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Examining the influence of Intellectual

capital
corporate governance on efficiency
intellectual capital efficiency
Evidence from top service firms in Australia 347
Ranjith Appuhami and Mohammed Bhuyan
Department of Accounting and Corporate Governance,
Macquarie University, Sydney, Australia

Abstract
Purpose – The purpose of this paper is to examine the influence of corporate governance on
intellectual capital (IC) in top service firms in Australia.
Design/methodology/approach – Drawing on the agency theory, the paper develops hypotheses
about relationships between corporate governance mechanisms (chief executive officer [CEO] duality,
board size, board composition and subcommittee composition) and IC. The study uses a multiple
regression analysis on data collected from corporate annual reports of 300 firm-year observations.
Findings – The findings of the regression analysis indicate that CEO duality, board composition and
remuneration committee composition are significantly associated with IC. In contrast, there is no
evidence that board size and audit committee composition have an effect on IC. The study contributes
to agency theory in general and the literature on IC and corporate governance more specifically.
Practical implications – The findings of the study might be of interest to regulators, investment
analysts, shareholders, company directors and managers in Australia, as well as academics, in
designing corporate governance mechanisms to develop IC.
Originality/value – Corporate governance is country-specific and, hence, its impact on managerial
decisions leading to IC is different from country to country. This study provides empirical evidence on
the relationship between corporate governance and IC in top service firms in Australia.
Keywords Australia, Intellectual capital, VAIC, Agency theory, Service firms,
Corporate governance mechanisms
Paper type Research paper

1. Introduction
Intellectual capital (IC) is increasingly being recognized as an important strategic
resource for organizations operating within the so-called knowledge-based economy
(Dzinkowski, 2000; Zerenler and Gozlu, 2008). The IC of an organization is located in its
relationships, structures and people, and adds value to the organization by creating and
maintaining creativity, innovations, information technology, interpersonal activities
and competitive advantage[1] (Guthrie, 2001; Tayles et al., 2007). Van der Meer-Kooistra
and Zijlstra (2001) claim that IC adds value to organizations by improving the exchange
of knowledge and the creation of new knowledge. Petty and Guthrie (2000, p. 156) note
that “[…] intellectual capital has the potential to improve the efficiency of both capital Managerial Auditing Journal
and labour markets”. Studies also find that IC has a positive influence on the Vol. 30 No. 4/5, 2015
pp. 347-372
performance and wealth of the organization (Zerenler and Gozlu, 2008; Phusavat et al., © Emerald Group Publishing Limited
0268-6902
2011). DOI 10.1108/MAJ-04-2014-1022
MAJ Despite the fact that, as a strategic resource, IC increases performance and creates
30,4/5 value for organizations, there are nevertheless problems with managing and controlling
IC in organizations. Van der Meer-Kooistra and Zijlstra (2001, p. 457) argue that if IC is
not managed properly, it will be suboptimal and “[…] its value-added capacity will not
be fully exploited”. Managing IC remains one of the key challenges for the accounting
profession, owing to its complexity and diversity (Dzinkowski, 2000). Several recent
348 studies, therefore, argue in support of the need to understand the role of corporate
governance in effectively deploying, protecting and retaining IC in organizations
(Keenan and Aggestam, 2001; La Rocca et al., 2008; Safieddine et al., 2009). Corporate
governance ensures that managerial decisions are made to enhance shareholders’
wealth through the adroit use of IC (Vafeas and Theodorou, 1998; Weimer and Pape,
1999; Keenan and Aggestam, 2001). Keenan and Aggestam (2001, p. 273) note that “[…]
the responsibility for the prudent investment of intellectual capital resides with
corporate governance”. However, few empirical studies show how corporate governance
influences the development of IC in organizations. In particular, there is limited
understanding of how various corporate governance mechanisms are connected to IC.
The aim of this study is to examine the influence of corporate governance
mechanisms on IC. Drawing on the agency theory and studies on corporate governance,
the paper develops hypotheses about the relationships between various corporate
governance mechanisms (such as chief executive officer [CEO] duality, board size, board
composition and committee composition) and IC. The study uses multiple regression
analysis on data collected from corporate annual reports of 300 firm-year observations.
The study specifically focuses on 30 top Australian service firms that seem to rely
heavily on IC (Edvinsson and Malone, 1997).
This study makes contributions to agency theory and the literature on both corporate
governance and IC. First, it explores whether corporate governance mechanisms
contribute to the development of IC in organizations. Many previous studies have
examined the two topics – IC and corporate governance – separately (Weimer and Pape,
1999; Abeysekera and Guthrie, 2005). Keenan and Aggestam (2001) also claim in this
respect that less attention has been devoted to the relationships between IC and
corporate governance, and instead, the focus of past studies has been on corporate
governance responsibility for financial and physical capital. Although a few recent
studies focus on both topics, they also examine the influence of corporate governance
mechanisms on IC disclosure (Cerbioni and Parbonetti, 2007; Jing et al., 2008).
Second, IC accounting research has now entered a third stage, which is concerned
with the implications of IC management for value creation (Dumay, 2013; Guthrie et al.,
2012). According to Dumay and Garanina (2013, p. 13), the third stage of IC accounting
research focuses on the “managerial implications of managing IC in all types of
organizations”. This study contributes to the third stage of IC accounting research by
investigating the effect of corporate governance mechanisms, which potentially
influence managers’ behaviour with regard to IC efficiency.
Lastly, the study also sheds light on macro-level corporate governance systems in
Australia generally, and corporate governance mechanisms and the nature of IC in top
service firms in Australia more specifically. Corporate governance mechanisms in firms
are largely dependent on each country’s legal framework, the strength of the capital
market, business culture and the political and economic environment. Previous studies
also note that corporate governance is country-specific; hence, its impact on managerial
decisions leading to IC differs from country to country (Vafeas and Theodorou, 1998; Intellectual
Weimer and Pape, 1999; Keenan and Aggestam, 2001). Different corporate governance capital
mechanisms and their influence on IC should therefore be separately examined in each
country. However, most previous studies are solely based on data collected from the
efficiency
USA and the UK.
The remainder of the article is organized as follows. Section 2 reviews the related
literature on both IC and corporate governance, and develops the hypotheses. Section 3 349
outlines the research method. Section 4 presents the empirical results based on multiple
regression analysis. Section 5 presents the summary and concluding comments.

2. Literature review and development of hypotheses

Prior studies have provided insights into the influence of corporate governance on
various aspects of organizations such as performance, culture, accountability and
disclosure of intangibles (Haniffa and Cooke, 2002; Brennan and Solomon, 2008). This
study, however, focuses on studies of corporate governance, IC and agency theory.
Agency theory provides a framework for analysing the linkages between corporate
governance and IC in organizations (Jensen and Meckling, 1976). The agency theory first
appeared in economics research and has since spread to areas such as accounting and
organizational management (Nyberg et al., 2010; Boyd, 1994; Cerbioni and Parbonetti,
2007). The theory focuses on the agency relationship between a principal and an agent,
and analyses the agency problem arising from “separation of ownership and control”
(Jensen and Meckling, 1976). In essence, the agency problem results from the potential
lack of goal congruence between shareholders (principals), who own organizations, and
managers (agents), who control the organizations, thus giving rise to opportunistic
behaviour by managers (Jensen and Meckling, 1976). As a result of goal incongruence,
managers tend to maximize their own welfare opportunistically by misusing firm
resources and making suboptimal decisions, usually at the expense of shareholders,
thereby creating “agency costs” (Fama and Jensen, 1983). Opportunistic behaviour
leading to agency cost can also take the form of “shirking, cheating, distorting
information, appropriating resources, and so on” (Das and Teng, 2001, p. 253). Agency
cost also includes the cost of using various mechanisms (e.g. appointing boards and
committees) to monitor managers’ behaviour. The problem is exacerbated by the
asymmetric information between managers and shareholders on operational and
investment decisions, and the owners’ inability to write complete contracts (Fama and
Jensen, 1983).
Managerial decision-making is expected to focus on the creation and leveraging of
value for stakeholders (Weimer and Pape, 1999). The creation of value is dependent not
only on how managers use financial capital and physical capital such as vehicles and
buildings but also on how they manage organizational IC (Keenan and Aggestam, 2001).
Managing IC implies that managers set goals and establish practices with regard to the
acquisition (creation) and efficient use of IC, and coordinate and motivate the behaviour
of organizational participants towards realizing these goals (Van der Meer-Kooistra and
Zijlstra, 2001).
The acquisition of IC refers to the competence and commitment gained through
training and the development of IC-related assets such as organizational participants
(Bontis, 1998). The acquisition and efficient use of IC can be undermined by the existence
of agency cost. For example, opportunistic managers can increase management’s
MAJ welfare in the form of compensation (agency costs) and reduce the cash flow available
30,4/5 for training and the development of IC. Further, in the presence of agency costs resulting
from information asymmetry, shareholders do not capture all of the value of the shares
of a firm, thereby increasing the cost of outside funds needed to invest in IC.
Various definitions of IC exist in the literature. An analysis of these definitions
reveals some important aspects of IC. Mouritsen (1998, p. 462) claims that IC is about
350 “[…] broad organizational knowledge, unique to a firm, which allows it constantly to
adapt to changing conditions”. According to Edvinsson and Malone (1997, p. 3), IC “[…]
is information and knowledge applied to work to create value”. These definitions mainly
highlight organizational knowledge as an important part of IC and stress that IC can be
developed through the management of organizational knowledge. Van der
Meer-Kooistra and Zijlstra (2001) note that IC is not only dependent on firm
competency – which is related to the experience and expertise of the firm’s internal
participants – but also on the characteristics of the network in which the firm operates.
Studies provide different classifications of IC[2]. There is, however, a broad
consensus that IC consists of three main elements, namely, human capital, structural
capital and relational capital (Mouritsen, 1998; Sveiby, 1998; Bontis, 1999; Tayles et al.,
2007)[3]. Human capital refers to the “sheer intelligence” of the employees of an
organization (Bontis, 1999, p. 447). This includes experience, education, knowledge,
skills, capabilities, morals, attitudes, commitments and creativity. Bontis (1999, p. 447)
argues that human capital is important for organizations because “[…] it is a source of
innovation and strategic renewal”. Studies note that human capital can be developed by
organizational governance practices involving training and education (Keenan and
Aggestam, 2001).
Structural capital deals with organizational processes, mechanisms, procedures,
structures and infrastructures. Unlike human capital, structural capital is “[…] the
knowledge embedded within the routines of an organization” (Bontis, 1999, p. 448).
Structural capital also includes an organization’s innovative capital such as hardware,
software systems, organizational culture, patents, copyrights and trademarks (Guthrie
and Petty, 2000; Tayles et al., 2007). According to Bontis (1999, p. 447), structural capital
contains “[…] elements of efficiency, transaction times, procedural innovativeness and
access to information for codification into knowledge which facilitates” employees in
“[…] their quest for optimum intellectual performance”. Lastly, relational capital refers
to the knowledge embedded in relationships external to the firm. It includes knowledge
of the organization’s relationships with market channels, customers, suppliers and
governmental and industrial networks (Bontis, 1999; Tayles et al., 2007). According to
Edvinsson (2013, p. 165), “[…] one of the more powerful and deeper understandings of
the modern knowledge economy is in relational or network dimensions” of IC. The IC
elements described above are alone not sufficient for successful performance and “[…]
they need to be combined to generate value” (Giuliani, 2013, p. 129).
Several studies highlight the importance of managing IC by minimizing agency
problems in organizations (Cerbioni and Parbonetti, 2007; Jing et al., 2008). The
corporate governance systems of an organization are expected to work as control
mechanisms to protect investors by minimizing the agency problem. According to Jing
et al. (2008, p. 139), corporate governance works as an “[…] intensive monitoring
package for a firm to reduce opportunistic behaviour” of managers and minimize the
negative impact on IC. It also ensures that decision-making by managers is focused on
developing, retaining and exploiting IC (Safieddine et al., 2009). Keenan and Aggestam Intellectual
(2001, p. 265) argue that: capital
[…] corporate governance has the responsibility for formulating the strategic focus of, efficiency
involving itself in critical decisions about, monitoring the management of, and being
accountable for the adroit investment of the intellectual capital of the firm.
Corporate governance is a “[…] framework of legal, institutional and cultural factors
shaping the patterns of influence that stakeholders exert on managerial 351
decision-making” (Weimer and Pape, 1999, p. 152). This broad definition of corporate
governance considers both internal and external corporate governance mechanisms.
The present study, however, focuses on internal corporate governance mechanisms that
protect outside investors against expropriation by insiders (La Porta et al., 2000). It also
identifies CEO duality, board size, board composition and committee composition as
internal corporate governance mechanisms which seem to play an important role in
Australian firms (see Henry, 2008; Kang et al., 2007; Kiel and Nicholson, 2003). The ASX
Corporate Governance Council in Australia has also paid special attention to these
governance mechanisms in developing its corporate governance principles and
recommendations issued in 2010 and 2014.
Before discussing the relationships between different corporate governance
mechanisms and IC efficiency, it is important to identify the various models for
measuring IC. The difficulty of measuring IC is widely acknowledged in the literature
(Petty and Guthrie, 2000). However, many studies on IC suggest three models for
measuring IC, namely, the market to book value ratio (M/B), Tobin’s q (Bontis, 1998) and
value added intellectual capital coefficient (VAICTM) (Pulic, 1998)[4]. Some studies also
use these models to measure the performance of organizations (see Andriessen, 2004;
Clarke et al., 2011). Performance potentially includes the development and efficient use
of IC. Therefore, the present study draws on the findings of studies that use the three
models to measure either the performance or IC of organizations to develop hypotheses
about the relationships between corporate governance mechanisms and IC.

2.1 CEO duality

Boards of directors are expected to control the behaviour of CEOs to ensure that CEOs
carry out their duties in the best interests of shareholders. Boards of directors may
control the behaviour of CEOs through various mechanisms such as monitoring CEOs’
activities, evaluating performance, specifying CEOs’ roles in contracts and hiring and
firing CEOs (Walsh and Seward, 1990).
CEO duality occurs when the same person holds both CEO and board chairperson
positions in an organization (Finkelstein and D’Aveni, 1994). According to agency
theorists, CEO duality represents a conflict of interest and ignores the board of directors
as the primary monitoring device protecting shareholders’ interests (Fama and Jensen,
1983). Fama and Jensen (1983, p. 314) argue that “[…] the board is not an effective device
for decision control unless it limits the decisions discretion of individual top managers”.
Thus, duality provides CEOs with wider powers over boards and impairs the board
independence needed to exercise effective control over the opportunistic behaviour
of CEOs. Boivie et al. (2011) note that the CEO as chairperson can control the agenda of board
meetings to advance his or her personal interest. This suggests that, as a result of the
opportunistic and risk aversion behaviours of CEOs, CEOs can use organizational
MAJ resources to increase their own welfare (increased compensations, bonuses and prestige)
30,4/5 and, hence, make suboptimal decisions about IC in their organizations when CEO
duality exists. In essence, according to agency theory, CEO duality can hinder the
efficient use and development of IC and thereby reduce the shareholder value.
In Australia, corporate governance principles and recommendations (hereafter
CGPRs) issued by the ASX Corporate Governance Council support the ideology of the
352 agency theory regarding CEO duality. According to CGPRs issued in 2010 and 2014, the
chair of the board should be an independent director and the roles of chair and CEO
should not be held by the same individual. The CGPRs (ASX, 2010) also note that if the
chair is not an independent director, the entity should consider appointing a lead
independent director or an independent deputy chair. Further, the CGPRs (ASX, 2014,
p. 13) note that “[…] a suitable non-executive director should be responsible for the
performance evaluation of the chair of the entity”.
Empirical studies, however, note the inconsistency in the results on duality.
Analysing 141 firms over a six-year period, Rechner and Dalton (1991) observe that
firms with independent leadership consistently outperform those with a duality
structure. Bliss (2011), also using a sample of 799 Australian firms, found that CEO
duality negatively affects the monitoring function of boards and, as a result, boards’
demand for high-quality audits. Consistent with these findings, Iyengar and Zampelli,
(2009, p. 1110), in a study of 1,880 firm-year observations, found that with respect to firm
performance, “[…] the selection of the dual structure, on average, is clearly suboptimal”.
Contrary to the above findings, Boyd (1995) finds that after controlling for
environmental uncertainties, duality can have a positive effect on firm performance
which drives IC development. Elsayed (2007), in an examination of 361 firm-year
observations, reports a positive impact of duality on firm performance when corporate
performance is low. Brickley et al. (1997, p. 218) also note that the separation of titles
could result in other agency costs such as “[…] information costs in controlling the
behaviour of a non-CEO chairman” and costs associated with firms changing their
“succession processes”. In contrast, some studies indicate that there is no significant
association between duality and firm performance and conclude that duality can affect
firm performance negatively or positively, depending on the personal characteristics of
the person who holds the two positions (Vafeas and Theodorou, 1998). Overall, there is
lack of consensus among researchers about the relationship between CEO duality and
firm performance. However, consistent with the agency theory and the findings of some
previous studies, the present study hypothesizes that:
H1. Ceteris paribus, there is a negative association between CEO duality and IC
efficiency.

2.2 Board size

“Board size” refers to the number of members on an organization’s board of directors.
Agency theorists identify two main issues associated with a larger board size which can
result in an agency problem:
(1) problems of communication and coordination of the board; and
(2) the inability of the board to control management (Jensen, 1993; Yermack, 1996;
Eisenberg et al., 1998).
While larger boards may be beneficial to organizations in terms of diversity and the Intellectual
pool of expertise, agency costs resulting from ineffective controls, lack of capital
coordination and poor communication created by larger boards, can overwhelm this
benefit (Jensen, 1993). Jensen (1993, p. 863), argues that “[…] [w]hen boards get
efficiency
beyond seven or eight people they are less likely to function effectively and are
easier for the CEO to control”. This suggests that the relationship between board
size and IC efficiency can be a “U” shape. In this respect, Yermack (1996, p. 210) also 353
notes that “[…] CEO performance incentives provided by the board through
compensation and the threat of dismissal operate less strongly as board size
increases”. Thus, according to the agency theory, a larger board size can be
ineffective in controlling and monitoring managers’ behaviour and, therefore,
ineffective in using IC efficiently and making prudent investments in IC. This also
suggests that due to a lack of monitoring by larger boards, opportunistic managers
could make suboptimal decisions about IC and, hence, destroy corporate value. In
Australia, the CGPRs (ASX, 2010, 2014) do not mention a specific number of
members for the board of a listed entity. According to the CGPRs (ASX, 2010, 2014),
the board should be of a size that is conducive to making appropriate decisions and
adequately discharging its responsibilities and duties.
Although studies in general support this view, empirical findings on board size are
inconsistent. Yermack (1996), using data from a sample of 452 large US firms, found a
negative relationship between board size and Tobin’s q, which is used as a measure of
IC. De Andres et al. (2005), also using a sample of 450 non-financial companies in
Western Europe and North America, found a negative relationship between firm value
and the size of the board of directors. In contrast, Chaganti et al. (1985), using a sample
of 42 failed and non-failed US firms, found that firms with larger boards have a greater
chance of survival. Jackling and Johl (2009), also in an examination of top Indian
companies, also found that larger board size has a positive impact on firm performance.
However, consistent with the agency theory and the general view of previous studies,
the present study hypothesizes that:
H2. Ceteris paribus, there is a negative association between board size and IC
efficiency.

2.3 Board composition

Board composition refers to the proportion of independent outside directors on the
board of directors of an organization. According to the ASX (2010, p. 16) CGPRs
“[…] an independent director is a non-executive director who is not a member of
management and who is free of any business or other relationship”. The ASX (2010,
2014) also recommends that the majority of board members should be independent
directors to ensure that the board is effective in adding value to the organization.
According to agency theorists, the aim of including independent directors is to
enhance the effectiveness of monitoring and control over management and,
therefore, to mitigate the agency problem. Unlike internal directors who are likely to
be aligned with a CEO’s interest, independent directors have incentives to
control top managers effectively because they are motivated to develop reputations
as experts in decision control (Fama and Jensen, 1983). Fama (1980, p. 293), notes
that:
MAJ […] the probability of top management’s collusion and expropriation of security holder wealth
might be lowered, the viability of the board as a market-induced mechanism for low-cost
30,4/5 internal transfer of control might be enhanced, by the inclusion of outside directors.
Independent directors can also provide organizations with wider expertise, prestige and
the contacts required by managers to make important decisions about organizational
resources such as IC (Haniffa and Cooke, 2002). Kroll et al. (2007) argue that outside
354 directors play a diverse range of roles and provide an array of resources – including IC –
that aid in strategy execution.
Although the above discussion based on agency theory appears compelling,
empirical evidence on the proportion of independent directors on the boards of directors
in firms is mixed. Inconsistent with agency theory, Barnhart and Rosenstein (1998), in a
sample of 321 US firms, found that there is a weak positive relationship between the
proportion of outside directors and Tobin’s q (IC) (see also, Rose, 2005). In contrast, Kiel
and Nicholson (2003), in a study of 348 of the largest Australian firms, found that there
is a negative relationship between outside directors and firm performance measured by
Tobin’s q. Kroll et al. (2007, p. 1198) also found that the boards of young firms are best
composed of a majority of original top management team members, rather than
independent outsiders.
In contrast to the above evidence, Ho and Williams (2003) examined 94 Swedish firms
and found a significant positive relationship between board composition and IC. Using
a sample of 1,250 appointment announcements made by 20 US firms, Rosenstein and
Wyatt (1990) also found that the announcement of the appointment of outside directors
results in a positive excess return. Further, in an examination of 1,124 firms in the UK,
Dahya and McConnell (2007) found that firms with outside directors in boards exhibit a
significant improvement in operating performance. Therefore, consistent with the
agency theory and the findings discussed above, the present study constructs the
following hypothesis:
H3. Ceteris paribus, there is a positive association between the proportion of
independent directors and IC efficiency.

2.4 Committee composition

According to the ASX CGPR (2010), the board should establish subcommittees to
adequately discharge its responsibilities and duties. Subcommittees include:
• A nominating committee: To examine selection and appointment practices,
including the appointment of the CEO.
• A remuneration committee: To determine the appropriateness of remuneration
policies.
• An audit committee: To focus on issues relevant to the integrity of financial
reporting (ASX, 2010).

While audit and remuneration committees have legislative and institutional bases
underlying their roles, the nomination committee has no such requirements (Cotter and
Silvester, 2003, p. 213). Thus, the present study focuses only on audit and remuneration
committees[5]. Stock exchanges, including the ASX, recommend that subcommittees
should have a majority of independent outside directors to perform their tasks
effectively. The CGPRs (ASX, 2010, 2014) also note that each subcommittee of the board Intellectual
of a listed entity should have at least three members. capital
Agency theorists note that independent subcommittees play a key role in boards’
decision-making processes (Fama and Jensen, 1983). Independent subcommittees also
efficiency
improve internal control processes and monitoring functions and act as means of
attenuating the agency problem (Vafeas and Theodorou, 1998; Cotter and Silvester,
2003; Cerbioni and Parbonetti, 2007; Jing et al., 2008). Further, independent 355
subcommittees help boards to solve some of the problems associated with the
coordination and communication of board activities (Yermack, 1996). According to
Newman and Mozes (1999), the delegation of corporate governance responsibilities to
subcommittees facilitates the efficient undertaking of board activities and corporate
functions. In essence, the establishment of independent subcommittees ensures that
opportunistic insiders within the organization efficiently use organizational resources
such as IC and make prudent investments in IC to enhance shareholders’ wealth (Keenan
and Aggestam, 2001).
There are limited studies investigating the relationships between the remuneration
committee and firm performance/IC. Cotter and Silvester (2003, p. 214), in a study of 109
large Australian companies, report that “[…] by ensuring that executive remuneration
packages are fair and equitable, independent compensation committees can reduce the
agency cost”. Using firms from the 1992 Fortune 250, Newman and Mozes (1999) found
that the relationship between CEO compensation and firm performance is more
favourable to the CEO (i.e. biased in the CEO’s favour at shareholder expense) among
firms that have insiders on the remuneration committee.
There is a growing body of literature that examines the relationship between the
audit committee and firm performance. Collier (2001), in an examination of 142
UK-based large companies found that 63 per cent of companies use independent audit
committees for the purpose of minimizing agency costs and information asymmetry.
Chan and Li (2008), in a study of Fortune 200 companies, found that the presence of
independent directors on both board and audit committee increases firm value. Using
a sample of Indian companies, Saibaba and Ansari (2013) also found that there is a
positive relationship between the audit committee and the financial performance of a
firm. To summarize, subcommittees composed of a majority of independent outside
directors enhance the effectiveness of the control process over the opportunistic
behaviour of managers and, hence, increase the efficiency of using IC and making
prudent investments in IC. Therefore, based on the agency theory and the findings of
prior studies, the present study proposes the following hypotheses:
H4. Ceteris paribus, there is a positive association between the level of independence
of the audit committee and IC efficiency.
H5. Ceteris paribus, there is a positive association between the level of independence
of the remuneration committee and IC efficiency.

2.5 Corporate governance systems in Australia

A country’s corporate governance systems are designed and implemented to minimize
agency problems (Yoshikawa et al., 2014; Porta et al., 1999). They are influenced by both
national factors such as legal frameworks, the nature of the capital market, business
culture, the political and economic environment on national corporate governance
MAJ mechanisms and international factors such as the growth of global e-commerce, global
30,4/5 corporate groups and international securities markets (Tomasic, 2001).
Corporate governance systems in Australia appear to be very similar to those in the
USA and the UK. In particular, the legal foundation and principles in Australia are
based on the English systems that were transplanted during the colonial era (Kimber
and Lipton, 2005). Australia’s corporate governance systems consist of multiple
356 country-level instruments such as legislation, common law, stock exchange listing rules,
codes of conduct, recommendations and principles. While some of these instruments are
mandatory (e.g. the Corporations Act), others are voluntary (e.g. CGPRs). These
instruments are expected to ensure that the main objective of corporate governance
systems in Australia is achieved, namely, to increase shareholders’ wealth by promoting
the “efficient operation of financial markets” and to “protect minority shareholders from
exploitation by dominant shareholders” (Kimber and Lipton, 2005, p. 184).
As a result of the corporate scandals that have occurred over the past two decades in
Australia (Ansett, OneTel and HIH) and around the world (Enron and WorldCom in the
USA), these instruments were revised or introduced periodically to improve the
effectiveness of corporate governance systems. Of these, the Corporations 2001 Act,
the Listing Rules issued by the ASX and the ASX’s CGPRs seem to play important roles
in corporate governance systems in Australia.
The Australian Securities Exchange, Corporations Act (2001) is the principal
component of legislation in corporate governance systems in Australia. The Act
specifies the obligations of companies regarding disclosures (including the preparation,
audit and lodgement of financial reports) and regulates takeovers and markets. It also
stipulates mandatory minimum standards such as directors’ duties, shareholders’ rights
and default rules for company constitutions. Since its introduction in 1991, the Act has
undergone substantial reforms. For example, the Corporate Law Economic Reform
Program Act 2004 was enacted to modify the Corporations Act 2001. These reforms
were similar to the provisions of the Sarbanes – Oxley Act, which was enacted in July
2002 in the USA, and which seeks to address governance matters such as disclosure and
auditor independence (Robins, 2006; Kimber and Lipton, 2005).
The Listing Rules issued by the ASX supplement the complementary provisions in
the Corporations Act 2001. The ASX Listing Rules govern or relate to the admission of
entities to the official list, the removal of entities from the list, the quotation of securities
and the suspension of securities from quotation. Some ASX Listing Rules mainly
concern the disclosure of corporate governance practices and, therefore, ensure that
market participants are informed about their investment decisions. For example, ASX
Listing Rule 3c (3) (i) in 1995 (this later became Rule 4.10.3), which required listed entities
to include a statement of the main corporate governance practices adopted in annual
reports, was the first legislation to recognize the importance of corporate governance in
Australia. The ASX Listing Rules also require listed entities to disclose information
about the top 20 shareholders in annual reports. Moreover, the ASX amended the Listing
Rules in 2003 to require the top 500 listed entities (based on market capitalization) to
have audit committees. Listed entities are required to comply with the Listing Rules for
admission to the official list. The ASX monitors listed entities on compliance with
Listing Rules and periodically issues feedback notes. These mandatory rules are
enforceable against listed entities by civil action or criminal proceedings.
 The issuing of CGPRs by the ASX Corporate Governance Council in March 2003 also Intellectual
marked a new era in corporate governance systems in Australia. In August 2002, the capital
ASX established the Council to develop a report based on best practices used in
developed markets (Henry, 2008). The report specifies ten principles and 28
efficiency
recommendations on corporate governance practices applicable to listed entities in the
ASX. Following an international review of global developments in corporate
governance after the global financial crisis of 2007-2008, the Council issued the third 357
edition of the report in March 2014. The new report sets out eight central principles and
29 specific recommendations. Although the principles are not legally enforceable
against entities, under Listing Rule 4.10.3, each listed entity is required to include in its
annual report either a corporate governance statement or the URL of the website where
such a statement is located (Australian Securities Exchange, 2014). The corporate
governance statement must disclose the extent to which the entity has adhered to the 29
specific recommendations. It is also worth noting that under the ASX Listing Rules,
some parts included in some recommendations are mandatory for some ASX-listed
entities. For example, entities included in the S&P/ASX 300 index must comply with
Part A of Recommendation 4.1, which is about the structure and disclosure
requirements of an audit committee (Australian Securities Exchange, 2014). In addition
to the Australian Securities Exchange, Corporations Act, 2001, Listing Rules and
CGPRs, the members of professional associations and industry groups need to comply
with their own codes of conduct and guidelines.

3 Research method
3.1 Sample selection
The present study focuses specifically on top service companies in Australia. The
success of service companies is largely dependent on their ability to attract and/or build
and deploy IC (Edvinsson and Malone, 1997). IC in service companies is recognized as
one of the driving forces of Australia’s economy (Guthrie and Petty, 2000). There is also
a growing consensus that service companies are associated with greater future
uncertainty leading to large information asymmetries and, hence, the agency problem
between managers and shareholders (Rueda-Manzanares et al., 2008).
The objective of the present study is to investigate the influence of corporate
governance on the IC of Australian service companies included in the top 200 companies
(as measured by market capitalization) trading on the ASX[6] during the 10-year period
from 2004 to 2013. There are 112 service firms in the top 200 companies. The initial
sample size dropped to 480 firm-year observations (48 firms ⫻ 10 years) following the
exclusion of financial institutions (e.g. banks, insurance and funds)[7], retail and
wholesale companies, real estate and foreign companies[8]. The study also excludes
companies for which the data needed to measure corporate governance and IC variables
is missing. Accordingly, the final sample is 300 firm-year observations (30 firms ⫻ 10
years) for the period 2004 to 2013[9].

3.2 Measurement of corporate governance and control variables

Data related to both corporate governance variables (duality, board composition, board
size and committee composition) and IC were hand-collected from the sample
companies’ annual reports. The analysis of annual reports involves identifying the title
of each director (i.e. executive or non-executive) and the role of each director (i.e.
MAJ membership of a nominating, audit or remuneration committee). CEO duality (DUAL) is
30,4/5 measured by a dummy variable with the value of 1 if there is a duality and 0 otherwise.
Board size (BSIZE) is measured by the total number of members on the board of
directors. Board composition (BCOM) is measured by the proportion of independent
directors on the board of directors. The composition of the audit committee (ACCOM)
and remuneration committee (RCCOM) is measured by the proportion of independent
358 directors on each committee.
Control variables for the study are selected based on previous studies on IC and
corporate governance (Ho and Williams, 2003; Cerbioni and Parbonetti, 2007; Jing et al.,
2008). Large companies are likely to invest more in IC because of increased financial
solvency. Thus, the study uses “size” as a control variable. Log of sales (LnSales) is used
as the measure of size. Firms with high performance might have more incentive to create
and use more IC efficiently; therefore, the study identifies performance as a control
variable and uses return on equity (ROE) as the measure of performance. ROE is
the ratio of net profit to equity capital. Firms are also likely to use debt capital to finance
IC-related investments because lenders interpret IC as a firm’s commitment to the
product market and view it positively (Balakrishnan and Fox, 1993). Thus, the leverage
measured by the ratio of total debt capital to total assets (LEVERAGE) is used as a
control variable. The study also includes both audit committee size (ACSIZE) and
remuneration committee size (RCSIZE) measured by the total number of members in
each committee as control variables. Table I summarizes all variables.

Variable Definition Measurement

Dependent variable
VAIC IC VAIC
Corporate governance (Independent) variables
DUAL Combined role of chairman Dummy variable with the value of 1 if there is a
and CEO duality and 0 otherwise
BSIZE Board size The total number of members of the board of
directors
BCOM Board composition Number of independent directors divided by
total number of directors on board
ACCOM Audit committee composition Number of independent directors divided by
total number of members in the committee
RCCOM Remuneration committee Number of independent directors divided by
composition total number of members in the committee
Control variables
LnSales Firm size Log of sales revenue of financial year
ROE Firm performance Net profit divided by equity capital
LEVERAGE Capital structure Total debt capital as a percentage of total
assets
ACSIZE Audit committee size Total number of members in the audit
Table I. committee
Measurement of RCSIZE Remuneration committee size Total number of members in the remuneration
variables committee
3.3 Measurement of IC Intellectual
The study uses the VAICTM model to measure the IC of sample observations. The capital
VAICTM model was developed (Pulic, 1998, 2000) to measure both the size and efficiency
of IC. It provides an objective, standardized and verifiable measurement of IC based on
efficiency
data collected from audited financial statements (Pulic, 1998, 2000; Firer and Williams,
2003). According to Pulic (1998), the higher the value of the VAICTM of a firm, the greater
the IC associated with the firm’s resources. The model has been widely used as the 359
primary measure of IC in the field of IC (Ho and Williams, 2003; Chen et al., 2005; Laing
et al., 2010)[10]. The VAICTM is the sum of three efficiency measures:
(1) Capital employed efficiency (CEE): This measures the value-added efficiency of
the capital employed.
(2) Human capital efficiency (HCE): This measures the value-added efficiency of
human capital.
(3) Structural capital efficiency (SCE): This measures the value-added efficiency of
structural capital.

Equation (1) below shows the VAICTM relationship algebraically:

VAICTMit ⫽ CEEit ⫹ CHEit ⫹ SCEit (1)

Where:
VAICTMit ⫽ IC coefficient for firm i at year t;
CEEit ⫽ VAit/CEit; CEE for firm i at year t;
HCEit ⫽ VAit/HCit; HCE for firm i at year t;
SCEit ⫽ SCit/VAit; SCE for firm i at year t;
CEit ⫽ book value of the net assets for firm i at year t;
HCit ⫽ total investment salary and wages for firm i at year t;
SCit ⫽ VAit – HCit; structural capital for firm i at year t; and
VAit ⫽ the value added by the resources of firm i at year t. VA can be calculated
using equation (2):

VAit ⫽ Iit ⫹ DPit ⫹ Dit ⫹ Tit ⫹ Mit ⫹ Rit (2)

Where:
Iit ⫽ interest expenses of firm i at year t;
DPit ⫽ depreciation expenses of firm i at year t;
Dit ⫽ dividends of firm i at year t;
Tit ⫽ corporate taxes of firm i at year t;
Mit ⫽ equity of minority shareholders in net income of subsidiaries of firm i at year t; and
Rit ⫽ profits retained of firm i at year t.

4. Empirical analysis and results

Endogeneity has become an issue in studies on corporate governance. Endogeneity is an
issue when some of the outcome variables (dependent variables) of a study, such as firm
MAJ performance, firm valuation and IC, drive corporate governance systems rather than
30,4/5 corporate governance systems driving outcome variables. In this study, for example,
dissatisfied shareholders may put pressure on the board to appoint more independent
directors as a result of inefficient IC management. Lehn et al. (2007) note that the firm’s value
(proxied by market-to-book value ratio) shapes the governance structure. When endogeneity
exists, standard OLS regression may provide inconsistent parameters, although many
360 studies note that the problem can be solved by using fixed-effects regression analysis for
panel data. For example, Henry (2008) used a firm-specific fixed effects regression model for
panel data to control for the endogeneity problem (see also Villalonga and Amit, 2006). Thus,
to test the hypotheses in this paper, a fixed-effects regression method in a panel data set by
pooling firms across 10 years is used. Using the variables identified in the previous section,
the study develops the following regression model:

VAICTM ⫽ ␤0 ⫹ ␤1DUALit ⫹ ␤2BSIZEit ⫹ ␤3BCOMit ⫹ ␤4ACCOMit

⫹ ␤5RCCOMit ⫹ ␤6LnSalesit ⫹ ␤7ROEit ⫹ ␤8LEVERAGEit
⫹ ␤9ACSIZEit ⫹ ␤10RCSIZEit ⫹ ␧it,

Where ␤ and ␧ represent the parameters and error term, respectively. Other variables
are as explained in the previous section.

4.1 Correlation and descriptive analysis

To identify potential multicollinearity problems, Pearson correlation coefficients
between independent variables were computed and reviewed. Table II presents the
matrix of Pearson correlation coefficients and reveals that the correlations of
independent variables are all below 0.507. Thus, the Pearson correlations suggest that
multicollinearity is not a problem (Haniffa and Cooke, 2002)[11].
Table III presents the summary of descriptive statistics for the dependent and
independent variables used to test the hypotheses developed in the study. It also
provides the time trend of the mean, minimum and maximum values of the variables.
The mean of the VAICTM for sample companies is 2.94, although it changes slightly over
the period 2004 to 2013. This indicates that the top service firms in Australia have used
IC efficiently. This finding is consistent with previous studies on IC in Australian
service firms. For example, Laing et al. (2010) find that VAIC in the Australian hotel
industry has grown from 2.21 in 2004 to 2.90 in 2007. Firms with CEO duality account
for just 27 per cent (81 instances) of the sample firm-year observations where the CEO
also serves as the chairperson of the board of directors. The mean of CEO duality was 41
per cent during the period 2004 to 2006 but dropped to 27 per cent during the period 2007
to 2013. The time trends indicate a decline in average instances of CEO duality. This
finding also suggests that the majority of top service firms are consistent with the
CGPRs issued by the ASX (2010). Previous studies on corporate governance also find
that the CEO’s role is separated from that of the board chairperson in most firms in
Australia. In an examination of the 116 largest Australian firms, for example, Henry
(2008) found that the CEO is also the board chairperson in fewer than 20 per cent of
firms. The average board size (BSIZE) of the sample firms is relatively small, containing
a mean of approximately 8 members with a range of 4 to 14. Average board size is also
relatively stable over the period 2004 to 2013. This finding is consistent with previous
 Corporate governance variables (N ⫽ 300)a Control variables (N ⫽ 300)
Variables DUAL BSIZE SqBCOM ACCOM RCCOM LnSales ROE LEVERAGE ACSIZE RCSIZE

DUAL 1.000
BSIZE ⫺0.024 1.000
BCOM 0.030 0.104 1.000
ACCOM 0.016 0.097 0.205** 1.000
RCCOM 0.061 0.032 0.081 0.507** 1.000
LnSales ⫺0.169** 0.452** ⫺0.013 0.002 ⫺0.098 1.000
ROE 0.026 ⫺0.143* 0.029 ⫺0.014 0.031 ⫺0.074 1.000
LEVERAGE ⫺0.144* 0.266** 0.010 ⫺0.051 ⫺0.030 0.333** 0.174** 1.000
ACSIZE ⫺0.135* 0.414** 0.158** 0.180** 0.092 0.444** 0.018 0.173** 1.000
RCSIZE ⫺0.209** 0.339** 0.056 0.004 ⫺0.289** 0.239** ⫺0.040 0.112 0.354** 1.000

Notes: ** , * significant at the 0.05 and 0.1 levels, respectively; a N ⫽ number of firm-year observations

Table II.
361

coefficients
efficiency
capital

Pearson correlation
Intellectual
 362
MAJ
30,4/5

Panel data
Table III.

descriptive statistics
From 2004 to 2013 From 2004 to 2006 From 2007 to 2010 From 2010 to 2013
(N ⫽ 300) (N ⫽ 90) (N ⫽ 120) (N ⫽ 90)
Variables Mean Minimum Maximum Mean Minimum Maximum Mean Minimum Maximum Mean Minimum Maximum

VAIC 2.94 ⫺9.42 11.33 3.06 ⫺6.36 9.45 3.41 ⫺6.19 11.33 2.18 ⫺9.42 10.29
DUAL 0.27 0.00 1.00 0.41 0.00 1.00 0.27 0.00 1.00 0.14 0.00 1.00
BSIZE 7.57 4.00 14.00 7.38 4.00 13.00 7.63 4.00 14.00 7.67 4.00 12.00
BCOM 0.79 0.00 1.00 0.78 0.25 0.92 0.82 0.38 1.00 0.78 0.32 1.00
ACCOM 1.00 0.50 1.00 0.99 0.50 1.00 1.00 1.00 1.00 1.00 1.00 1.00
RCCOM 0.97 0.25 1.00 0.96 0.25 1.00 0.96 0.63 1.00 0.99 0.75 1.00
LnSales 13.66 8.20 17.07 13.23 8.20 16.94 13.75 9.90 17.05 13.98 11.64 17.07
ROE 18.42 ⫺91.00 130.00 20.70 ⫺44.55 70.36 21.54 ⫺90.91 129.98 11.98 ⫺87.76 58.82
LEVERAGE 36.02 0.00 85.00 35.74 0.00 83.55 38.46 0.00 85.46 33.03 0.00 60.22
ACSIZE 3.72 1.00 7.00 3.47 1.00 6.00 3.73 2.00 7.00 3.94 3.00 7.00
RCSIZE 3.67 1.00 11.00 3.52 1.00 11.00 3.55 1.00 11.00 3.98 2.00 8.00
findings in Australia. For example, Kang et al. (2007) found that 39 of the 100 top Intellectual
Australian firms have a board size of eight or nine directors (see also Henry, 2008). capital
Turning to board composition (BCOM), it is interesting to note that independent outside
directors represent the majority on boards, with average representation being 80 per cent. In
efficiency
a similar study, Kang et al. (2007) found that the boards of 83 out of 100 sample firms have a
majority of independent directors. While there is no evidence for fully internal boards, only
9 of the 300 firm-year observations have fully external boards. The time trend does not 363
indicate a change in board composition over the period. Focusing on subcommittees, the
mean proportions of independent directors on audit (ACCOM) and remuneration (RCCOM)
committees are 100 and 97 per cent, respectively. This suggests that the majority of both
audit and remuneration committees of top Australian service firms contain independent
rather than executive directors. With regard to the time trend of audit committees, while
there were some firms with audit committees with non-independent directors during the
period 2004 to 2006, all companies in the sample had 100 per cent independent audit
committees from 2007 to 2013. The findings of the time trends analysis on the independent
variables are consistent with previous studies on corporate governance in Australia (Henry,
2008; Christensen et al., 2010). As discussed in Section 2.5, the global developments in
corporate governance after the global financial crisis of 2007-2008 partially explains the time
trends of the independent variables.

4.2 Regression results

Table IV presents the results of the pooled firms across 10 years using a fixed-effect
regression model, linking IC and corporate governance mechanisms. The F value of the

Unstandardized
coefficients
B Std. error t p value

Intercept ⫺6.349 4.627 ⫺1.417 0.158

Corporate governance variables
DUAL 4.341 2.006 2.165 0.031**
BSIZE 0.600 0.106 1.068 0.287
BCOM 2.622 0.882 2.975 0.003***
ACCOM ⫺0.707 0.259 ⫺0.166 0.868
RCCOM 0.765 0.074 0.439 0.061*
Control variables
LnSales 0.013 0.216 0.148 0.883
ROE 0.044 0.006 7.289 0.000***
LEVERAGE 0.037 0.011 3.423 0.001***
ACSIZE ⫺0.190 0.161 ⫺1.070 0.286
RCSIZE 0.047 0.125 0.063 0.950
Adjusted R2 0.391
F value 12.056 Table IV.
P value 000 Panel data fixed-
N 300 firm-year observations effect regression
results: dependent
Note: *** , ** , * significant at the 0.01, 0.05 and 0.1 levels, respectively variable – VAIC
MAJ model is statistically significant at the 1 per cent level with an adjusted R 2 of 39.1 per
30,4/5 cent. Regarding corporate governance variables, unlike agency theory, CEO duality
(DUAL) has a positive and significant (p ⬍ 0.05) impact on IC. This finding suggests that
firms use IC efficiently and make prudent investments in IC when the two roles of chair
and CEO are not separated. The finding is also in line with a number of previous studies
in Australia (Christensen et al., 2010) and countries such as the USA (Boyd, 1995;
364 Elsayed, 2007). For example, Christensen et al. (2010), in a study of 1,039 Australian
firms, found that duality is positively significant for market-based measure (proxied by
Tobin’s q). This suggests that an individual who possesses a concentration of power is
motivated to add value to the firm by efficiently using IC[12].
Board size (BSIZE) shows a positive association with IC efficiency. However, consistent
with some previous studies in Australia (Henry, 2008), there is no significant evidence to
conclude that board size affects IC efficiency positively[13]. Thus, H2 is rejected. Board
composition (BCOM) is significantly positively associated with IC efficiency (p ⬍ 0.01). This
finding is consistent with agency theory and supports H3 that there is a positive association
between the proportion of independent directors and IC efficiency. This significant positive
result is also consistent with previous studies in Australia (Henry, 2008) and some other
countries (Ho and Williams, 2003; Dahya and McConnell, 2007). As previously discussed, the
significant positive result suggests that boards with a majority of independent directors are
more likely to minimize top management’s exploitation of shareholders’ wealth and use IC
efficiently to add value to their firms. It is also likely that the boards with a majority of
independent directors contribute to the significant positive relationship between CEO
duality and IC efficiency (H1) by effectively managing and monitoring CEO’s behaviour to
enhance the IC efficiency.
Consistent with H5 and previous studies (Cotter and Silvester, 2003; Newman and
Mozes, 1999), the coefficient on remuneration committee composition (RCCOM) is
significant and positive (p ⬍ 0.1). As previously discussed, the interpretation of this
result is that the independent directors on the remuneration committee ensure that
executive remuneration packages are fair and equitable; hence, sufficient funds are
available to acquire IC. However, audit committee composition (ACCOM) is not found to
influence IC in top service firms in Australia. Thus, H4 is rejected. One reason may be
that the variation in the audit committee composition across firm-years is not
substantial. It is also likely that independent outside directors in the audit committee are
not necessarily independent (Jing et al., 2008). In this vein, Ezzamel and Watson (1997)
note that the conflicting management and control roles of independent outside directors
explain their potential failure to apply proper governance in firms.
In respect of control variables, ROE and leverage are significant at 1 per cent. These
findings are in line with the argument of previous studies that firms with improved
performance are likely to invest in IC to create, leverage and maintain the value of the
firm (Keenan and Aggestam, 2001). No evidence is found, however, to suggest that any
of the other control variables such as firm size (LnSales), audit committee size (ACSIZE)
and remuneration committee size (RCSIZE) have a significant influence on IC
development in top service firms in Australia[14].

4.3 Additional analysis

The VAICTM model used in the above analysis is partially based on the Skandia
Navigator model. Many studies based on the Skandia Navigator model (see Edvinsson
and Malone, 1997) categorize IC into human capital and structural capital. The Skandia Intellectual
Navigator model does not identify “capital employed” (which is an element of the capital
VAICTM) as an element of IC. Ståhle et al., (2011), in an analysis of each component of
VAIC, also found that there is a weak correlation between CEE and the value added to
efficiency
firms (measured by market-to-book value ratio). Thus, as an additional analysis,
drawing on the Skandia Navigator model, the present study measures IC efficiency
based on two elements of the model: 365
(1) HCE; and
(2) SCE.

As discussed in Section 2.5, the equation below shows the IC efficiency based on HCE
and SCE:
ICEit ⫽ HCEit ⫹ SCEit; IC coefficient for firm i at year t;
HCEit ⫽ VAit/HCit; HCE for firm i at year t; and
SCEit ⫽ SCit/VAit; SCE for firm i at year t.
Based on the IC coefficient (ICEit) and the variables identified in the previous section, the
study develops the following regression model:

ICEit ⫽ ␤0 ⫹ ␤1DUALit ⫹ ␤2BSIZEit ⫹ ␤3BCOMit ⫹ ␤4ACCOMit

⫹ ␤5RCCOMit ⫹ ␤6LnSalesit ⫹ ␤7ROEit ⫹ ␤8LEVERAGEit ⫹ ␤9ACSIZEit
⫹ ␤10RCSIZEit ⫹ ␧it

As shown in Table V, an additional analysis is performed using the panel data

fixed-effect regression including a dummy variable for firm. The results remain
consistent with those reported in Table IV. CEO duality and board composition
significantly influence IC efficiency in Australian service firms. Firm performance
(ROE) and leverage are also significant variables and are consistent with the main
model.

5. Summary and concluding remarks

This study examines the influence of corporate governance mechanisms on IC
efficiency. Drawing on the agency theory and previous studies on corporate governance,
the study hypothesizes the relationships between corporate governance mechanisms
such as CEO duality, board size, board composition and the composition of
subcommittees (audit and remuneration). Using data collected from 300 firm-year
observations in top service firms in Australia, the study finds that CEO duality, board
composition and remuneration committee composition significantly influence IC
efficiency in the service firms. However, there is no evidence to support the proposition
that board size and audit committee composition influence IC. Overall, these findings are
in line with Keenan and Aggestam (2001) and Dittmar and Mahrt-Smith’s (2007)
argument that the responsibility for prudent development and the efficient use of IC
resides with the corporate governance mechanisms of firms.
Agency theory, used as the framework for the study, supports the corporate
governance principles and recommendations issued by the ASX in Australia. However,
MAJ Unstandardized
30,4/5 coefficients
B Std. error t p value

Intercept ⫺2.195 4.627 ⫺0.462 0.644

Corporate governance variables
366 DUAL 4.341 2.088 2.080 0.039**
BSIZE 0.621 0.206 1.097 0.274
BCOM 1.998 0.918 2.178 0.030**
ACCOM ⫺1.721 4.453 ⫺0.386 0.700
RCCOM 0.176 1.929 0.091 0.093*
Control variables
LnSales ⫺0.141 0.225 ⫺0.626 0.532
ROE 0.024 0.006 3.863 0.000***
LEVERAGE 0.027 0.011 2.442 0.016**
ACSIZE ⫺0.094 0.168 ⫺0.561 0.576
RCSIZE 0.008 0.130 0.061 0.951
Adjusted R2 0.351
F value 13.012
Table V. P value 0.000
Panel data fixed- N 300 firm-year
effect regression observations
results: dependent
variable – ICE Note: *** , ** , * significant at the 0.01, 0.05 and 0.1 levels, respectively

agency theory may not fully explain corporate governance mechanisms in some
organizational settings. As described above, the findings for H3 (board composition)
and H5 (remuneration committee composition) are significant and support the agency
view, while the findings for H1 (CEO duality) are significant and against the theory.
Similarly, the findings for H1 are not consistent with the CGPRs issued by the ASX
Corporate Governance Council, which recommend that the role of chairperson should be
separated from the CEO role. This suggests that while agency theory largely explains
corporate governance mechanisms in the services sector, the effectiveness of each
governance mechanism is also dependent on other factors such as individual and
institutional characteristics, country-level corporate governance systems (corporate law
and listing rules – see Section 2.5) and capital market operations. Thus, shareholders
and directors should be encouraged to consider the above factors in designing corporate
governance systems to find an appropriate balance between monitoring and IC
efficiency.
This study has a number of limitations that might benefit from further research.
First, the study focuses only on top service firms in Australia. However, each service
sector seems to be influenced by sector-specific cultural, business, economic, political
and legal factors, and the influence of corporate governance (e.g. information
technology, professional and commerce) on the IC of each sector can be different (Haniffa
and Cooke, 2002; Vafeas and Theodorou, 1998; Weimer and Pape, 1999). Thus, it would
be of interest for future research to separately examine the relationships between
corporate governance mechanisms and IC in each business sector. Second, the study
uses data collected from corporate annual reports. Future researchers may consider Intellectual
using other methods of data collection to examine the relationship between corporate capital
governance mechanisms and IC (e.g. interviews and surveys). Finally, the study uses the
VAICTM as a proxy for IC. The measurement of IC is a complex matter and is still a
efficiency
much-debated issue in the IC literature (Guthrie, 2001). Further research is needed in this
area to identify a model that can correctly measure IC in firms.
367
Notes
1. Recently, some studies have argued that while IC is associated with wealth creation, the
concept of intellectual liabilities such as the depreciation of IC and risk or non-monitory
obligations of IC has the potential to destroy wealth (De Santis and Giuliani, 2013).
2. This study does not intend to provide an overview of the difference classifications of IC.
3. According to the balanced scorecard by Kaplan and Norton (1992), IC consists of internal
process perspective, customer perspective and learning and growth perspective.
4. M/B is calculated by dividing the market value of the firm by its book value. Tobin’s q
measures the relationship between the market value of the firm and the replacement value of
its assets. VAICTM is described in the research method section of the paper.
5. The annual reports of some firms in the sample do not provide information on nominating
committees.
6. ASX 200 companies have been identified, as of 2012.
7. Financial institutions’ recorded assets represent funds received from depositors.
8. Foreign companies are likely to be influenced by different corporate governance practices.
9. Although the study’s sample may suffer from survivorship bias, the effect is minimal because
this study does not directly measure the performance of sample firms.
10. Owing to the difficulty of measuring IC, there are very limited alternative methods for
measuring IC (Petty and Guthrie, 2000; Bontis, 1998). In a study on VAIC, Ho and Williams
(2003, p. 478) note that other alternative “measures of IC have been criticized due to
subjectivity in measurement and difficulty in verification”. In contrast, other studies have
criticized VAIC for not measuring IC correctly. For example, Ståhle et al., (2011, p. 537) argue
that “VAIC parameters have nothing to do with intellectual capital. They merely indicate the
efficiency of the labour and capital that the company invests”. Dumay (2014) also argues that
VAIC methodology is part of the second stage IC research and calls for the third-stage IC
research which focuses more on practice-based IC research. Further, Andriessen (2004), in an
examination of different IC measures, also notes that there is no correct IC value measurement
method for improving external reporting.
11. Multicollinearity becomes a serious problem where correlation values exceed 0.8 (Haniffa and
Cooke, 2002).
12. This finding is also consistent with the stewardship theory, which describes executive
managers want to perform well rather than act opportunistically (Donaldson and Davis,
1991).
13. As an additional analysis, the regression model has been rerun with squared term of board
size to examine the possibility of a non-linear relationship between IC efficiency and board
size. However, no evidence is found to support the non-linear relationship.
MAJ 14. Lagged relationship has also been tested based on 270 firm-year observations (nine years ⫻
30,4/5 30 firms). However, the results do not support any of the hypotheses developed in this study.

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Further reading
Nazari, J.A. and Herremans, I.M. (2007), “Extended VAIC model: measuring intellectual capital
components”, Journal of Intellectual Capital, Vol. 8 No. 4, pp. 595-609.

Corresponding author
Ranjith Appuhami can be contacted at: ranjith.bala-appuhamilage@mq.edu.au

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