Governance indices: An Australian perspective

Abstract

This study develops a weighted internal governance index as a comprehensive proxy of good governance in Australia. We identify those variables empirically found to be associated with good governance and include them in a principal component analysis to calculate the index. We apply Principal Component Analysis to examine the internal governance of a sample of 450 listed Australian companies for the period 1999 – 2006. Results indicate that there are two key facets to internal governance in Australia: Board Activity and Board Independence. They in turn incorporate eight specific governance factors which are included in the index on a weighted basis. This approach contributes to the literature by overcoming a number of limitations of previous governance measures and is the first internal governance index to be developed. A similar approach could be employed in other countries to overcome difficulties with previous index efforts and to provide a more comprehensive measure of firm level (internal) governance. The findings of this study have many implications: for firms, there is now a straight forward basis on which to compare their governance standards with those of competitors as well as against prior years. For investors, they can now easily identify which firms are better governed and incorporate this factor in the share selection process as well as lobby for further improvements.