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Corporate governance and financial reporting disclosures

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  • 1. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.org Corporate Governance and Financial Reporting Disclosures: Bangladesh Perspective Dr. Md. Shamimul Hasan Assistant Professor, Department of Business Administration World University of Bangladesh, Dhaka, Bangladesh, Dr. Syed Zabid Hossain Professor, Department of Accounting and Information Systems, University of Rajshahi, Former Pro-vice Chancellor, University of Khulna, Bangladesh Dr. Robert J. Swieringa Professor of Accounting, Anne and Elmer Lindseth Dean Emeritus, John Graduate School of Management, Cornell University, Ithaca, New York, Former Board Member of FASB ABSTRACTFinancial reporting disclosures are very essential to the shareholders of a company becausethey frequently use these disclosures for their economic decisions about the businessenterprise. Board of directors, corporate management and external auditor may have aninfluence on financial reporting disclosures. From this perspective, the study investigates theinfluence of corporate governance on financial reporting disclosures. The results show thatcorporate governance is significantly associated with the extent of financial reportingdisclosures. External auditor, multilisting and profitability are significantly (5 percent level)associated with overall financial reporting disclosures index.Keywords: Bangladesh, financial reporting disclosure, corporate governance1. IntroductionThis research investigates the influence of corporate governance on corporate financialreporting disclosures. The scandals of high profile companies such as Enron, WorldCom,Tyco and some other firms in the U.S, have realized the question of the effectiveness ofmonitoring mechanisms in organizations (Raphaelson and Wahlen, 2004). Corporategovernance refers to the structures and processes for the direction and control of companies. 20
  • 2. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.orgGood governance contributes to sustainable economic development by enhancing theperformance of companies and increasing their access to outside capital. Corporategovernance reduces emerging market vulnerability to financial crises, reinforces propertyrights, reduces transaction costs and the cost of capital, and leads to capital marketdevelopment. Weak corporate governance frameworks reduce investors’ confidence, and candiscourage outside investment. Also, as pension funds continue to invest more in equitymarkets, corporate governance is crucial for preserving retirement savings (World Bank:2009). Corporate governance is affected by the relationships among participants ingovernance system. Controlling shareholders, which may be individuals, family holdings,bloc alliances, or other corporations acting through a holding company or cross holdings, cansignificantly influence corporate behavior. As owners of equity, institutional investors areincreasingly demanding a voice in corporate governance in some markets. Individualshareholders usually do not seek to exercise governance rights but may be highly concernedabout obtaining fair treatment from controlling shareholders and management. Creditors playan important role in a number of governance systems and can serve as external monitors overcorporate performance. Employees and other stakeholders play an important role incontributing to the long-term success and performance of the corporation, while governmentsestablish the overall institutional and legal framework for corporate governance (OECD:2004).In Bangladesh, January 10, 2011 is called Black Monday because the stock market collapsedon that date and has not yet recovered. Though a lot of measures have been taken by theSecurities and Exchange Commission (SEC), Dhaka Stock Exchange (DSE), ChittagongStock Exchange (CSE), Bangladesh Bank (BB), and Ministry of Finance (MoF), there is noresult of these efforts. Almost every day of the year 2011, small investors were engaged inmany activities, including procession, press-conference, hunger-strike, block the roads, andclose the stock market trade as a part of their expression of frustration. They solicitedintervention of the Prime Minister for stabilizing the market. Even they expressed theiranguish and frustration by opening their chest and inviting government officials to shootthem. The probe report opined that there are many issues that are responsible for collapse ofthe market. Governance of SEC and other institutions could not satisfy the probe committee(PC). One of the main recommendations of the committee was the removal of chairman,executive director and directors of SEC (SMIR, 2011). This recommendation clearly indicates 21
  • 3. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.orga red flag for corporate governance. Whereas, SEC is the only regulating authority of thelisted companies that regulates annual financial reporting disclosures of the companies, it isexpected that the financial reporting disclosures of the companies are not regularly monitored.Under these crucial circumstances, investors believe that the capital market in Bangladesh isvolatile up till now.Good corporate governance is an important prerequisite for attracting the patient capitalneeded for sustained long-term economic growth, and can lead to better relations withworkers, creditors, and other stakeholders. Corporate ownership is concentrated andcompanies are often controlled by a small number of related shareholders. A few companieshave dispersed ownership. Most securities in Bangladesh are held by individuals- thecontrolling family or members of the public – rather than institutions or other companies: 43percent of market is held by sponsors who are from the founders’ families, and 38 percent isheld by the public at large. Sponsors often have management and or board positions incompanies. Institutional investors hold only 10 percent of the market but are sometimesrepresented on company boards. Foreigners hold 1 percent of the market (World Bank: 2009).There is no single model of corporate governance (OECD: 2004). The SEC issued Guidelineson Corporate Governance in 2006. Listed companies are required to “comply or explain”. TheGuidelines cover some key topics, including the functioning of the board, and internal andexternal controls. The Guidelines do not deal with other aspects of corporate governance,including shareholder rights. Compliance is at its early stage – in 2007, about 33 percent ofcompanies declared full compliance with the Guidelines and 60 percent declared partialcompliance (World Bank: 2009). There are no provisions for punitive measures for non-compliance of any one of the conditions mentioned in the notification. Only “comply orexplain” basis is not enough in Bangladesh for ensuring good governance.Although financial information disclosed by the Bangladeshi companies is increasing day byday, the reliability of this reporting is decreasing day by day due to lack of practices ofcorporate governance. Adherence to corporate governance practices will help improve theconfidence of investors, reduce the cost of capital, underpin the good functioning of financialmarkets, and ultimately induce more stable sources of financing (OECD: 2004). Goodgovernance in the corporate sector is a burning issue in Bangladesh. 22
  • 4. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.orgIn this paper we argue that there is obviously an influence of corporate governance oncorporate financial reporting disclosures index. The researchers commence their analysis bymeasuring overall disclosure index by twenty non-financial companies included in DSE. Theresearchers use a comprehensive measure of disclosure that captures the nature and extent ofinformation and are able to glean insights about the disclosures index. This would be the firstknown study to examine the association between corporate governance and overall financialreporting disclosures index. The weak form of corporate governance in Bangladesh allows theresearchers to (1) overview corporate financial reporting practices by non-financialcompanies listed in DSE, (2) identify different aspects of corporate governance , and (3) toexamine the association between corporate governance and corporate financial reportingdisclosures index.Next, the researchers test hypotheses about the relationship between corporate governanceand corporate reporting disclosures index. The researchers capture the impact of corporategovernance using three measures, such as dependent variable (corporate financial reportingdisclosures index), independent variables, and linkage between dependent and independentvariables.Present examination of the relationship between corporate governance and corporate financialreporting disclosures index extends the literature on the determinants of corporate reportingdisclosures index. Previous researches have investigated a range of factors potentiallyassociated with disclosures including board independence, dominant personality, board size,institutional ownership, external auditors, general public ownership, leverage, asset size,profitability, multilisting, and number of shareholders. However, the influence of corporategovernance on corporate financial reporting disclosures index has not been examinedpreviously. Present finding of significant relationship between external auditor and corporatereporting disclosures index supports the tenets of principal-agent theory and demonstrate thepotential for this powerful and legitimate stakeholder group to influence corporate financialreporting disclosures index in Bangladesh. Several other factors found to be associated withcorporate financial reporting disclosures in prior researches have been controlled. A finalcontribution of this research relates to the growing body of literature on corporate governance(external auditor engagement) and corporate financial reporting disclosures. Present studyextends this area of research by investigating and finding support for the role of externalauditor in relation to corporate financial reporting disclosures. The research provides robust 23
  • 5. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.orgempirical evidence in support of claims in the literature that external auditor’s demand candrive corporate action.The remainder of the paper is organized as follows. The next section reviews the priorliterature and develops the hypotheses for the study. Section 3 outlines the data and method,section 4 presents the results of the analysis and Section 5 concludes.2. Literature Review and Hypotheses Development2.1 Prior Literature One function of financial reporting is to restrain management to act against the shareholders’ interest (Watts and Zimmerman, 1978). Due to increasing complexity of business today, there is a demand for disclosure of more comprehensive information in the annual report as both potential and existing investors make their economic decision by using this information. In the global investor opinion survey of McKinsey & Company (2002) on corporate governance issues, a majority of the investors agree that corporate governance remains a great concern with strengthening the quality of accounting disclosures as a top priority. Majority of institutional investors is willing to pay a high premium for companies having good governance. The survey also provides evidence that a majority of respondents (71 percent) states that accounting disclosures are the most important factor that influences their investment decisions and 52 percent of respondents identify that improving financial reporting quality is a governance priority for policymakers. Good governance goes hand-in-hand with reduced risk of financial reporting problems and other bad accounting outcomes (Hermanson, 2003). Information disclosed by the companies in their annual report can be used as important input in various corporate governance mechanisms (Bushman and Smith, 2001). Good governance by board of directors can influence financial reporting disclosures, which in turn has an important impact on shareholders confidence (Levitt, 1998 and 2000). There has been a considerable debate in recent times about the need for strong corporate governance (McConomy and Bujaki, 2000), with the countries around the world drawing up guidelines and codes of practice to strengthen governance (Cadbury, 1992; 24
  • 6. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.org Corporate Governance Code of Bangladesh, 2006). The rationale for this emphasis can be linked to growing concerns over the integrity of stock markets (International Federation of Accountant – IFAC, 2010; Millstein, 1999). Previous studies have shown that good corporate governance reduces adverse effects of earnings management as well as likelihood of creative financial reporting arising from fraud or errors (Beasley, 1996; Dechow, et al, 1996; McMullen, 1996). Traditionally, the external auditor has also played an important role in improving the credibility of financial information (Mautz and Sharaf, 1961; Wallace, 1980). The differences in corporate governance across countries emerge as a result of the variations in the ownership structure and understanding the effects of various ownership structure variables is vital to shed light on corporate governance and control process of firms under difference national types of institutional arrangements (Li, 1994). Recent empirical works on the association between traditional financial reporting disclosures and corporate governance Chen and Jaggi (2000) and Eng and Mark (2003). Chen and Jaggi (2000) find a positive association between the proportion of independent non-executive directors and the comprehensiveness of information in mandatory financial disclosure of Hong Kong companies. Eng and Mark (2003) find that lower managerial ownership and significant government ownership are associated with increased disclosure and that an increase in outside directors reduces the corporate disclosure of firm listed on the Stock Exchange of Singapore. In Malaysia, one-man or family run companies (Halim, 2001) and significant government equity holdings (Abdullah, 2006) distinguish the ownership pattern of Malaysian companies that may complicate the corporate governance systems. Extensive occurrence of individual and family run companies tends to discourage professionalism, encourage non-compliance and facilitate creative accounting as well as to result in severe conflicts of interests (Halim, 2001).2.2 The Variables and Hypotheses Development 2.2.1 Dependent Variable: An Overall Disclosures Index (ODI) of sample companies was used as the dependent variable and several corporate governance and control variables were used as the 25
  • 7. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.org independent variables to test the influence or impact of the corporate governance variables over the ODI. 2.2.2 Primary Independent Variables (Corporate Governance Variables): 1. Board Independence (bi) 2. Dominant Personality (dp) 3. Board Size (bs) 4. Institutional Ownership (io) 5. General Public Ownership (gp) 6. External Auditor (ea) 2.2.3 Secondary Independent Variables (Control Variables) 1. Leverage (lvg) 2. Asset Size (asstsz) 3. Profitability (profitab) 4. Multi Listing (multilis) 5. Number of Shareholders (shareholders)Board IndependenceThe board, which comprises a number of independent directors, has a greater monitoring andcontrolling ability over management (Fama and Jensen, 1983). The state of ‘independence’ ismet when a director inter alia is neither holding significant ownership nor holding anyexecutive position in the company (Bursa Malaysia, 2006). In Bangladesh, SEC corporateguidelines stated that one-tenth of the total number of the company’s board of directors,subject to a minimum of one, should be independent directors. But in Malaysia, if a companyhas only three board members, two of them are required to be independent (Bursa Malaysia,2006). Fama and Jensen (1983), Ho and Wong (2001), Cheng and Courtenay (2004) andNorita and Shamsul-Nahar (2004) found a significant positive association. On the other hand,Eng and Mark (2003), Gul and Leung (2004) and Barako et al. (2006) found a negativeassociation. This variable is taken in this study as an independent variable and the hypothesisis as follows: 26
  • 8. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.org Ho: There is no association between board independence and overall disclosures index.CEO Duality / Dominant PersonalityThe corporate governance literature has emphasized the need to separate the position of CEO(chief executive officer) and board chairman to guarantee the board independence andimprove transparency (Jensen, 1993). In this respect, Dechow et al. (1996) revealed that theduality CEO-chairman increases the likelihood of violating the accounting principles inAmerican firms. Byard et al. (2006) indicated that the presence of a CEO who serves also asthe board chairman is associated with poor quality of financial information. Similarly, Beekset al. (2004) and Firth et al. (2007) reported that the financial reporting is more relevant in thecase of separating the positions of CEO and board chairman for British and Chinese firms.Nevertheless, other authors did not detect a significant association between CEO duality andfinancial reporting (Ahmed et al., 2006; Bradbury et al., 2006; Petra 2007). CEO duality isconsidered as an independent variable in this study and the hypothesis is as under: Ho: There is no association between CEO Duality and overall disclosures indexBoard SizeThe number of directors is an important factor in the board of directors’ effectiveness. Alarger board size may bring a greater number of directors with experience (Xie et al., 2001)that may represent a multitude of values (Halme and Huse, 1997) on the board. On thecontrary, a reduced number of directors imply a high degree of coordination andcommunication between them and managers (Jensen, 1993). Chaganti et al. (1985) claimedthat smaller boards are manageable and more often play a role as a controlling functionwhereas larger boards may not be able to function effectively as the board leaves themanagement relatively free. Indeed, Vefeas (2000), Ahmed et al. (2006) and Bradbury et al.(2006) found that large board size reduces the information content of income and intensifiesthe earning management respectively for American, Singapore and New Zealand firms.However, several authors argued that the high number of directors ensures the value relevanceof financial statements (Byard et al., 2006), while others did not confirm this link (Firth et al.,2007). The study by Bonn (2004) found no relationship between board size and firmperformance. She further argued that the board size only measures the factual number of 27
  • 9. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.orgdirectors without capturing their task. Hence, one could argue that it is the skills andknowledge base that the board brings to the firm not the number. In contrast, Dwevedi andJain (2005), found an insignificant positive relationship. They conclude that larger boards arein a position to improve the governance of the company. As such, board size is used as anindependent variable in the current study and the hypothesis is as follows: Ho: There is no association between board size and overall disclosures index.Institutional OwnershipConsidering the influence of shareholder activism in governance reforms is important toobtain insight into governance practices (Daily et al., 2003). To date, institutional investors’participation has emerged as an important force in corporate monitoring mechanism to protectminority shareholders’ interest. The significant increase in the institutional shareholdings hasled to the formation of a large and powerful constituency to play a significant role incorporate governance. In the UK, institutional investors own between 65 to 75 percent of theUK stock market, which suggest a prominent role that institutional shareholders can play asan agent to the governance systems (Mallin,2003). To mitigate the problems associated withconflict between controlling owners and minority shareholders in Asian firms, theinvolvement of institutional investors’ equity participation may improve corporategovernance practices (Claessen and Fan, 2002). Concentrated shareholdings by institutionprovide an incentive for diligent monitoring as they have the resources, expertise and strongerincentives to actively monitor the actions of management and prevent managers’opportunistic behavior (Wan Hussin and Ibrahim, 2003).Institutional shareholders are often characterized in academic research as sophisticatedinvestors who have advantages in acquiring and processing information compared with otherinvestors (Bartov et al., 2000; Jiambalvo et al., 2002). Consequently, institutional investorscan be more effective as traders and monitors than can small, diffuse retail investors.Intuitional investors could actually prefer that information not be broadly disseminatedbecause they are concerned about either a decline in the quality of the informationcommunicated or a loss of their information advantage (NIRI, 2000). Recent studies indicatea negative relation between institutional ownership and voluntary disclosure (Kelton et.al.2004). While examining the determination of a firm’s decision to provide shareholders accessto conference calls, Bushee at al. (2003) find that firms that provide open conference calls 28
  • 10. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.orghave a lower institutional ownership than firms that do not provide open calls. Institutionalownership is accepted in the present study as an independent variable and the hypothesis is asgiven below. Ho: There is no association between institutional ownership and overall disclosures index.General PublicDifferences in the proportion of a firm that is owned by outsiders may account for some of theobserved differences - in the comprehensiveness of mandatory disclosure, because the greaternumber of people who need to know about the affairs of a firm, the greater will be the detailsrequired of an item of information and the more comprehensive the disclosure of a firm willbe (Apostolou and Nanopoulos, 2009). Leftwich et al. (1981) suggested that issuing financialreports could solve monitoring problems associated with increases in the proportion of thefirm owned by outsiders. If this is true, one would expect to find from a population ofreporting firms that, as the number of shareholders or the proportion of the firm owned byoutsiders’ increases, the financial information disclosed in annual reports will become morecomprehensive. It is expected that if a company has a large proportion of public ownership,the political cost will be bigger and the company will decide to disclose more information.General Public is an independent variable and the hypothesis is- Ho: There is no association between general public and overall disclosures index.External AuditorThe external audit can be an effective control mechanism to monitor the managers andguarantee the integrity of financial reports (Jensen and Meckling, 1976; Watts andZimmerman, 1983). The appointment of an independent external auditor can reduce theprobability of earnings manipulation by shrinking managerial opportunism (DeAngelo, 1981;Becker et al., 1998; Chung et al., 2003). In practice, the auditor reputation or quality isassociated with being part of or affiliated with a major international auditing firm (Brown etal., 2010). Several authors advocated that financial information is more reliable for “BIG 4”clients in comparison with other companies (Teoh and Wong, 1993; Becker et al., 1998). InBangladesh, there are six audit firms that have international links. The following tablepresents the list of those audit firms: 29
  • 11. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.org Table-3: International Link of Audit FirmsName of the firm International firm with which linkedRahman Rahman Haq and Co. KPMGHoda Vasi Chowdhury and Co. Delloite Haskins and SellsS.F. Ahmed and Co Earnest and YoungHowlader Younus and Co. Arther YoungA Quasem and Co. Cooper and LybrandM.J. Abedin and Co. Moor StephenExternal auditor is an independent variable and our hypothesis is- Ho: There is no association between external auditor and overall disclosures index.LeverageBusiness enterprises may borrow from different sources. Lending institutions always want toensure security of their supplied funds. Lenders want reliable information about borrowers.That is why borrowers usually furnish more information in their annual reports to meet theinformation needs of creditors, investors and other stakeholders. So, there is an associationbetween the amount of loan and the level of disclosure of the reporting entity. Considering,these things, a few disclosure studies were conducted to examine the association, if any,between gearing ratio and corporate disclosure level. Ahmed and Nicholls (1994) and Chowand Wong-Boren (1987) have found no significant association between leverage ratio and theextent of voluntary disclosure in Bangladesh and Mexico respectively. Karim (1996) andBelkaoui et al. (1977) have observed a significant negative relationship between thementioned variables. On the contrary, Robbins and Austin (1986) had found a significantpositive correlation between debt and municipal disclosures. Leverage is selected as anindependent variable and our hypothesis is- Ho : There is no association between leverage and overall disclosures index.Asset Size 30
  • 12. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.orgMany disclosure studies e.g., Chow and Wong-Boren (1987); Cooke (1991, 1992 and 1993);Ahmed and Nicholls (1994) suggest that there is a significant relationship between companyasset size and the extent of voluntary disclosure. Ahmed and Courtis (1999) carried out ameta-analysis of 28 disclosure studies and found that a significant association exists betweencorporate size and disclosure levels. Marston and Shrives (1996) reviewed a number ofdisclosure studies and reached the same conclusion. Therefore, asset size is selected as anindependent variable and our hypothesis is – Ho : There is no association between asset size and overall disclosure index.ProfitabilityProfitability affects the level of disclosures. Adelberg (1979) found that the narrativedisclosures were deliberately made complex to communicate bad news and made more lucidand easily understandable to communicate good news. As profits are always good news to theinvestors and other stakeholders, therefore, management discloses more information aboutthis variable in their annual reports. Profitability was used by a number of researchers as anindependent variable for fluctuations in disclosure level. There are mixed results found aboutthe association between profitability and disclosure. Singhvi (1967), Singhvi and Desai(1971), Inchausti (1997), Raffournier (1995), Wallace and Naser (1995), Cerf (1961),Hossain (1998), Razzaque (2004), Ahmed (2009) and Hasan (2011) found a positiveassociation between profitability and the extent of disclosure. But, Belkaoui and Kahl (1978)found a negative association between them. Again, McNally et al. (1982), Malone et al.(1993), Meek et al. (1995), Suwaidan (1997), and Abd Elsalam (1999) found no associationbetween them. Profitability is used as an independent variable and our hypothesis is - Ho : There is no association between profitability and overall disclosures index.Multiple ListingThe capital orientation of companies may also influence companies in making differentialdisclosure. Voluntary disclosures may be associated with the objective of raising capital(Horngren, 1957; Cooke, 1991). Listing status may also be viewed as a screening scenario.Firms listed in more prestigious markets may provide signals to customers, suppliers and 31
  • 13. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.orgcreditors about the strength of the company and that may also encourages brand recognition.It also provides signals about the future prospects of the company (Mittoo, 1992). That alsoimpacts on the perceptions of other groups like government and local authorities, consistentwith Roberts et al. (1998); Wallace, Naser and Mora (1994) are also in the same opinion.Listing status has been tested and identified to be significant by Firth (1979), Cooke (1989),Meek and Gray (1989), Wallace et al. (1994), Hossain et al. (1995), Meek et al. (1995) andInchausti (1997). Multiple listing is used as an independent variable and our hypothesis is - Ho : There is no association between multiple listing and overall disclosures index.ShareholdersShareholders are the real owners of a company. They are also treated as internal and externalstakeholders. They have direct interest to the company. They can change the management andappoint new agents if they believe that the existing management is not managing the entityefficiently. It is expected that a large number of shareholders will exert more pressure onmanagement. Number of shareholders is an important factor in determining the corporatedisclosure level (Alam, 2008) and as such it is taken as independent variable in this study.The hypothesis is- Ho: There is no association between number of shareholders and overall disclosuresindex.3. Methodology3.1 Selection of SampleStratified sampling technique was used as our populations were heterogeneous and it reducesthe sampling error. Each business segment was considered as a stratum and accordingly fourstratums had been selected purposively and five companies were then selected from eachstratum as shown in the following table. Table -1: Distribution of Population and Sample Size of the Companies Sample as percent Percent of total Stratum Population Size Sample Size of Population Sample Textile 12 5 42 25 Pharmaceuticals 13 5 38 25 Cement 7 5 71 25 32
  • 14. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.org Food & Allied 8 5 63 25 Total 40 20 214 100Total size of population was 40 and sample size was 20 which represent 50 percent of totalpopulation. The sample size in terms of percentage of population was dissimilar and thepercent of sample size of each stratum was equal i.e., 25 percent.3.2 Selection of Disclosure ItemsA draft check list was prepared that provided the basis for a survey with yes / no questionsthat was used to select the individual items for the final checklist. Finally, two-hundred itemswere used to measure a company disclosure score. The 200 items reflect the followingdisclosure items of an annual report. Table -2: Summary of Draft and Final Disclosure Checklist Disclosure Total Items (Draft) Items accepted (Final) Percentage of Parts Key items accepted Number % Number %General Disclosure Items GDI 25 11 20 10 80Company Profile Items CPI 25 11 15 8 60Directors Report Items DRI 30 14 28 14 93Financial Highlight Items FHI 30 14 27 14 90Accounting Polices Items API 26 12 26 13 100Income Statement Items ISI 14 6 14 7 100Balance Sheet Items BSI 48 22 48 24 100Cash Flow Statement Items CFSI 22 10 22 11 100 Overall Disclosure 220 100% 200 100% 91%3.3 Scoring the Disclosure ItemsVarious approaches are available to develop a scoring scheme to determine the disclosurelevel of corporate annual reports. The items were considered equally important to disclose andhence a dichotomous unweighted approach was used for scoring. If a company discloses anitem it will be awarded one and if not it will be awarded zero.3.4 Developing Overall Disclosure Index 33
  • 15. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.orgPartial Compliance Unweighted Approach was used to measure the overall disclosure index.This is the first time that this approach is used in Bangladesh to measure the overall disclosureindex because the level of compliance of the companies is not the same. The formula is asfollows:Where, PCJ = Total compliance score for each company and Xi = Level of compliance with each part of disclosure requirement. Rj = Total number of disclosure part of each company.6. Statistical Analysis6.1 Descriptive Statistics for Surveyed CompaniesDescriptive analysis of a company is essential in order to measure the company performancein disclosing information in the annual report. In this overall disclosure indexes, standarddeviation, coefficient of variation and rank of the companies have been calculated. Rankinghas been made on the basis of coefficient of variation of the company; the lowest coefficientof variation means the company is more consistent in disclosing information in annual reportand received upper rank. Table-3: Descriptive Statistics of Surveyed CompaniesSerial Descriptive Statistics Company Name Rank No. Mean SD CV ODITextile Segment: 1 HR Textile Mills Limited 12 0.56 0.26 0.46 0.67 2 BEXTEX Limited 5 0.76 0.14 0.19 0.63 3 Apex Weaving and Finishing Ltd 8 0.66 0.14 0.22 34
  • 16. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.org 4 Saiham Textile Mills Ltd. 11 0.49 0.16 0.33 5 Alltex industries limited 8 0.69 0.15 0.22Pharmaceuticals Segment: 6 IBN SINA 7 0.74 0.16 0.21 7 LIBRA 3 0.73 0.13 0.17 8 SQUARE 4 0.80 0.14 0.18 0.72 9 BEXIMCO 10 0.71 0.18 0.26 10 ORION 10 0.62 0.16 0.26Cement Segment: Heidelberg cement Bangladesh 11 Ltd. 1 0.81 0.10 0.12 12 Meghna Cements Mills Ltd. 11 0.62 0.20 0.33 13 Aramit Cement Ltd. 9 0.62 0.15 0.24 0.67 14 Confidence Cement Ltd. 2 0.63 0.09 0.14 15 Lafrage Surma Cement Ltd. 9 0.65 0.15 0.24Food and Allied Segment: 16 Apex Foods Ltd 2 0.74 0.10 0.14 17 Fu-Wang Foods Ltd 8 0.66 0.15 0.22 18 Gulf Foods Ltd 6 0.65 0.13 0.20 0.66 19 Fine Foods Ltd 9 0.61 0.15 0.24 Rahima Foods Corporation 20 11 0.65 0.21 0.33 Ltd6.2 Descriptive Statistics for Independent VariablesThere is diversity of the levels of financial disclosures across companies. The overall financialdisclosures index score assigned to the companies had a mean disclosure index of 67 percent,a standard deviation of 0.07, a maximum score of 81 percent, and a minimum score of 49percent. Hence, the aim of the analysis was to identify the variables, both quantitative andqualitative, that were responsible for such variations in the level of financial disclosures. Thedescriptive statistics for the dependent and independent variables are presented in thefollowing table. Table- 4: Descriptive Statistics for Dependent and Independent Variables Variables N Minimum Maximum Mean Std. Deviation Odi 20 0.49 0.81 0.67 0.08 35
  • 17. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.org Bi 20 0.00 60.00 17.50 12.21 Dp 20 0.00 1.00 0.30 0.47 Bs 20 4.00 11.00 7.15 2.01 Io 20 0.00 83.90 28.42 23.03 Gp 20 12.35 68.33 37.65 16.07 Ea 20 0.00 1.00 0.25 0.44 Lvg 20 0.00 1.00 0.75 0.44 Asstsz 20 14.74 12218.00 2272.72 3914.73 profitab 20 -15.66 156.56 21.87 41.19 multilis 20 0.00 1.00 0.95 0.22 sholders 20 545.00 65556.00 13567.25 17622.87 6.3 Correlation Matrix and Multicollinearity Analysis Pearson’s Pair Wise Product Moment Correlation Coefficient (r) is computed in order to examine the correlation between dependent and independent variables. A correlation matrix of all the values of r for the independent variables along with the dependent variables had been constructed by using Statistical Package for Social Science (SPSS), which is shown in the following table. Table- 5: Correlation MatrixVariable odi bi Dp Bs Io Gp ea lvg astsz pftab multilis sholdersOdi 1Bi -0.10 1Dp 0.37 -0.14 1Bs 0.21 -0.44* -0.44* 1Io 0.30 -0.01 -0.19 0.62** 1Gp 0.05 -0.26 0.10 -0.13 -0.57** 1Ea 0.48* -0.17 0.13 0.37 0.34 -0.07 1Lvg 0.43* 0.11 0.38 0.16 0.36 -0.44* 0.33 1Astsz 0.33 -0.27 -0.04 0.76** 0.57** -0.22 0.45* 0.32 1Pftab 0.54** -0.21 0.20 0.39* 0.45* -0.09 -0.04 0.26 0.39* 1Multilis 0.54** 0.06 0.15 0.02 0.12 -0.16 0.13 0.40* 0.12 0.05 1sholders 0.42* -0.22 0.13 0.42* 0.13 0.17 0.41* 0.39* 0.64** 0.31 0.12 1* Correlation is significant at the 0.05 level (1-tailed).**Correlation is significant at the 0.01 level (1-tailed). 36
  • 18. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.orgMulticollinearity in the independent variables had been diagnosed through bivariate analysis.The above table represents the correlation matrix of the dependent and independent variables.Judge et al. (1985) and Bryman and Cramer (1997) suggested that simple correlation betweenindependent variables should not be considered harmful until they exceed 0.80 or 0.90. Thehighest value of the observed correlations is 0.76; therefore, the observed correlations are notharmful. These finding suggest that multicollinearity between independent variables isunlikely to pose a serious problem in the interpretation of the results of the multivariateanalysis.6.4 ANOVA TechniqueOne way ANOVA technique was used to have a concrete outcome of accepting or rejectingthe hypothesis. The following table shows the ANOVA and the level of significant at 5percent. Table- 6: ANOVA (b)model sum of squares df mean square F sig. 1 Regression 0.097358001 11 0.008850727 Residual 0.021241999 8 0.00265525 3.3332935 0.049186143 Total 0.1186 19 a predictors: (constant), sholders, multilis, io, bi, dp, ea, gp, profitab, lvg, asstsz, bs b dependent variable: odiThe table-6 gives us a direction regarding the acceptance or rejection of hypothesis. P valueindicates that there is a significant relationship between corporate governance and overalldisclosure index. Therefore, null hypothesis (Ho) is rejected.6.5 Empirical ModelIt is already observed from the above analysis that there is a relationship between corporategovernance and the extent of disclosure, but the effect of each variable on the disclosure levelis still unknown at this stage. The following Ordinary Least Square (OLS) regression model isdeveloped in order to identify the effect of each variable on the disclosure level.Where, 37
  • 19. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.org ODI = Overall Disclosure Index α = the intercept ε = the error termIn regression analysis, the enter method of Statistical Package (SPSS) was used in order toverify the influence of independent variable that were chosen for the study over the dependentvariable. The summary output of the model for the all sample companies is shown in thefollowing table. Table – 7: Model Summary Model R R Square Adjusted R Square Std. Error of the Estimate 1 .906(a) 0.821 0.575 0.05153 a Predictors: (Constant), sholders, multilis, io, bi, dp, ea, gp, profitab, lvg, asstsz, bsThe adjusted coefficient of determination of R2 indicates that around 57 percent of thevariation in the dependent variable is explained by variations in the independent variables.Thus the model is capable of explaining 57 percent variability of disclosed information in theannual reports of sample companies. Table- 8: Coefficients (a) Unstandardized Standardized Model Variables Coefficients Coefficients T Sig. B Std. Error Beta (Constant) 0.438 0.175 2.495 0.037 Bi 0.001 0.002 0.093 0.340 0.743 1 Dp 0.007 0.072 0.042 0.097 0.925 Bs -0.005 0.025 -0.118 -0.189 0.855 Io 0.000 0.001 0.038 0.131 0.899 Gp 0.001 0.001 0.250 0.944 0.373 Ea 0.092 0.038 0.519 2.414 0.042 Lvg 0.006 0.056 0.032 0.103 0.921 Asstsz 0.000 0.000 -0.058 -0.138 0.894 Profitab 0.001 0.000 0.611 2.500 0.037 Multilis 0.161 0.058 0.455 2.752 0.025 Sholders 0.000 0.000 -0.003 -0.012 0.991 A Dependent Variable: odi 38
  • 20. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.orgIt is observed that external auditor, profitability and multi listing are significantly associatedwith disclosures level. The coefficient of external auditor, profitability and multi listing arestatistically significant at 5 percent level.The board independence, board size, dominant personality, institutional ownership, generalpublic, leverage, assets size, and number of shareholders are not statistically significant evenat 10 percent level.6. DiscussionsThe purpose of the current study is to examine the level of financial disclosures amongBangladeshi companies and its association with corporate governance characteristics. On thewhole, the study concludes that the level of financial disclosures in Bangladesh is increasinggradually but it is still below the level of expectation. Besides, the reliability and transparencylevel of financial disclosures is very low and hence the confidence level of external users’ isalso at a very low stage. Therefore, shareholders do not use the information provided in theannual report in making their economic decisions as they do not have confidence on it. Thestudy found that there is an association between corporate governance characteristics and thelevel of financial disclosures. The authors used six corporate governance variables in thecurrent study. Only the association between external auditor and the level of financialdisclosures is found significant. In support of agency-theory and involvement of competentauditors’, the authors provide evidence of the ability of a competent auditor to influencecorporate financial disclosures reporting. World Bank report stated that audits are notreviewed in Bangladesh and many market participants are skeptical of audit quality. Thereare some key weaknesses in the non-financial disclosure frame work, especially in thedisclosure of ownership and control.Other variables such as board independence, board size, dominant personality, institutionalownership and general public are not significantly associated with the level of financialdisclosures. The weakness of these variables indicates that corporate governance structure ofBangladesh is weak. World Bank (2009) assessed corporate governance scenario inBangladesh. According to the report, ‘some companies have one independent director, somehave none, board size is about 6 to 8 members, ownership is concentrated by a small numberof related shareholders- sponsors held 43 percent of the market, general public held 38 percentand institutional investors held 10 percent’. The WB report clearly shows that board 39
  • 21. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.orgindependence, board size, institutional ownership and general public are not in a position toinfluence corporate financial reporting disclosures.The more powerful the stakeholders, the more prepared the company to adapt to meet thestakeholders expectations (Cotter, 2011). According to this statement, only concentratedownership has the power to influence the level of corporate financial reporting disclosures inBangladesh. Stakeholders’ theory typically views the world from the perspective of themanagement of the organization who are concerned strategically with the continued successof the company (Roberts, 1992). External users rely on the report provided by external auditoras they cannot access to the information of companies directly. These external users wouldlike to have more relevant and reliable information which is used in making their economicdecisions. According to agency theory, there exists a conflict of interest between concentratedownership and external users. Again, as per stakeholder theory, a company’s continuedexistence needs the support of its stakeholders and their approval must be sought and theactivities of the corporation be adjusted to meet their expectations (Cotter, 2011). Thus, themanagement of corporations always tries to make them successful by providing a rosy pictureof companies. Under these circumstances, the opinion about the financial disclosures ofexternal auditor plays an important role to the external users. The primary objective ofappointing an external auditor is to protect the right of external stakeholders by producing atrue and reliable audit report. In Bangladesh, external auditors work for clients like otheremployees and their activities cannot protect the right of external stakeholders and this is theonly reason for which external stakeholders do not fully rely on annual report in making theireconomic decisions. It is commonly believed that auditors are working only for their ownincentives and companies disclose information only to comply with the SEC rules andregulations. But, SEC does not examine the compliance of financial disclosures and corporategovernance code. Consequently, the image of external auditor in Bangladesh is degrading dayby day. Although concentrated ownership has the power to influence the level of corporatedisclosures but they do not have sufficient knowledge about accounting and financialreporting in Bangladesh.External auditor (an expert in accounting, reporting and auditing) is the only authority (as perthe Companies Act. 1994) to certify the financial statements of limited companies. Externalstakeholders are to rely on the audit report. Obviously, the audit report is an influential factorabout level of disclosures, reliability, relevancy, consistency, transparency and so on. But, 40
  • 22. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.orgexternal users do not have faith on audited financial statements and disclosures. In theInternational Conference of Chartered Accountants in Dhaka, the Honourable President of thePeople’s Republic of Bangladesh Md. Zillur Rahman (2010) warned the professionalaccountants that “The government mostly depends on direct and indirect taxes to meet budgetexpenditure but many individuals or institutions for avoiding the tax amounts prepare theirbalance sheets in ways which do not reflect the real accounts,”. Again in 19th Convocationorganized by ICAB, President Md. Zillur Rahman (2011) urged the Chartered Accountants toshow utmost honesty and integrity alongside their professionalism in preparing the financialstatements for government and corporate entities. He opined that the professional CharteredAccountants must always work to ensure transparency and accountability. Therefore, theresult of our study is fully supported by the assumptions of external stakeholders and others.7. ConclusionIt is evident from the above discussion that external auditor, a corporate governance variable,can significantly influence the level of corporate financial disclosures. Other variables, suchas, board independence, board-size, dominant personality, institutional ownership and generalpublic are not meaningfully associated with the level of financial disclosures. As such, thecorporate governance structure in Bangladesh is not at the acceptable level.Finally, there is a potential limitation in the present study that needs to be acknowledged.Board competencies, family ownership, managerial ownership, competencies of auditcommittee members and so on have not been included in corporate governance variables asthese disclosures were not available in the corporate annual report. There are also some keyweaknesses in the non-financial disclosure frame work, especially in the disclosure ofownership and control (WB, 2009).7. Opportunities for Further ResearchFindings of this study warrant further investigation on corporate governance scenario inBangladesh. An empirical study can be conducted by applying survey method as the datarequired to measure corporate governance is not available in corporate annual reports. In thiscontext, it is essential to collect data by using governance & transparency index (GTI). 41
  • 23. European Journal of Developing Country Studies, Vol.9 2010 ISSN(paper)2668-3385 ISSN(online)2668-3687 www.BellPress.orgAcknowledgementThe authors acknowledge the involvements and comments of following well-knownresearchers in the field:Richard Heaney, University of Western Australia, Zahirul Hoque, La Trobe University,Australia, Kamran Ahmed, La Trobe University, Australia, Asheq Rahman, MasseyUniversity, New Zealand, Omar Al Farooque, University of New England, Australia, JillSolomon, King’s College, London, UKReferences:Abd Elsalam (1999). cited in Jahangir Alam (2008). Financial disclosure in developing countries with specialreference to Bangladesh. Doctoral Dissertation, University of Ghent, Belgium.Abdullah, S. N (2006). Board structure and ownership in Malaysia: The case of distressed listed companies.Corporate Governance, 6(5): 582-594Adelberg, A. H. (1979). Narrative disclosures contained in annual reports: means of communication ormanipulation. Accounting and Business Research, 10 (Summer): 179-189Ahmed. Alim Al Ayub (2009). Compliance of financial disclosure in corporate annual reports of banking sectorin Bangladesh. Doctoral Dissertation, University of RajshahiAhmed, K., Hossain, M. & Adams, M. (2006). The effects of board composition and board size on theinformativeness of annual accounting earnings. Corporate Governance: An International Review, 14, (5): 418-431Ahmed, K. and Des Nicholls (1994). The impact of nonfinancial company characteristics on mandatorydisclosure compliance in developing countries: The case of Bangladesh. The International Journal of AccountingEducation and Research, 29: 62-77Ahmed, K. and Courtis, J. K (1999). Association between corporate characteristics and disclosure levels inAnnual Reports: A Meta-Analysis, British Accounting Review, 31(1): 35-61Alam, Jahangir (2008) Financial Disclosure in Developing Countries with Special Reference to Bangladesh.Doctoral Dissertation, University of Ghent, Belgium.Apostolou, K. Apostolos and Konstantinos A. Nanopoulos.(2009). Voluntary accounting disclosure andcorporate governance: evidence from Greek listed firms. Int. J. Accounting and Finance, 1(4)Barako, D. G., Hancock, P. and Izan, H. Y. (2006) Relationship between Corporate Governance Attributableand Voluntary Disclosures in Annual Reports: The Kenyan Experience. Financial Reporting, Regulation andGovernance, 5(1): 1-25.Bartov, E., Radhakrisnan, S. and I. Krinsky. (2000). Investor sophistication and patterns in stock returns. TheAccounting Review. 75 (1): 43-63Becker, C., DeFond, M., Jiambalvo, J & Subramanyam, K. (1998). The Effect of Audit Quality on EarningsManagement. Contemporary Accounting Research, , 15: 1-24 42
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