directors (32) as a percentage of the number of total directors (319) was 1.% overall with (3 of 51) 5.9% being employees with options directors in the mining companies and (29 of 319) 1.8% being employees with options directors in the industrials. The number of professional directors (121) as a percentage of the number of total directors (319) was 37.9% overall with (7 of 51) 13.7% being professional directors in the mining companies and (114 of 319) 42.5% being professional directors in the industrials. There were very few government representatives, academics or community representatives (public stakeholders) indeed. The three government representative - 8 -

9 directors identified were actually officials of a Chinese Government instrumentality. Excluding these, there remains only one non equity holding academic as a public stakeholder in our sample group. We contrast these results with the numbers and percentages of directors representing those IPOs that made the top 5 companies list in 22. Of the 348 directors in total in our 22 list, there were 54 mining company directors and 294 industrial company directors. The number of shareholder directors (311) as a percentage of the number of total directors (348) was 89.4% overall with (45 of 54) 83.3% being shareholder directors in the mining companies and (266 of 294) 9.5% being shareholder directors in the industrials companies. The number of non shareholder supplier directors (1) as a percentage of the number of total directors (348) was.3% overall with (1 of 54) 1.9% being supplier directors in the mining companies and ( of 294) being supplier directors in the industrials. The number of employees with options directors (2) as a percentage of the number of total directors (348) was.6% overall with (2 of 54) 3.7% being employees with options directors in the mining companies and ( of 35) being employees with options directors in the industrials. The number of professional directors (28) as a percentage of the number of total directors (348) was 8.% overall with (6 of 54) 11.1% being professional directors in the mining companies and (22 of 294) 7.5% being professional directors in the industrials. Again, there were very few public stakeholder directors, given the time from listing to the 22 time horizon. The number of government representative directors from the Chinese - 9 -

10 Government instrumentality had grown to 5. There remained only one non equity holding academic as a public stakeholder in our 22 group of companies. Table 1 also reports the changes in the numbers of directors and the percentage changes for each director type since the IPO. While the number of directors has increased overall by 8.3% (5.9% for mining companies and 9.7% for the industrials), the biggest increase has been in the number of shareholder directors, 147.7%, reflecting a 25% increase amongst the mining companies and 177.1% amongst the industrials. It appears the numbers of non shareholder supplier directors, supplier with options directors and employees with options directors have made way for equity holding directors. The number of non shareholding professional directors has also made way for shareholding directors, particularly amongst the industrial companies. The following table reports the details of board composition by director type for our sample group: INSERT TABLE 1 HERE Data was also collected on the basis of the gender of the directors in our IPOs compared to the gender of the directors as reported as at annual report time 22. The number of female directors was only about 5% of our sample group population. We found no female directors amongst the mining companies in either time period

11 The table below reports the details of board composition by gender for our sample group: INSERT TABLE 2 HERE 4 Conclusion We find a substantial increase in the percentage of shareholder directors to non shareholder directors, particularly amongst the industrial companies group. It appears that the non shareholding supplier directors, option holding directors and professional directors made way for shareholding directors in our group of IPOs that hold a position in the top 5 companies listed on the Australian Stock Exchange. Over 4 in 5 directors (311 directors of 348 directors) have a shareholding interest in our group of 54 companies. This suggests that essentially directors putting their own capital at risk is an important element in the Australian capital market. Removing the financially interested directors (supplier, employees with options and professional directors) there remains only 6 non equity interested stakeholder directors. If we then remove the 5 beneficial directors of the Chinese Government instrumentalities there remains only 1 academic director as a public non equity interested stakeholder director. This finding is contrary to Luoma and Goodstein s (1999) study and suggest public stakeholder directors are not significant at this level of office. The low proportion of female directors on the boards of our sample of 54 is also surprising. There were no female directors amongst the mining companies. There were, however, around 1 female director in 2 directors amongst the industrial companies

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13 References Agle, B. R., Mitchell, R. K. and Sonnenfeld, J. A. (1999) Who Matters to CEOs? An Investigation of Stakeholder Attributes and Salience, Corporate Performance, and CEO Values. Academy of Management Journal, 42, Clarkson, M. B. (1995) A Stakeholder Framework for Analyzing and Evaluating Corporate Social Performance. The Academy of Management Review, 2, Dimovski, B., and Brooks, R., (forthcoming) Stakeholder Representation on the Boards of Australian Initial Public Offerings. Applied Financial Economics Evan, W. F. and Freeman, R. E. (1993) In Ethical Theory and Business (Eds, Beauchamp, T. and Bowie, N.) Prentice Hall, Englewood Cliffs, N.J., pp Freeman, R., Edward (1984) Strategic Management: A Stakeholder Approach, Pitman, Boston. Freeman, R. E. (1999) Divergent Stakeholder Theory. Academy of Management Review, 24, Freeman, R. and Evan W.F. (199) Corporate Governance: A Stakeholder Interpretation. Journal of Behavioral Economics 19, Jones, T. M. and Wicks, A. C. (1999) Convergent Stakeholder Theory. Academy of Management Review, 24, Jones, T. and Goldberg, L.D. (1982) Governing the Large Corporation: More Arguments for Public. Academy of Management Review, 7, Luoma, P. and Goodstein, J. (1999) Stakeholders and Corporate Boards: Institutional Influences on Board Composition and Structure. Academy of Management Journal, 42, Mak, Y.T. and Roush, M. L. (2) Factors Affecting the Characteristics of Boards of : An Empirical Study of New Zealand Initial Public Offerings. Journal of Business Research, 47,

14 . Table 1: Board Composition by Director Type. Sample size 54 Companies IPOs Mining Companies 1 Industrial Companies Top Companies Mining Companies 1 Industrial Companies 44 Director Type Nos. and % of total Shareholder 132 (41.4%) Customers (.%) Suppliers 2 (6.3%) Suppliers with 9 options (2.8%) Gov t 3 Representatives (1.%) Academics 1 (.3%) Employees 1 (.3%) Employees with 32 Options (1.%) Professional 121 (37.9) Mining Company 36 (7.6%) (.%) 5 (9.8%) (.%) (.%) (.%) (.%) 3 (5.9%) 7 (13.7%) Industrial Company 96 (35.8%) (.%) 15 (5.6%) 9 (3.4%) 3 (1.1%) 1 (.4%) 1 (.4%) 29 (1.8%) 114 (42.5%) Nos. and % of Total 311 (89.4%) (.%) 1 (.3%) (.%) 5 (1.4%) 1 (.3%) (.%) 2 (.6%) 28 (8.%) Mining Company Industrial Company change change change (147.7%) (83.3%) (25%) (9.5%) (177.1%) (.%) (.%) (.%) (.%) (.%) -19 (-95.%) -9 (-1%) +2 (66.7%) (.%) -1 (-1%) -3 (-93.8%) -93 (-76.9%) 1 (1.9%) (.%) (.%) (.%) (.%) 2 (3.7%) 6 (11.1%) -4 (-8.%) (.%) (.%) (.%) (.%) -1 (-33.3%) -1 (-14.3%) (.%) (.%) 5 (1.7%) 1 (.3%) (.%) (.%) 22 (7.5%) -15 (-1%) -9 (-1%) +2 (66.7%) (.%) -1 (-1%) -29 (-1%) -92 (-8.7%) Total 319 (1.%) 51 (1.%) 268 (1.%) 348 (1.%) +29 (8.3%) 54 (1.%) +3 (5.9%) 294 (1.%) +26 (9.7%)

15 Table 2: Board Composition by Gender. Sample size 54 Companies No. of Female 16 (5.%) Male 33 (95.%) Total 319 (1.%) IPOs Mining Company (.%) 51 (1.%) 51 (1.%) Industrial Company 16 (6.%) 252 (94.%) 268 (1.%) No. of 16 (4.6%) 332 (95.4%) 348 (1.%) 22 Top Companies Mining Company (.%) 54 (1.%) 54 (1.%) Industrial Company 16 (4.5%) 278 (95.5%) 291 (1.%)