Pacific-Basin Finance Journal 13 (2005) 29 52

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Agency costs and ownership structure in Australia

Grant Fleming a, Richard Heaney b,*, Rochelle McCosker a
b

a
School of Finance and Applied Statistics, ANU, Canberra, ACT 0200, Australia
School of Economics and Finance, RMIT Business, RMIT University, 12/239 Bourke Street, Melbourne,
Victoria 3000, Australia

Received 19 May 2003; accepted 19 April 2004

Available online 4 July 2004

Abstract
Financial economics often assumes that equity agency costs increase with the separation of
ownership and control. This paper tests this relationship using a survey sample of approximately
3800 Australian small and medium enterprises for 1996 1997 and 1997 1998. Following Ang et al.
[J. Finance 55 (2000) 81], we estimate a zero equity agency cost benchmark (in terms of operating
expenses and asset utilization ratios) for the 100% owner-manager firm. We then examine how
agency costs change when ownership and control are separated. We report a positive relationship
between equity agency costs and the separation of ownership and control.
D 2004 Elsevier B.V. All rights reserved.
JEL classification: G32
Keywords: Equity agency costs; Small to medium enterprises (SMEs); Owner managers; Separation of control
and ownership

1. Introduction
Equity agency costs are zero in a 100% owner-managed firm. As the firms ownership
structure changes and ownership is separated from control, incentive alignment problems
become more important. Much of the literature since Jensen and Meckling (1976) focuses
on the effect of equity agency costs on financial decisions, governance decisions,
ownership structure decisions and firm value. One limitation with these studies, however,
is that the magnitude of agency costs is rarely discussed.

* Corresponding author. Tel.: +61-3-9925-5905; fax: +61-3-9925-5986.

E-mail address: Richard.Heaney@rmit.edu.au (R. Heaney).
0927-538X/$ - see front matter D 2004 Elsevier B.V. All rights reserved.
doi:10.1016/j.pacfin.2004.04.001

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G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

This paper replicates and extends the agency cost analysis of Ang et al. (2000) using a
unique Australian small and medium size enterprise (SMEs) data set. SMEs are chosen
because this group of firms includes 100% owner-managed firms, the base case zero
equity agency cost firm, as well as firms with varying levels of separation between
ownership and management. SMEs are also of interest because of their importance to most
economies. While SMEs occupy a central place in the Australian economy, accounting for
99.8% of Australias private sector and employing approximately 65.3% of private sector
employees (Australian Bureau of Statistics, 2002a) they also occupy an important place in
the Organisation for Economic Cooperation and Development (OECD) countries generally, constituting approximately 95% of all enterprises and account for around 60 70% of
employment in the countries.
This study is based on the Business Longitudinal Survey (BLS) conducted by the
Australian Bureau of Statistics, which provides a rich source of data for analysis of the
importance of agency costs. The Australian environment has received little attention and,
due to nation-specific factors, agency impacts in Australia may differ from the United States
(Craswell et al., 1997). Thus, replication of the Ang et al. (2000) analysis is important
because across countries, differences in product and factor markets, political, legal and
regulatory frameworks, as well as internal control systems may influence the agency costs
arising from separation of ownership and control (Jensen, 1993). While replicating the basic
results reported in Ang et al. (2000), we also extend this work to include a more
comprehensive set of equity holder variables and a broader set of control variables. The
finer partitioning of the nonmanager SME equity holders provides further support for the
argument that equity agency costs increase as outsiders take on a greater share of the firms
equity. We also repeat the analysis for 2 years, 1996 1997 and 1997 1998 in order to
provide some insight into the stability of the observed agency cost relationship over time.
Our results appear stable over the 2-year period selected for this study and tend to support
the US-based Ang et al. (2000) findings. We structure our analysis in the paper as follows.
Section 2 provides a review of the literature. Section 3 describes the data and the results of
analysis are presented in Section 4 with summary and discussion in Section 5.

2. Literature review
Considerable research focuses on agency costs as a determinant of corporate contracting
and financial decision making, including capital (or ownership) structure, dividend policy,
executive compensation and accounting policy choice.1 Agency theory brings to the
forefront of empirical and theoretical research the role of a variety of internal and external
monitoring and bonding mechanisms, providing an explanation for the existence of many
common corporate characteristics such as debt covenants, management incentive plans and
public audits.2 The theories of Coase (1937), Williamson (1971, 1985), Alchian and
Demsetz (1972), Alchian and Woodward (1987) and Jensen and Meckling (1976) have
1
See, e.g., La Porta et al. (2000) and Dewenter and Warther (1998) regarding dividend policy; Core et al.
(1999) regarding executive compensation; and Watts and Zimmerman (1990) for accounting policy choices.
2
See, for instance, Williams (1987), Shleifer and Vishny (1997) and Agrawal and Knoeber (1996).

G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

31

led to the development of the concept of the firm as a nexus of contracts between many
stakeholders, including equity holders, debt holders, employees and other parties. Although
pooling of the resources of a large number of investors facilitates the creation of larger
enterprises with the associated benefits of greater scale of production and the minimisation
of transaction and contracting costs, the spread of investors can result in more complex
corporate structures as well as the separation of ownership and control. The equity agency
costs that arise from this separation are the focus of this paper.
The agency relationship existing between the owners of the firm and the managers of
the firm give rise to agency costs because the manager may not act in the owners best
interests (Milgrom and Roberts, 1992). Self-motivated management behaviour includes
direct expropriation of funds by the manager, consumption of excessive perquisites,
shirking and suboptimal investment. This behaviour can be controlled through monitoring
and bonding, although in equilibrium there are inevitably residual agency costs. The actual
magnitude and impact of this self seeking behaviour varies across firms depending on
factors such as the nature of monitoring and bonding contracts, the managers taste for
nonpecuniary benefits and the cost of replacing the manager (Jensen and Meckling, 1976;
Shleifer and Vishny, 1989).3
Ang et al. (2000) provide one of the first attempts to measure the magnitude of agency
costs. They focus on the question of whether there is a difference, in the cost of running a
firm and in the utilisation of its assets, between a firm facing zero equity agency costs
(owner-managed) and firms where ownership and management are separated. For the
owner-manager firm, there is no separation of ownership and control and the equity holders
and managers interests are completely aligned. This is why we say that the owner-managed
firm provides the base case for equity agency costs comparisons. As owner-manager equity
ownership falls below 100%, the manager has a reduced residual claim on the firm. Under
relatively dispersed equity ownership, the manager has a greater incentive for shirking or the
consumption of excessive perquisites. This is because although the firms value falls by the
full amount of management nonpecuniary consumption or shirking, the manager only bears
a proportion of the expenses related to their ownership stake. A lower managerial equity
holding means that they have a decreased incentive to exert effort in their job and seek out
profitable investments. Thus, the agency costs attributable to the divergence of interests of
managers and owners should vary inversely with the managers ownership stake (Jensen and
Meckling, 1976).
There are several ownership and managerial structures that may mitigate agency costs.
One approach is to employ those with a special relationship with the owner, such as family
members and business associates (Fama and Jensen, 1983a). This is particularly the case in
small firms where the benefits of unrestricted risk sharing and specialisation of management could be less than the costs of controlling the agency problems that arise in these
firms. This substitutes for costly control mechanisms by reducing conflicts of interest
between the manager and the owner (Fama and Jensen, 1983a).
Other stakeholders may also provide management monitoring and thus reduce the
magnitude of equity agency costs. These include concentrated equity holders, banks and
3
If the manager has specific skills for the firm, and has entrenched herself, she may be costly to replace
(Shleifer and Vishny, 1989).

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G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

venture capital providers. Concentrated equity holders could control equity agency costs
due to the incentives that such equity holders have to monitor manager behaviour
(Craswell et al., 1997; Shleifer and Vishny, 1997; Huddart, 1993; Zeckhauser and Pound,
1990). Of course concentrated equity holding may bring with it a separate set of problems
(Demsetz and Lehn, 1985; Demsetz, 1983; Shleifer and Vishny, 1997).
Founding families are the most prevalent form of concentrated ownership found in SME
firms, and in developed countries family businesses account for a significant share of the
economy (Bhattacharya and Ravikumar, 2001).4 Fama and Jensen (1983a) argue that family
relationships among the owner-managers reduce the agency costs associated with separation
of decision control and residual claims. Families are likely to have a committed, undiversified stake in the firm and strong incentives to monitor (see also Anderson et al., 2002;
Bhattacharya and Ravikumar, 2001). The existence of a family presence over successive
generations also enables personal and well-informed relationships to be sustained with
parties external to the firm, such as banks (Anderson et al., 2002). This may lead to other
benefits for the firm, such as a reduced cost of financing. There are limits, however, to the
effectiveness of family ties in reducing equity agency costs. For example, Ang et al. (2000)
suggest that older firms with larger families in Anglo-Saxon economic systems have more
dispersed ownership and as a result monitoring by a sole owner is expected to be more
effective than monitoring by large families. This is because the interests of family members
may not always be aligned in these firms. Concerns also arise as to the ability and inclination
of families to expropriate wealth from other stakeholders of the firm, due to the power and
influence they hold. However, because firm survival is an important concern for families,
they are likely to be more concerned with firm value maximisation than other large equity
holders (Anderson et al., 2002).
Other concentrated equity holders include employees and parent companies. These
groups have varying levels of access to information about the firm and this will affect their
monitoring and bonding ability. While employee equity holders may behave somewhat
like family in their ability to monitor management, the situation for parent company equity
holders is more difficult. Although tight links might be expected to exist between a parent
company and its subsidiary, this is not necessarily the case because subsidiaries are often
small. While these firms remain profitable, they may not attract much parent company
attention. In this situation, there is considerable scope for SME management to engage in
perquisite consumption or make suboptimal investment. This is a situation where agency
costs would be expected to be high as the manager of the SME is not the owner.
Furthermore, parent companies by their nature have substantial control over subsidiaries
and so may be in a position to expropriate wealth from the other equity holders where the
subsidiary is not 100% owned.
Debt finance provides an alternative and/or complementary control mechanism to
managerial equity ownership and family ownership for reducing the equity agency costs of
a firm (Agrawal and Knoeber, 1996; Seetharaman et al., 2001). The benefits of debt
4
Difficulties often arise in defining a family business. Suggested definitions of a family business include a
business that is predominantly owned and run by a single household (Bhattacharya and Ravikumar, 2001, p. 187).
Other studies define family control by ownership percentage, such as Ang et al. (2000) who suggest that agency
costs are lower in firms with more than 50% of their equity controlled by families.

G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

33

financing are at least threefold. First, debt financing along with other external financing
can induce monitoring by lenders (Agrawal and Knoeber, 1996). Second, debt may
directly reduce agency costs by reducing free cash flow available for expropriation or
investment in negative net present value projects (Jensen, 1986). Third, compared to the
alternative of issuing new equity, the issue of debt increases the managers equity holding
as a proportion of equity financing, further enhancing alignment of interests. In Australia,
banks generally provide financing to SMEs and these financial intermediaries have been
shown to play a more direct role in the management of the firm compared to other capital
providers. They develop a detailed knowledge of the firms they finance and they may
provide funds to businesses that other capital providers neglect. Venture capital providers
also provide finance to SMEs and they also provide monitoring in order to limit the
opportunistic behaviour of the firms they fund (Lerner, 1995). Most theories on financial
intermediation emphasise the monitoring roles that these intermediaries undertake through
gathering information on the firms they finance.
The nature of the firm as a nexus of contracts gives rise to the separation of ownership
and control and consequently agency costs. The agency costs of equity are argued to arise
from the direct expropriation of funds by the manager, consumption of excessive
perquisites, shirking, suboptimal investment and entrenching activities. Furthermore, it
is argued that the magnitude of these costs varies across firms depending on the ownership
structure and control mechanisms employed. Theory suggests that agency problems may
be mitigated, through greater managerial equity ownership or through monitoring by large
equity holders, including family members, and external financiers. Surprisingly, there is
little evidence of the magnitude of equity agency costs in the literature and this paper
contributes to the literature by measuring agency costs associated with differing ownership
structures in Australia.

3. Data
The data used in this study is drawn from a unique data set, the Business Longitudinal
Survey (BLS) conducted by the Australian Bureau of Statistics (ABS). This survey draws
on a subset of the 1994 1995, 1995 1996, 1996 1997 and 1997 1998 Business Growth
and Performance Surveys (Australian Bureau of Statistics, 2000), although we focus on
the years ending 1996 1997 and 1997 1998 due to the larger sample size and richer data
evident in these years. The BLS covers SMEs with 200 or fewer employees, and it
accounts for about 75% of the private sector nonagricultural workforce employed during
the survey period (Australian Bureau of Statistics, 2000).
There are a number of variables drawn from the survey. Table 1 provides a summary
of the variables along with definitions. Following Ang et al. (2000), we focus on two
ratios in the analysis of equity agency costs. The first ratio is discretionary expenses-tosales. Comparison of the expense-to-sales ratio for a 100% owner-managed firm with
that of a firm with varying levels of separation between ownership and control provides
a standardised measure of the magnitude of equity agency costs. This indicates how
effectively the firms management controls operating expenses and it tends to capture the
impact of agency costs such as excessive perquisite consumption. Discretionary

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G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

Table 1
Variable definition
Variable name
Agency costs
opexpsa

lnopexsa
salass
lnsalass
Ownership
shdrmgr
eqhwown
eqhnwf
eqhnwn
wown100
wown50
family50

eqhpar
Control variables
eqhven
bkdbtass
roa
rdsales
lnsales
Industry dummy variables

Age variables

Definition
The ratio of discretionary expenses-to-sales. Discretionary expenses consists of
all other operating expenses. This excludes corporate wages, salaries and other
labour related items, interest expense, rent, leasing and hiring expenses,
purchases, depreciation and bad debts written off (%).
Natural log of opexpsa
The ratio of sales to total assets (%)
Natural log of salass

Dummy variable that takes the value of 1 if a firm is managed by a equity

holder and 0 otherwise.
Equity holding of working owner (%)
Equity holding of nonworking owner, part of controlling family (%)
Equity holding of nonworking owner, not part of controlling family (%)
Dummy variable that takes the value of 1 if the working owner holds 100%
of the firms equity and 0 otherwise.
Dummy variable taking the value of 1 when the working owner holds greater
than 50% of the firms equity and 0 otherwise.
Dummy variable with a value 1 when family equity holding is greater than
50%, and 0 otherwise following the definition of a controlling family used in
Ang et al. (2000)
Parent firm equity holding (%)

Venture or development capital provider equity holding (%)

Total bank debt divided by total assets (%)
Return on assets (%)
R&D expenditure to sales (%)
Natural log of sales
Ten two-digit ANZSIC industry dummy variables as per Table 3 with a value
of 1 for the firms in the industry and 0 otherwise. We exclude the retail trade
industry (industry code 500).
Fifteen dummy variables with value of 1 for firms in the age category and 0
otherwise as per Table 4. We exclude the last category, 30 or more years old
(category 16).

expenses consist of all other operating expenses. This variable excludes corporate wages,
salaries and other labour-related items, interest expense, rent, leasing and hiring
expenses, purchases, depreciation and bad debts written off. Wages and salaries are
excluded as it is often impossible to track true labour costs in a family business using
accounting information.
The second ratio used is the asset utilisation ratio. This ratio is chosen to proxy for the
loss in revenue per dollar of investment that may be attributable to inefficient asset use.
This can result from poor investment decisions such as investment in negative net-presentvalue projects, failure to use assets productively or consumption of perquisites. It may also
be the result of management shirking, or exerting insufficient effort.

G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

35

The expenses-to-sales and asset utilisation ratios are critical to our analysis. Therefore, we
applied a series of checks and filters on the data which reduced the available sample from a
maximum of approximately 5500 surveyed firms to the final samples of 3820 firms for
1996 1997 and 3793 firms for 1997 1998. Firms that ceased operating during the year and
firms with zero values for sales, assets or total operating expenses are excluded from the
sample, as were those firms with extremely large or extremely small efficiency ratio values.
We also trim the top and bottom 5% to control for influential observations at both extremes
for each of the two variables. Due to the generous size of the sample, we believe that this is
not an unreasonable filtering activity. More importantly, the sample reduction had little
impact on the univariate and multivariate analysis reported in the next section. The details of
the filtering process are reported in Table 2. While the filters removed the impact of very
large and very small values there was also evidence of skewness in both ratios. This is
corrected with the use of log transformation for the multivariate regression analysis.
Measures of ownership structure are critical as analysis of equity agency costs requires
comparisons between 100% owner-manager firms and firms that exhibit varying levels of
separation between ownership and management. Variables are also captured to reflect the
impact of employees and parent company equity holders. Following Ang et al. (2000), we
include a dummy variable for the existence of a manager/equity holder and we include
variables to capture the impact of the primary owner equity holding and nonworking
family equity holdings. Rather than include one proxy for nonmanager equity holders as
occurs in Ang et al. (2000), we include two variables, nonworking equity holders who are
not part of the controlling family and parent company equity holders. It should be noted
that some of the variables (see Table 1) differ from those used in the Ang et al. (2000). For
example, apart from the shdrmgr dummy variable, the remainder are continuous variables
reflecting the percentage ownership rather than dummy variables.
We include variables to control for the level of debt and the level of venture capital
equity holding. Banks play an important part in small business financing and there is
evidence of increasing venture capital provider involvement in SME financing. We are
unable to replicate all of the variables used by Ang et al. (2000) in capturing the impact of
bank monitoring due to limitations of the survey instrument. Debt to total assets is
included in the analysis, although this is not a particularly good proxy for bank monitoring
Table 2
Summary of data filtering
Number of observations

Maximum number of firms available for survey

Less: firms not surveyed during the year
Less: firms ceased business during year
Less: firms with zero sales
Less: firms with zero assets
Less: firms with no expenses
Less: firms with zero other operating expenses
Less: extremely large or small observations for either ratio
Final number of firms for analysis

1996/1997

Balance

1997/1998

Balance

9733

4296

371

108

111

2

235

790

9733
5437
5066
4958
4847
4845
4610
3820
3820

9733

4202

409

98

214

4

215

798

9733
5531
5122
5024
4810
4806
4591
3793
3793

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G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

Table 3
Industry classification
Code

Industry

Percentage of sample

100
200
300
400
500
600
700
800
900
1000
1100

Mining
Manufacturing
Construction
Wholesale trade
Retail trade
Accommodation, cafes and restaurants
Transport and storage
Finance and insurance
Property and business services
Cultural and recreational services
Personal and other services

1996 1997

1997 1998

0.99
40.71
5.76
16.62
10.50
3.53
3.40
2.33
12.23
1.73
2.20

1.31
34.63
6.44
14.99
10.89
4.08
3.94
4.47
14.39
2.48
2.36

and is included as a control variable. We leave further analysis of the impact of bank
monitoring to future research. Finally, we include venture capital equity holdings, although
it should be noted that only 15 firms reported equity in this category.
Finally, a number of variables are included to control for other confounding effects.
These variables include performance (return on assets), growth options (R&D to sales),
firm size, industry and firm age as defined in Table 1. To control for size, we include the
natural log of sales in all of our regressions, although sensitivity analysis indicates that the
use of the total number of employees as an alternative measure of size has little impact on
the results. We also include 10 industry dummies, one for each two-digit ANZSIC code
included in the survey excluding the retail industry, in all of our regressions (see Table 3).
There are also 15 dummy variables to capture the impact of firm age. One dummy variable
Table 4
Age of business variable
Age of business

Category

Less than 2 years old

2 years to less than 4 years old
4 years to less than 6 years old
6 years to less than 8 years old
8 years to less than 10 years old
10 years to less than 12 years old
12 years to less than 14 years old
14 years to less than 16 years old
16 years to less than 18 years old
18 years to less than 20 years old
20 years to less than 22 years old
22 years to less than 24 years old
24 years to less than 26 years old
26 years to less than 28 years old
28 years to less than 30 years old
30 or more years old

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16

Percentage of sample
1996 1997

1997 1998

4.06
9.82
10.45
10.39
10.52
8.40
5.26
7.04
5.68
2.67
4.24
1.52
3.87
3.66
1.05
11.36

4.14
9.02
9.97
10.18
9.36
10.60
5.77
3.69
6.78
4.72
4.51
1.77
1.24
4.17
2.82
11.28

G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

37

for each age grouping (Table 4) excluding the last, is included in all regressions. These
two sets of dummy variables are not reported separately in the analysis reported in
Tables 9 and 10.
The descriptive statistics for the full sample of 3820 and 3793 SMEs for 1996 1997
and 1997 1998 are presented in Tables 5 and 6. The minimum and maximum values of
the operating expense ratio (opexpsa) for the 1996 997 (1997 1998) sample firms are
3% (3%) and 67% (62%) with an average of 21% (20%). The asset utilisation ratio
(salass) has a minimum of 33% (37%) and maximum of 1017% (1044%) with a mean of
270% (282%) for 1996 1997 (1997 1998). On average for 1996 1997 (1997 1998) the
primary owner holds 66% (67%) of the firms equity and nonworking family members
held 6% (6%). This highlights the existence of concentrated ownership in SMEs in
Table 5
Descriptive statistics of variables used to analyse agency costs
Mean

Median

Maximum

Minimum

Standard
deviation

Skewness

Kurtosis

Panel A: 1996 1997 (N = 3820)

opexp %
20.51
16.71
lnoexsa
2.79
2.82
salass %
269.74
215.57
lnsalass
5.36
5.37
eqhwown %
66.49
100.00
eqhnwf %
6.03
0.00
eqhnwn %
2.10
0.00
eqhpar %
14.87
0.00
eqhven %
0.22
0.00
bkdbtass %
22.28
7.44
sales ($mil.)
7.72
1.63
lnsales
7.42
7.40
roa %
14.59
7.44
rdsales %
0.78
0.00

66.94
4.20
1016.67
6.92
100.00
100.00
100.00
100.00
100.00
1212.50
1688.00
14.34
512.50
1318.00

3.04
1.11
32.51
3.48
0.00
0.00
0.00
0.00
0.00
0.00
0.01
1.95

538.46
0.00

13.99
0.70
192.61
0.71
43.65
19.37
12.05
35.00
4.22
38.82
35.88
1.82
42.11
21.58

114.18

0.15
146.26

0.16

0.69
3.50
6.46
1.96
21.10
10.60
0.03

0.01
248.59
5964.06

377.80
2.33
511.27
2.66
1.64
14.96
46.49
4.90
468.31
263.59
1.37
2.54
4898.10
36,3774.80

Panel B: 1997 1998 (N = 3793)

opexpsa %
20.07
16.47
lnoexsa
2.77
2.80
salass %
281.69
223.65
lnsalass
5.40
5.41
eqhwown %
67.30
100.00
eqhnwf %
5.78
0.00
eqhnwn %
1.98
0.00
eqhpar %
14.71
0.00
eqhven %
0.22
0.00
bkdbtass
21.06
5.22
Sales ($mil.)
7.42
1.74
lnsales
7.45
7.46
roa %
15.10
7.66
rdsales %
0.52
0.00

62.39
4.13
1044.00
6.95
100.00
100.00
100.00
500.00
100.00
867.43
900.93
13.71
800.00
104.55

3.01
1.10
36.76
3.60
0.00
0.00
0.00
0.00
0.00

8.82
0.01
1.79

609.09
0.00

13.50
0.71
202.28
0.71
43.65
19.39
11.44
35.62
3.90
34.28
21.86
1.83
45.64
3.85

104.88

0.21
142.90

0.13

0.73
3.64
6.52
2.51
20.25
6.09
0.02

0.06
419.69
1440.45

347.78
2.32
485.50
2.59
1.69
15.89
47.56
13.62
448.94
111.00
0.76
2.51
8361.78
27,288.84

Descriptive statistics are presented for selected variables used in analysis of agency costs for a sample of 3820 and
3793 small corporations for 1996 1997 and 1997 1998. See Table 1 for definitions of these variables. Data is
taken from the Business Longitudinal Survey.

38

Table 6
Correlation coefficients
opexpsa

salass

lnsalass

shdrmgr

eqhwown

eqhnwf

eqhnwn

eqhpar

eqhven

bkdbtass

roa

rdsales

sales

lnsales

Panel A: 1996 1997

opexpsa
1.00
lnoexsa
0.93
salass

0.11
lnsalass

0.15
shdrmgr

0.03
eqhwown
0.00
eqhnwf

0.05
eqhnwn
0.00
eqhpar

0.02
eqhven
0.02
bkdbtass
0.03
roa

0.05
rdsales

0.01
sales

0.07
lnsales

0.17

1.00

0.17

0.19

0.03

0.01

0.05
0.00

0.01
0.01
0.03

0.05

0.02

0.08

0.19

1.00
0.92
0.10
0.16

0.02

0.04

0.14

0.01
0.07
0.23

0.02

0.01

0.06

1.00
0.13
0.19

0.02

0.05

0.15

0.02
0.05
0.19

0.02

0.02

0.01

1.00
0.45

0.06

0.07

0.38

0.07
0.10
0.04
0.01

0.14

0.24

1.00

0.27

0.17

0.63

0.07
0.12
0.10
0.01

0.17

0.38

1.00

0.03

0.13

0.02
0.03

0.05

0.01

0.01
0.02

1.00

0.07

0.01
0.00

0.02
0.00

0.01
0.02

1.00

0.02

0.13

0.07
0.00
0.20
0.41

1.00
0.00
0.00
0.00
0.02
0.05

1.00

0.09

0.01

0.02

0.10

1.00
0.00

0.02

0.15

1.00

0.01

0.02

1.00
0.36

1.00

Panel B: 1997 1998

opexpsa
1.00
lnoexsa
0.93
salass

0.12
lnsalass

0.16
shdrmgr

0.04
eqhwown
0.00
eqhnwf

0.03
eqhnwn
0.00
eqhpar

0.03
eqhven
0.00
bkdbtass
0.05
roa

0.08
rdsales
0.05
sales

0.11
lnsales

0.18

1.00

0.17

0.20

0.04
0.00

0.03
0.00

0.02
0.00
0.03

0.07
0.05

0.14

0.19

1.00
0.92
0.10
0.17

0.03

0.02

0.15
0.00
0.08
0.25

0.07
0.01

0.06

1.00
0.12
0.18

0.04

0.02

0.15

0.01
0.07
0.21

0.08
0.02

0.01

1.00
0.45

0.08

0.02

0.37

0.05
0.10
0.06

0.01

0.19

0.24

1.00

0.28

0.16

0.63

0.06
0.12
0.11

0.01

0.23

0.37

1.00

0.02

0.12

0.02
0.01

0.03

0.03

0.01
0.02

1.00

0.07

0.01
0.02

0.04

0.02
0.00
0.03

1.00

0.02

0.13

0.07
0.03
0.27
0.40

1.00
0.01

0.01
0.00
0.03
0.04

1.00

0.09

0.04

0.04

0.10

1.00

0.04

0.03

0.15

1.00

0.01
0.01

1.00
0.50

1.00

G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

lnoexsa

G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

39

Australia. The average debt-to-asset ratio is 22% (21%) and the average firm has sales of
approximately $7.7 (7.4) million. The correlations, reported in Table 6, suggest that there
is not much evidence of multicollinearity with correlations generally below 0.50. An
exception is the correlation between parent company equity holding and primary owner
equity holding with a value of
0.63.

4. Analysis
There are two approaches taken in this paper in the analysis of equity agency costs
arising from the separation of ownership and control. First, we compare discretionary
operating expenses and asset utilisation between owner-managers and others using t-tests
and Mann Whitney U-tests to test for statistically significant differences. The second set
of tests also consider agency cost impacts but in a multiple regression setting with
inclusion of controls for other monitoring parties such as banks, venture capital suppliers,
performance, growth options, size, industry and age.
4.1. Univariate tests
The univariate analysis is based on the distinction between whether the firms manager
is an equity holder or an outsider. We define a firm as an owner manager type firm where
one or more director, partner or proprietor is employed within the firm. In all other cases
we define the firm as having an outsider-manager firm. The difference in the mean and
median agency cost ratios and asset utilisation ratios across the two groups are reported in
Tables 7 and 8 along with test statistics for differences. The tests are also run across
different subsets of the sample based on different levels of ownership. These additional
comparisons are based on whether the primary owner holds 100% of the firms equity; the
primary owner holds greater than 50% of the firms equity; family equity holding exceeds
50%; and where no family or primary owner holds more than 50% of the firms equity.
The latter case is referred to here as the dispersed ownership case.
It is evident that most SMEs are managed by equity holders rather than outsiders, with
3152 and 3103 firms managed by an equity holder or 83% and 82% of the 3820 and 3793
firms for 1996 1997 and 1997 1998, respectively. It should be noted that despite this, there
is still a substantial number of firms managed by outsiders (668 and 690 firms for 1996
1997 and 1997 1998). In both Tables 7 and 8, there is a statistically significant difference
between owner-managed firms and all other firms when all available firms are included in
analysis. Both the average discretionary expense to sales ratio and the average sales to assets
ratio are statistically significantly different across these two groups. While owner-managed
firms incur less discretionary expenses as a percentage of sales they also earn a greater level
of sales per dollar of assets in place. The results are evident both for the 1996 1997 and
1997 1998 financial years. With average operating expense ratios for 1996 1997 (1997
1998) of 21.54 (21.11) and 20.29 (19.84) for firms managed by outsiders and firms managed
by equity holders, respectively, the 1.25 (1.27) percentage difference in these means is
statistically significant at the 5% level (Table 7). This implies that the discretionary operating
expenses of a firm with median annual sales of $1.6 million ($1.7 million) are $20,000

40

G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

Table 7
Agency costs (proxied by the operating expense ratio), ownership structure, and managerial alignment with equity
holders
Owner manager
Number
Panel A: 1996 1997
All firms
3152
Primary owner
owns 100%
of the firm
(wown100)
Primary owner
owns >50%
of the firm
(wown50)
Family ownership
>50% of the
firm (family50)
No owner or family
owns >50% of
the firm

2084

Ratio mean Number

(median)

Ratio mean
(median)

20.29
(16.64)
20.71
(17.07)

21.54
(17.17)
20.12
(15.74)

0.59
(
1.33)

2.01
(
1.82)

0.49
(
0.47)

668
141

1.25*

2292

20.48
(16.86)

151

20.42
(16.22)

0.06
(
0.64)

0.05
(
0.02)

2518

20.36
(16.69)

210

19.45
(15.54)

0.92
(
1.15)

0.96
(
0.87)

634

20.01
(16.35)

458

22.50
(18.81)

2.49*
(2.46)*

2.82
(
2.30)

19.84
(16.25)
20.31
(16.63)

690

21.11
(17.41)
20.01
(16.97)

1.27*
(1.16)*

0.30
(0.34)

2.16
(
2.06)

0.27
(
0.16)

Panel B: 1997 1998

All firms
3103
Primary owner
owns 100%
of the firm
(wown100)
Primary owner
owns >50%
of the firm
(wown50)
Family ownership
>50% of the
firm (family50)
No owner or family
owns >50% of
the firm

Diff. mean Diff. t-statistics

(median) (Mann Whitney)

Outsider-manager

2101

155

2297

20.12
(16.47)

167

19.90
(16.87)

0.22
(0.40)

0.21
(
0.19)

2503

19.95
(16.36)

231

20.27
(16.87)

0.31
(0.50)

0.34
(
0.55)

600

19.38
(16.19)

459

21.53
(17.62)

2.15*
(1.43)*

2.55
(
1.99)

Percentage operating expense ratios (ratio of discretionary operating expenses to annual sales) are presented for a
sample of 3820 (3793) SME firms for 1996 1997 (1997 1998). Panel A presents the data for the 1996 1997
financial year, Panel B for 1997 1998. The data is divided into two groups of firms: those managed by owners,
and those managed by an outsider. Subgroups are formed where the primary owner owns 100% of the firm
(Wown100), where the primary owner owns greater than half of the firm (Wown50), where families own greater
than 50% of the firm (Family50), and where no owner or family member owns more than half of the firm. The
primary owner is defined as a working owner, and is calculated through examination of the ownership stake of
proprietors, partners and/or directors (eqhwown). Data is taken from the Business Longitudinal Survey conducted
by the Australian Bureau of Statistics.
* Indicates statistical significance at the 5% levels. The t-test and the Mann Whitney U-test, in parentheses,
test for statistically significant differences in the ratios of the two groups. The difference in mean ratio t-statistic
assumes unequal variances.

G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

41

Table 8
Agency costs (proxied by the asset utilisation ratio), ownership structure, and managerial alignment with equity
holders
Owner manager
Number
Panel A: 1996 1997
All firms
3152
Primary owner
owns 100%
of the firm
(wown100)
Primary owner
owns >50% of the
firm (wown50)
Family ownership
>50% of the
firm (family50)
No owner or family
owns >50%
of the firm

2084

Ratio mean Number

(median)

Ratio mean
(median)

278.83
(224.33)
295.31
(245.48)

226.88
(176.49)
292.17
(217.39)

51.94*
(
47.84)*

3.14
(
28.09)

668
141

6.69
(
8.04)

0.18
(
0.32)

2292

290.95
(239.74)

151

290.62
(216.67)

0.33

0.02
(
23.07) (
0.38)

2518

287.70
(236.20)

210

287.88
(218.57)

0.18
0.01
(
17.63) (
0.44)

634

243.57
(189.62)

458

198.91
(158.05)

44.66*
4.28
(
31.57)* (
4.68)

291.27
(234.78)
305.58
(250.75)

690

238.62
(182.04)
312.03
(247.26)

52.65*
(
52.74)*
6.45
(
3.48)

6.51
(
7.72)
0.34
(
0.03)

Panel B: 1997 1998

All firms
3103
Primary owner
owns 100% of the
firm (wown100)
Primary owner owns
>50% of the
firm (wown50)
Family ownership
>50% of the firm
(family50)
No owner or family
owns >50%
of the firm

Diff. mean Diff. t-statistics

(median) (Mann Whitney)

Outsider-manager

2101

155

2297

303.29
(249.59)

167

310.00
(245.13)

6.71
(
4.46)

0.37
(
0.06)

2503

300.84
(246.44)

231

298.42
(236.57)

2.42
(
9.87)

0.16
(
0.96)

600

251.32
(202.03)

459

208.52
(162.99)

42.80*
4.04
(
39.04)* (
4.43)

Percentage asset utilisation ratios (annual sales to assets) are presented for a sample of 3820 (3793) SME firms
for 1996 1997 (1997 1998). Panel A presents the data for the 1996 1997 financial year; Panel B for 1997
1998. The data is divided into two groups of firms: those managed by owners, and those managed by an outsider.
Subgroups are formed where the primary owner owns 100% of the firm (Wown100), where the primary owner
owns greater than half of the firm (Wown50), where families own greater than 50% of the firm (Family50), and
where no owner or family member owns more than half of the firm. The primary owner is defined as a working
owner, and is calculated through examination of the ownership stake of proprietors, partners and/or directors
(eqhwown). Data is taken from the Business Longitudinal Survey conducted by the Australian Bureau of
Statistics.
* Indicates statistical significance at the 5% level. The t-test and the Mann Whitney U-test, in parentheses,
test for statistically significant differences in the ratios of the two groups. The difference in mean ratio t-statistic
assumes unequal variances.

42

G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

($21,590) greater per year when an outsider manages the firm (all figures are in Australian
dollars). Furthermore, the results in Table 8 indicate that the owner-managed firms are also
run more efficiently when an owner manages the firm. The difference in mean asset
utilisation ratio for 1996 1997 (1997 1998) implies that the sales of a median-sized firm
with $783,500 ($772,000) of total assets are approximately $406,900 ($406,400) higher
when an owner rather than an outsider manages the firm.
The sample has been stratified into subgroups according to the level of ownership held by
the manager or the family consistent with Ang et al. (2000). There is no statistically
significant difference between the owner-managed firms and outsider-managed firms for the
groups where the primary owner owns 100%, where the primary owner owns 50% or more
of the firm or where the family owns 50% or more of the firm. Perhaps in Australian firms,
where there are high levels of ownership by managers or family, the level of monitoring is
such that nonowner managers choose not to exhibit excessive perquisite consumption,
shirking and the like. Nevertheless, once the level of manager or family ownership drops
below 50%, there is evidence of statistically significantly greater levels of discretionary
expenditure and lower levels of asset utilisation where the manager is an outsider.
In their US-based study, Ang et al. (2000) find that the mean and median operating
expense ratios are higher for outsider-managed firms than insider-managed firms for all
four ownership structures. This consistency is not apparent in our sample. Nevertheless,
there is evidence of statistically significant and economically important equity agency costs
in Australian SMEs except where the primary owner or family ownership exceeds 50%.
4.2. Multivariate tests
A more complete analysis of the equity agency cost problem is provided using
multivariate regression. Ownership structure factors that are likely to influence the agency
costs of a firm are examined both individually and as a group. These include whether the
manager is a equity holder or an outsider, the level of primary owner equity holding, the
level of nonworking family equity holding, the level of nonworking equity holding that is
not family held and the level of parent company equity holding. External monitoring is
proxied by the leverage ratio for bank monitoring and venture capital provider equity
ownership. In addition, return on assets, R&D to sales, firm size, industry classification
and age are included in the regressions as control variables, although the industry and age
coefficients are not reported separately. The full regressions take the following form:
lnoexsa B0 B1 shdrmgr B2 eqhwown B3 eqhnwf B4 eqhnwn
B5 eqhpar B6 eqhven B7 bkdbtass B8 roa B9 rdsales
B10 lnsales Bi industry Ba age e;
lnsalass B0 B1 shdrmgr B2 eqhwown B3 eqhnwf B4 eqhnwn
B5 eqhpar B6 eqhven B7 bkdbtass B8 roa B9 rdsales
B10 lnsales Bi industry Ba age e;

G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

43

where lnoexsa = the natural log of the operating expense-to-annual sales ratio (a proxy for
agency costs), lnsalass = the natural log of the asset utilisation ratio (a proxy for agency
costs), and e = regression residual.
Ownership variables are:
shdrmgr = a dummy variable equalling 1 if the manager is a equity holder, otherwise 0.
eqhwown = percentage of equity held by the primary owner.
eqhnwf = percentage of equity held by nonworking owner, part of controlling family.
eqhnwn = percentage of equity held by nonworking owner, not part of controlling family.
eqhpar = percentage of equity held by parent companies.
Control variables are:
bkdbtass = bank debt to total assets ratio.
eqhven = equity holding of venture capital providers.
roa = return on assets.
rdsales = ratio of R&D to sales.
lnsales = natural logarithm of annual sales.
industry = a set of 10 dummy variables, one for each two-digit ANZSIC included in the
survey excluding the retail industry.
age = a set of 15 dummy variables for age groupings classified in Table 4, excluding the
16th category.
The natural log of the discretionary expense-to-sales ratio and the natural log of the
asset utilisation ratio are used in multiple regressions due to the better statistical
characteristics of these transformed variables.5 The estimated parameters are adjusted
for comparison with the results reported in Ang et al. (2000).6
Table 9 presents the results for the analysis where the natural log of the discretionary
operating expenses-to-sales ratio is the dependent variable (our agency cost proxy), and
Table 10 gives the findings when the natural log of the asset utilisation ratio is used. There
are six different model specifications (columns 2 7), one for each ownership structure
variable with the last including all of the ownership variables included in Eq. (1). Industry
and age dummy variables, return on assets, R&D expenditure and size proxies are
included in all regressions to control for confounding effects, although the separate age
and industry dummy variable coefficients are not reported.
Column 2 of Table 9 presents the results of having an owner as a manager rather than
an outsider-manager when our proxy for agency costs is the natural log of the discretionary
expense ratio. It is evident in Panel A and Panel B that the log of the discretionary
5

While this generates better-behaved regression residuals, when the analysis is repeated on the larger
unadjusted data set, there is little difference in the reported results.
6
The results in the Tables 9 and 10 take the form ln(ratio) = a + bX. To find the relationship between the ratio
and X we must find d(ratio)/dX. We know that d ln (ratio)/dX = b from the regression estimates and so it is clear
that this can be restated as [1/(ratio)] d(ratio)/dX = b. Thus, d(ratio)/dX = bratio. Because we take the natural log of
the percentage form of the ratio and wish to discuss our analysis in percentage form (to be consistent with the Ang
et al. (2000), US study) we multiply the coefficient by the average ratio in percentage form. Where necessary
transformed results are used in discussion to facilitate comparisons with the US results of Ang et al. (2000).

44

G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

Table 9
Determinants of SME agency costs (proxied by operating expense ratio)
1

Panel A: 1996 1997 (N = 3820)

Intercept
2.7922*
(34.26)
Ownership variables
Manager/equity

0.0849*
holder (shdrmgr)
(
2.96)
Primary owner
working (eqhwown)
Nonworking
family (eqhnwf)
Nonworking not
family (eqhnwn)
Parent companies
equity (eqhpar)
Control variables
Venture capitalists
0.0011
equity (eqhven)
(0.43)
Debt-to-asset
0.0001
ratio (bkdbtass)
(0.52)
Return on

0.1820*
assets (roa)
(
6.41)
R&D to sales

0.0740*
(rdsales)
(
5.06)
Log of annual

0.0437*
sales (lnsales)
(
6.34)
R2
0.20
F-statistic
29.71*
Panel B: 1997 1998 (N = 3793)
Intercept
2.7667*
(34.94)
Ownership variables
Manager/equity

0.1059*
holder (shdrmgr)
(
3.86)
Primary owner
equity (eqhwown)
Nonworking family
(eqhnwf)
Nonworking not
family (eqhnwn)
Parent companies
equity (eqhpar)
Control variables
Venture capitalists
0.0011
equity (eqhven)
(0.59)
Debt-to-asset ratio
0.0002
(bkdbtass)
(0.85)
Return on

0.1992*
assets (roa)
(
7.20)

2.8206*
(35.05)

2.7060*
(37.67)

2.6851*
(37.60)

2.7537*
(37.22)

2.9376*
(33.34)

0.0013*
(4.27)

0.0421
(
1.37)

0.0013*
(
3.35)

0.0025*
(
3.98)

0.0013
(
1.38)
0.0000
(0.07)

0.0010*
(
3.89)

0.0017*
(
3.14)

0.0004
(
0.48)

0.0010
(0.41)
0.0002
(0.67)

0.1777*
(
6.29)

0.0732*
(
5.05)

0.0481*
(
6.72)
0.20
29.95*

0.0013
(0.53)
0.0001
(0.35)

0.1863*
(
6.53)

0.0763*
(
5.58)

0.0391*
(
5.88)
0.20
29.75*

0.0014
(0.57)
0.0001
(0.28)

0.1834*
(
6.46)

0.0751*
(
5.29)

0.0389*
(
5.84)
0.19
29.37*

0.0019
(0.76)
0.0002
(0.69)

0.1808*
(
6.39)

0.0749*
(
5.33)

0.0495*
(
6.81)
0.20
30.04*

0.0005
(0.22)
0.0003
(1.01)

0.1808*
(
6.36)

0.0747*
(
5.40)

0.0526*
(
7.16)
0.20
27.34*

2.7178*
(34.74)

2.6460*
(37.07)

2.6329*
(37.16)

2.6704*
(36.59)

2.8391*
(33.23)

0.0007*
(2.25)

0.0905*
(
3.05)

0.0006+
(
1.67)

0.0014*
(
2.39)

0.0009
(
0.87)

0.0002
(
0.42)

0.0018
(0.92)
0.0002
(0.74)

0.2006*
(
7.27)

0.0007
(0.37)
0.0003
(1.02)

0.1984*
(
7.17)

0.0006*
(
2.44)

0.0009+
(
1.66)

0.0004
(
0.44)

0.0013
(0.65)
0.0002
(0.73)

0.1980*
(
7.17)

0.0015
(0.74)
0.0002
(0.55)

0.2033*
(
7.27)

0.0015
(0.77)
0.0002
(0.53)

0.2025*
(
7.24)

(continued on next page)

G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

45

Table 9 (continued)
1

Panel B: 1997 1998 (N = 3793)

R&D to sales
0.7551*
(rdsales)
(3.48)
Log of annual

0.0471*
sales (lnsales)
(
6.77)
R2
0.21
F-statistic
31.42*

0.7560*
(3.45)

0.0467*
(
6.55)
0.20
31.09*

0.7471*
(3.39)

0.0414*
(
6.13)
0.20
30.95*

0.7554*
(3.42)

0.0412*
(
6.09)
0.20
30.86*

0.7458*
(3.37)

0.0468*
(
6.45)
0.20
31.05*

0.7335*
(3.38)

0.0501*
(
6.86)
0.21
28.06*

The dependent variable used to estimate the impact of agency costs is the natural log of the ratio of discretionary
operating expenses to annual sales percentage (lnoexsa) and the independent variables are defined in Table 2.
Columns 2 7 examine ownership variables separately. Column 8 combines all variables in one model. Each
specification includes a set of 10 industry dummy variables and 15 firm age dummy variables for differing firm
age groupings although these are not reported separately here. Whites (1980) heteroscedasticity consistent tstatistics are presented in parentheses beneath the coefficients. Data is taken from the Business Longitudinal
Survey conducted by the Australian Bureau of Statistics.
* (+) indicates statistical significance at the 5% (10%) levels. The t-statistics are Whites heteroscedasticity
adjusted t-statistics.

operating expense ratio is lower when the manager is also an owner. After adjustment to
remove the impact of log transformation from the estimated coefficients of
0.085 for
1996 1997 and
0.106 for 1997 1998, we find that a firm managed by an owner has
agency costs that are 1.743% and 2.127% lower than those firms managed by outsiders in
1996 1997 and 1997 1998, respectively. These results are significantly different from
zero at the 1% level and are larger than the 1.25% and 1.27% differences reported for all
firms in the univariate results in Table 7. The coefficients indicate that the agency costs for
a firm with median annual sales of $1.6 million and $1.7 million for 1996 1997 and
1997 1998, respectively, are approximately $28,399 and $36,930. This difference is
smaller than that reported by Ang et al. (2000) for US firms, where the operating expense
ratio was 5.4% greater when the firm uses an outsider manager. This variation would seem
to be sample-specific, although the magnitude and statistical significance of the costs
suggest that equity agency costs are important both in the United States and in Australia.
Column 2 of Table 10 indicates that the natural log of the asset utilisation ratio is higher
when the manager is an equity holder in both 1996 1997 and 1997 1998. After adjustment
for the log transformation the asset utilisation ratio is 48.823% and 46.310% of total assets
higher when the manager is an owner rather than an outsider. These results are significant at
the 5% level and are very similar to the univariate differences reported in Table 8. This
difference implies that the revenues of a median size firm, which has $783,500 and
$772,000 in total assets for 1996 1997 and 1997 1998, are $382,528 and $357,512 higher
when an equity holder rather than an outsider manages the firm. This difference is
reasonably close to that found in US firms where the asset utilisation ratio was 51% of
total assets greater when the firm is managed by an owner rather than an outsider.
These results support the managerial alignment theory with a reduction in the tendency
of managers to act in their own interests or to expropriate the firms resources for their own
perquisite consumption as the level of ownership that the manager maintains increases.
The results also support the Fama and Jensen (1983a) proposition that small firms may
efficiently control equity agency problems by enlisting an owner as a manager. Due to the

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G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

owners concern with the performance and running of the firm, they make more vigilant
managers when compared to those managers who have no ownership interest in the firm.
It is expected that the expense (asset utilisation) ratio would be negatively (positively)
related to the primary owners equity holding. This expectation is consistent with the work
of Jensen and Meckling (1976) who suggest that managerial equity ownership aligns the
managers interests with equity holders (the convergence-of-interests hypothesis). This is
also consistent with the expectation that large equity holders make more effective monitors
(Shleifer and Vishny, 1986; Zeckhauser and Pound, 1990). We find in column 3 of Table 9
that the operating expense ratio declines as the primary owners equity holding increases
and in column 3 of Table 10 it is also evident that the asset utilisation ratio increases as the
primary owners equity holding increases. These results are significant at the 5% level and
are consistent with the findings of Ang et al. (2000). Equity agency costs appear to
decrease as the primary owners equity holding increases, supporting the convergence of
interest hypothesis. As the primary owners equity holding increases, their incentive to
consume excessive perquisites declines since their equity of the firms profits rises with
their ownership equity, while their benefits from perquisite consumption remain the same.
These findings also suggest that agency costs decrease as the ownership of the firm
becomes more concentrated (Shleifer and Vishny, 1986).
It was argued above that agency costs would decrease as family equity holding increases
and in this case we focus on the additional impact of nonworking family equity holders. A
negative relationship between discretionary expense to sales ratio and nonworking family
equity ownership is apparent in column 4 of Table 9 yet there is no statistically significant
relationship observed between the asset utilisation ratio and the level of equity ownership of
nonworking family equity holders.7 Thus, there is some evidence with respect to discretionary expenses to suggest that family members, other than the owner manager, may
undertake an important role in the control of equity agency costs in SMEs. Due to the special
relationships that exist, families are in a unique position to undertake effective monitoring
and disciplining of managers (Fama and Jensen, 1983a; DeAngelo and DeAngelo, 1985).
We expect that agency costs that are attributable to the separation of ownership and
control vary inversely with nonworking nonfamily equity ownership (Milgrom and
Roberts, 1992). Hence, we expect a negative relationship between these equity holders
and the operating expense ratio, and a positive relationship with the asset utilisation ratio.
Column 5 of Tables 9 and 10 indicates that there is generally no statistically significant
relationship between the level of nonworking equity holders who are not family and the
level of agency costs. Perhaps this is not surprising given that the average equity holding
of this group is around 2%.
The last of the ownership variables is the equity holding of parent companies. Ang et al.
(2000) did not analyse this variable, although it may be important from a policy perspective
to analyse the impact of parent company ownership on agency costs. While it could be
argued that parent companies set up strong monitoring and bonding contracts to reduce the
impact of agency costs the results reported in column 6 of Tables 9 and 10 show that the
level of discretionary expenses (asset utilisation) increases (decreases) with the level of
7
It is possible that the monitoring of nonworking family equity holders has a greater impact on the day-today expenses incurred by the firm than on the longer-term utilisation of assets.

G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

47

Table 10
Determinants of SME agency costs (proxied by asset utilisation ratio)
1

Panel A: 1996 1997 (N = 3820)

Intercept
5.0293*
(56.08)
Ownership variables
Manager/equity
0.1810*
holder (shdrmgr)
(6.01)
Primary owner
equity (eqhwown)
Nonworking
family (eqhnwf)
Nonworking not
family (eqhnwn)
Parent companies
equity (eqhpar)
Control variables
Venture capitalists

0.0015
equity (eqhven)
(
0.54)
Debt-to-asset
0.0011*
ratio (bkdbtass)
(3.16)
Return on assets (roa)
0.3390*
(8.54)
R&D to sales (rdsales)

0.0548*
(
3.33)
Log of annual
0.0270*
sales (lnsales)
(3.50)
R2
0.14
F-statistic
19.22*
Panel B: 1997 1998 (N = 3793)
Intercept
5.0681*
(57.06)
Ownership variables
Manager/equity
0.1644*
holder (shdrmgr)
(5.48)
Primary owner
equity (eqhwown)
Nonworking
family (eqhnwf)
Nonworking not
family (eqhnwn)
Parent companies
equity (eqhpar)
Control variables
Venture capitalists

0.0014
equity (eqhven)
(
0.37)
Debt-to-asset
0.0014*
ratio (bkdbtass)
(4.25)

4.9036*
(54.59)

5.2535*
(64.58)

5.2559*
(64.73)

5.1040*
(61.22)

4.8401*
(50.62)

0.0030*
(
9.11)

0.0682*
(2.10)
0.0018*
(4.39)
0.0010
(1.50)

0.0013
(
1.20)

0.0014*
(
2.91)

0.0027*
(9.49)
0.0003
(0.48)

0.0021*
(
2.12)

0.0011
(
0.44)
0.0010*
(2.76)
0.3273*
(8.24)

0.0573*
(
3.47)
0.0407*
(5.16)
0.15
21.33*

0.0022
(
0.86)
0.0012*
(3.61)
0.3421*
(8.73)

0.0525*
(
3.42)
0.0170*
(2.26)
0.13
17.88*

0.0023
(
0.89)
0.0013*
(3.64)
0.3408*
(8.71)

0.0534*
(
3.41)
0.0175*
(2.32)
0.13
18.07*

0.0033
(
1.25)
0.0010*
(2.83)
0.3363*
(8.43)

0.0527*
(
3.48)
0.0405*
(5.03)
0.15
20.75*

0.0016
(
0.61)
0.0009*
(2.43)
0.3295*
(8.25)

0.0562*
(
3.46)
0.0486*
(6.02)
0.15
19.77*

4.9645*
(57.27)

5.2824*
(66.90)

5.2704*
(67.13)

5.1257*
(63.10)

4.9449*
(52.33)

0.0029*
(
7.85)

0.0667*
(2.06)
0.0011*
(2.62)

0.0004
(
0.54)

0.0009
(
0.87)

0.0020*
(
3.93)

0.0032
(
0.86)
0.0013*
(3.86)

0.0022
(
0.58)
0.0012*
(3.62)

0.0023*
(8.43)

0.0006
(
1.09)

0.0010
(
0.97)

0.0011
(
0.29)
0.0013*
(3.93)

0.0020
(
0.57)
0.0016*
(4.71)

0.0020
(
0.56)
0.0016*
(4.71)

(continued on next page)

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G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

Table 10 (continuned)
1

Panel B: 1997 1998 (N = 3793)

Return on
0.3416*
assets (roa)
(9.74)
R&D to sales

1.0747*
(rdsales)
(
4.79)
Log of annual sales
0.0272*
(lnsales)
(3.62)
R2
0.15
F-statistic
21.29*

0.3307*
(9.63)

1.0720*
(
4.66)
0.0382*
(4.98)
0.16
22.90*

0.3453*
(9.83)

1.0870*
(
4.83)
0.0182*
(2.52)
0.14
20.17*

0.3454*
(9.84)

1.0850*
(
4.82)
0.0187*
(2.57)
0.14
20.16*

0.3398*
(9.75)

1.0295*
(
4.52)
0.0409*
(5.19)
0.16
22.98*

0.3315*
(9.60)

1.0502*
(
4.56)
0.0470*
(5.94)
0.16
21.21*

The dependent variable used to estimate the impact of agency costs is the natural log of the ratio of annual salesto-total assets percentage (lnsalass) and the independent variables are defined in Table 2. Columns 2 7 examine
ownership variables separately. Column 8 combines all variables in one model. Each specification includes a set
of 10 industry dummy variables and 15 firm age dummy variables for differing firm age groupings though these
are not reported separately here. Whites (1980) heteroscedasticity consistent t-statistics are presented in
parentheses beneath the coefficients. Data is taken from the Business Longitudinal Survey conducted by the
Australian Bureau of Statistics.
* (+) Indicates statistical significance at the 5% (10%) levels. The t-statistics are Whites heteroscedasticity
adjusted t-statistics.

parent company equity holding and the estimated coefficients are generally statistically
significant at the 5% level. While parent company neglect may explain the increase in
agency costs for 100% owned subsidiaries it is also likely that parent companies are in a
position to expropriate wealth from the remaining shareholders due to their control of the
firm where the parent company holds less that 100% of the equity in the subsidiary. The
parameter estimates from Table 9 suggest that a 1% increase in parent company equity
generates a 0.02% (0.01%) increase in discretionary operating expenses given the 1996
1997 (1997 1998) estimates. This is not large, although it could be important for some
firms.
Control variables include leverage, venture capital equity holding, return on assets,
R&D to sales and size. Given the perceived importance of bank monitoring for SMEs, we
expect that agency costs would decrease with increased monitoring, although we are
unable to analyse this question due to data limitations. By its nature, leverage tends to
capture the history of firm borrowing rather than the current level of bank survelliance of
the firm and in this study the leverage measure provides inconclusive results consistent
with Ang et al. (2000). The inconsistent debt-to-asset findings highlight the need for better
proxies for bank surveillance, although this is beyond the scope of our study. Furthermore,
the impact of monitoring by venture capital providers does not appear to be important
given the statistically insignificant coefficients reported in each of the regressions. This
most likely reflects the low level of venture capital investment evident in Australian
SMEs, with few SMEs identifying the existence of venture capital equity holding.
While the discretionary expenses are negatively related with the performance measure,
return on assets, the level of asset utilisation is positively correlated with this variable. This
is consistent with strongly performing firms showing lower levels of discretionary
expenses and greater levels of asset utilisation. We include R&D to sales to capture
growth options and it is apparent that this variable is negatively related with both asset

G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

49

utilisation and the level of discretionary expenses. The latter result is consistent with the
propensity for growth firms to generate lower levels of revenue from their asset base as
new products and processes are developed and so asset utilisation levels may indeed be
lower for firms with high levels of R&D expenses. It is also possible that firms with high
levels of R&D experience cash shortages and so this could explain the lower levels of
discretionary expenses evident for firms with high R&D expenditure.
In each of the six models examined we observe that the logarithm of annual sales, our
control for firm size, is negatively (positively) related with the discretionary expenses-tosales ratio (sales-to-assets ratio) and statistically significant at the 5% level. This supports
the prediction of economies of scale effects. Industry control variables, although not
reported separately, are statistically significant at the 5% level. These results support the
importance of controlling for industry while examining the discretionary expense to sales
ratio and the sales to assets ratios. However, examination of the age indicator variables
failed to show any statistically significant coefficients.
One final model is examined in column 7 of Tables 9 and 10 where we include all of the
ownership and control variables examined in columns 2 6. The ownership variable
coefficients exhibit the predicted negative (positive) sign in Table 9 (Table 10) except for
the nonworking equity holder coefficients in Table 10 where the parameters are generally
negative and statistically insignificant. Perhaps this result is not surprising given the small
average percentage ownership of the nonworking owners, whether part of the family (6%)
or not (2%). Multicollinearity may also explain the lack of statistical significance for the
parent company equity holding coefficients in Table 9.8 The control variable parameters
exhibit similar levels of sign, magnitude and statistical significance to those reported for
the individual ownership variable regressions.
4.3. Multivariate test sensitivity issues
As discussed in the previous section, we use bank debt-to-assets in our main analysis to
proxy for a banks incentive to monitor. As many leverage measures exist we also analyse
the ratio of bank debt-to-equity (dbteqty) for robustness. In order to examine this ratio a
smaller sample is undertaken excluding firms with negative debt-to-equity ratios and those
firms with zero equity.9 The reduced sample size is 2967 and 2900 firms for 1996 1997
and 1997 1998, respectively. Our results appear robust to the alternative specification of
this variable. We also examine an alternative control variable for size, the total number of
employees (totemp). We obtain similar results to those obtained when using lnsales.
Finally, we replicate the analysis including the large and the small observations specifically excluded in the analysis reported above, giving 4610 and 4591 firms for 1996 1997
and 1997 1998. Analysis of this extended data set was undertaken to assess the impact of
the arbitrary exclusion of the very large and the very small observations. The results of this
analysis are consistent with those obtained from our reduced sample.
8

We thank the reviewer for pointing out this possible explanation for the change in the level of statistical
significance between the columns 6 and 7 results reported for the parent company equity holding coefficients in
Table 9.
9
We also truncated this data set at the 5th and 95th percentiles.

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G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

5. Conclusions
The motivation for this paper arises from the lack of measurement of the equity agency
costs variable in financial economics research. Many studies in the finance, accounting
and economics literature assume that agency costs are important in determining the
ownership structure of a firm. However little empirical evidence on the impact of agency
costs has appeared in the literature. This paper draws upon ownership structure and agency
cost theory, generally derived from the US perspective, to analyse the impact of equity
agency costs on Australian SMEs.
It is found that agency costs are lower in firms managed by equity holders, consistent
with the argument that reducing the separation of ownership and control reduces agency
costs. While this result is consistent with US research, the magnitude of the agency costs
as proxied by the operating expense ratio and the asset utilisation ratio is somewhat lower
in Australia, suggesting nation-specific factors may influence the impact of the separation
of ownership and control.
Testing for the effect of managerial and employee ownership on the agency costs of a
firm reveals that agency costs decrease as managerial and employee equity holdings
increase. This provides evidence for the convergence-of-interests hypothesis put forth by
Jensen and Meckling (1976) at a variety of levels within the firm. The comparable figure
for managerial ownership of small US firms is larger for both the operating expense ratio
and the asset utilisation ratio, although both effects are statistically significant.
Examination of family ownership reveals that the agency costs of a firm decrease as
family ownership increases. This supports the work of Fama and Jensen (1983a) and
DeAngelo and DeAngelo (1985) who suggest that, due to their special relationships with
the firm, families are in a unique position to undertake effective monitoring and
disciplining of managers.
We also analyse the relationship between the level of parent company ownership and
agency costs and find evidence of positive (negative) relation between parent company
equity holding and discretionary expenses (asset utilisation). This is consistent with the
existence of equity agency costs arising from parent company ownership and separate
subsidiary management. Consistent with the literature, our results suggest that parent
company controls are not sufficient to remove the impact of equity agency costs for our
sample of SMEs. It is apparent that the level of agency costs increase with the level of
parent company equity holding.
Investigation of the relationship between the debt-to-asset ratio, proxying for banks
incentive to monitor, and equity agency costs failed to generate any clear results. The
relationship between firm leverage and the asset utilisation ratio is statistically significant
and positive while operating expense ratio is positively related though not statistically
significant. It would appear that the existence of debt is consistent with more efficient asset
use, although this appears to have little impact on the level of discretionary expenses. This
issue requires further investigation. Testing for the effect of venture capital equity holdings on
the agency costs of a firm failed to produce any significant results. We suggest that this may be
due to the small sample of firms that received venture capital financing within our sample.
Overall, this paper has identified agency costs attributable to differing ownership
structures and provided evidence that agency costs vary in Australian SMEs. These results

G. Fleming et al. / Pacific-Basin Finance Journal 13 (2005) 2952

51

are important for future research and for a richer understanding of the wealth effects of
different ownership structures in Australia.

Acknowledgements
We would like to express our thanks to the Australian Bureau of Statistics for providing
the data used in this paper. We would also like to thank Professor Ghon Rhee and an
anonymous reviewer for their much valued comments and suggestions. Work on the first
draft of the paper was completed while the authors were at the ANU, although subsequent
rewrites, arising from the review process, were completed by the second author while at
RMIT.

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