News Corp's Australian shares slumped over 7 percent on Monday to a two-year low as the phone hacking scandal fallout worsened with the arrest of the former head of Rupert Murdoch's UK newspaper arm and the resignation of Britain's police chief.

The shares fell 7.6 percent to as low as A$13.65, their lowest since July 2009, and also a 7.4 percent discount to News Corp's last U.S. close, implying that $3 billion of market capitalization would be wiped out when U.S. trade resumes.

There's a lot of sentiment and emotion driving the stock, said Simon Burge, chief investment officer at ATI Asset Management in Sydney, which holds News Corp shares.

From an earnings point of view, News of the World was less than 1 percent of earnings but this has catapulted to something greater and it is hard to quantify.

It was the biggest one-day slide for the shares since November 2008.

On Sunday, detectives arrested Rebekah Brooks, former head of News Corp's British newspaper arm, on suspicion of intercepting communications and corruption.

Paul Stephenson, London's police commissioner, quit in the face of allegations that police officers had accepted money from the paper and had not done enough to investigate hacking charges that surfaced as far back as 2005.

The scandal is also capturing attention in Australia, Murdoch's homeland. News Ltd dominates the Australian newspaper industry, commanding nearly three-quarters of daily metropolitan newspaper circulation.

The company's interests include The Australian, a national broadsheet, and The Daily Telegraph, the country's biggest-selling tabloid and a 30 percent interest in 24-hour news channel Sky News Australia.

In an editorial, the Wall Street Journal commented that phone-hacking is illegal, and said it was up to British authorities to enforce their laws. Murdoch's Dow Jones & Co publishes The Wall Street Journal.

If Scotland Yard failed to do so adequately when the hacking was first uncovered several years ago, then that is more troubling than the hacking itself, the WSJ said on its web site.

In a report on its web site, Bloomberg News cited two unnamed sources as saying independent directors of New York-based News Corp have begun questioning the company's response to the crisis and whether a leadership change is needed.

On the board, venture capital executive Tom Perkins and Viet Dinh, a law professor at Georgetown University, are leading the efforts of independent directors, according to one of the people in the Bloomberg report.

The report said News Corp's independent directors, who hold nine of 16 board seats, have expressed frustration over the quality and quantity of information they've received about the scandal and concern about management's ability to handle the crisis given how slowly the company has responded, the person said.

However, in an emailed response to Reuters, Perkins denied the report.

The Bloomberg reporter didn't talk to me. There is no substance to her speculations, as far as I know, Perkins said.

The News of the World, which published its final edition a week ago, is alleged to have hacked up to 4,000 phones including that of murdered 13-year-old Milly Dowler, sparking a furor that forced Murdoch to close the paper and drop a $12 billion plan to buy all of highly profitable broadcaster BSkyB .

Meanwhile, shares in News Corp takeover target Australian pay-tv firm Austar also slid on Monday on investor worries the deal may not proceed.

Austar has agreed to a $2 billion-plus takeover offer from its bigger rival Foxtel, which is owned by telecoms firm Telstra , News Corp's News Ltd division and billionaire James Packer's Consolidated Media Holdings .

Austar last traded down 4 percent while Consolidated Media fell 3.4 percent.

(Reporting by Victoria Thieberger; additional reporting by Michael Erman in New York; Editing by Balazs Koranyi and Dean Yates)