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Siagian2013
1. The current issue and full text archive of this journal is
available at www.emeraldinsight.com/2042-1168.htm
JAEE 3,1
reporting
quality,
and firm
value:
evidence
from
Indonesia
2. 4 Ferdinand Siagian
College of Business, Minnesota State
University,
Mankato, Minnesota, USA, and
Sylvia V. Siregar and Yan Rahadian
Accounting Department,
University of Indonesia, Jawa Barat, Indonesia
Abstract
Journal of
Accountin
g in
Emerging
Economie
s
V
o
l
.
3
N
o
.
r
D
O
Purp
ose –
The
purp
ose
of
this
paper
is to
inves
tigate
whet
her
corpo
rate
gover
nanc
e
practi
ces
and
the
qualit
y of
repor
ting
are
assoc
iated
with
firm
value
for
publi
c
firms
in
Indo
nesia.
Desi
gn/m
ethod
ology
/appr
oach
– The
autho
rs
hypot
hesiz
e that
there
are
positi
ve associations
between firm
value and
corporate
governance
practices and
reporting
quality. For the
authors’
proxies for
corporate
governance and
reporting
quality they
develop two
new indices.
First, they
develop a
corporate
governance
index (the CGI)
to measure
corporate
governance
practices by
Indonesian
firms. Second,
they develop a
reporting
quality index
(the RQI) to
measure the
firms’ quality
of reporting
and
disclosures. To
examine the
associations the
authors run
multivariate
regressions of
their proxies
for firm value
on the two
indices.
Findings –
Consistent with
the first
hypothesis, the
paper finds
positive
associations
between
corporate
go
ve
rn
an
ce
an
d
dif
fer
en
t
pr
ox
ies
of
fir
m
va
lu
e.
Th
es
e
fin
di
ng
s
su
gg
est
th
at
fir
ms
th
at
im
pl
e
m
en
t
be
tte
r
co
rp
or
ate
go
ve
rn
an
ce
ha
ve higher
values.
Contrary to
the second
hypothesis,
the paper
finds
negative
associations
between
reporting
quality and
the proxies
for firm
value. These
findings
indicate that
lower value
firms tend to
disclose
more
information
that is
consistent
with the
P3LKE than
higher value
firms.
Research
limitations/i
mplications –
The results
suggest that
corporate
governance
practice by
Indonesian
public firms
is value
relevant and
therefore,
should
provide
incentives to
the firms to
improve their
governance.
This shows
that the
Indonesian
government’s
efforts to
promote
corporate
governance
3. provide
benefits
to
publicly
traded
firms.
The
results
also
indicate
that
firms
with low
values
are more
likely to
disclose
informat
ion that
is
consiste
nt with
the
P3LKE.
This
warrants
further
research
because
this
finding
is
inconsist
ent with
the
contenti
on that
more
disclosu
res
s
h
P
r
The
autho
rity
needs
to put
more
effort
s in
prom
oting
good
corpo
rate
gover
nanc
e
imple
ment
ation
s and
maki
ng
sure
that
publi
c
firms
impr
ove
their
discl
osure
s and
repor
ting
qualit
y in
order
to
provi
de
benef
its to the users
of financial
information.
Originality/val
ue – Corporate
governance
index for
public firms is
not readily
available in
Indonesia.
Therefore, the
authors develop
an index to
measure
corporate
governance
implementation
s by Indonesian
public firms.
To the authors’
knowledge, this
is the first
paper that
develops an
index to
measure
adherence to
the P3LKE,
which is a
comprehensive
measure of the
quality of
reporting.
Keywords
Corporate
governance,
Disclosure,
Re
po
rti
ng
,
Fir
m
va
lu
e,
Q
ua
lit
y,
Pe
rfo
rm
an
ce,
Pe
rfo
rm
an
ce
m
an
ag
e
m
en
t,
In
do
ne
sia
Pa
pe
r type
Research
paper
1.
Introductio
n
This paper
investigate
s whether
corporate
governance
and the
quality of
reporting
are
associated
with firm
value.
Specificall
y, we test
the
association
between
firms
corporate
governance
index
(CGI)
scores and
their values
that we
measure
using
4. price-to-book value (PBV), Tobin’s Q, and return on assets (ROA). We also
investigate Corporate
the association between firms reporting quality index (RQI) scores and their values. governanceAfter the financial crisis in 1997 and 1998, the Indonesian Government initiated
several efforts to improve corporate governance and reporting quality. For example,
the government through the capital market authority (BAPEPAM) promotes
corporate
governance by requiring independent board members and an audit committee that is
chaired by an independent director (Siagian and Tresnaningsih, 2011). In 2002, the 5
BAPEPAM issued the P3LKE that provides guidance about what to report and
disclose in the financial statements for firms that are publicly traded in the JSX
(BAPEPAM, 2002). The objectives are to improve firm performance and the quality
of
financial statements reported to the public.
Separation of ownership and control creates agency problems within the firms
( Jensen and Meckling, 1976; Fama and Jensen, 1983). As a result, managers may
take
actions that are not for the best interest of the shareholders. Because the shareholders
are usually dispersed and do not have the capabilities to directly monitor and control
managers’ actions, performance of the firm may be harmed. Moreover, the managers
have better information about the firm than the shareholders. This asymmetry of
information costs the shareholders because they cannot make informed decisions.
A set of governance mechanisms can be implemented to mitigate the agency
problems. The purpose of the corporate governance is to make sure that managers
will
act for the best interests of the shareholders. In addition, it can force the managers to
disclose important information so that the information asymmetry between the
managers and shareholders can be minimized. We hypothesize that firms that
implement good corporate governance and have more disclosures will have less
agency
problems and will have higher values.
To test our hypothesis we develop two indices in this study. The first index is the
CGI that we use to measure corporate governance implementations in a public firm.
This index is divided into five parts: rights of shareholders, equal treatment of
shareholders, role of stakeholders, disclosure and transparency, and board
responsibilities. The second index is a reporting and disclosure index (the RQI)
that we develop to measure firm’s adherence to the Financial Reporting and
Disclosure Guidance (the P3LKE) issued by the Indonesian Capital Market
Regulatory Body (the BAPEPAM). We consider firms that adhere to the P3LKE as
firms with high-quality report.
Using a sample of 125 firms that were traded in the JSX we find that corporate
governance is positively associated with firm value suggesting that firms with higher
CGI score have higher value. The results are consistent for all three proxies of firm
value that we use in our tests. In our sensitivity test, we use weighted CGI by putting
different weights on corporate governance practices according to their importance.
We find that the results are consistent with our main test using the non-weighted
scores.
We find that RQI score is negatively associated with all proxies for firm value.
These findings do not support our hypothesis that predicts positive association
5. between reporting quality and firm value. One possible explanation is that firms
with low values disclose more information that is consistent with the P3LKE
because
they try to improve their values by emitting more information to the market. This
inconsistent finding warrants further research to examine why high-value firms
disclose less information that is consistent with the P3LKE.
We make two contributions to the literature. First, we contribute to the literature by
showing that corporate governance is positively associated with firm value for
public
6. JAEE
firms in Indonesia. The use of CGI in Indonesia is still rare because such index for
public
3,1 firms is not readily available. By developing a CGI for public firms we are able to
measure corporate governance implementations by Indonesian firms. Second, to
our
knowledge, compliance to the P3LKE has not been studied before and we are the
first
to develop a checklist to measure firm adherence to the guidance. This index allows us
to
comprehensively evaluate the quality of reporting for our sample firms. Other
studies
6
use other proxies for reporting quality such as earnings management or
discretionary
accruals (Xie et al., 2003), conservatism (Mayangsari, 2003), and restatement of
financial reports (Agrawal and Chadha, 2004). Different from those studies, we use a
comprehensive reporting index issued by the capital market authority. We provide
new evidence that the guidance is more likely to be followed by firms with low value
that is shown by a negative association between the RQI score and firm value.
The remainder of the paper is organized as follows. We draw the theories about the
subjects and develop the hypotheses in Section 2. Section 3 describes the research
method, sample selection procedure, and descriptive statistics. We present the results
of the tests in Section 4 and conclude the study in Section 5.
2. Literature review and hypotheses development
Separation of ownership and control in firms creates agency problems ( Jensen and
Meckling, 1976; Fama and Jensen, 1983). Managers who are involved in firm’s daily
operations have superior information than the shareholders who are usually dispersed.
Because of the dispersion the shareholders do not have the ability to directly observe
the managers. This asymmetry of information creates problems if the managers’
objectives are not aligned with the objectives of the shareholders. There is a potential
moral hazard problem that the managers will pursue their own interests at the expense
of the shareholders. Because of information asymmetry the shareholders cannot
accurately evaluate the actual performance of the managers.
Corporate governance represents a set of mechanisms that are intended to reduce
agency risk that result from information asymmetry (Asbaugh et al., 2004). They
state that corporate governance allows for better monitoring and control so that the
managers are more likely to make decisions that are for the best interest of the
shareholders such as investing in positive NPV projects. It also improves protection
to the shareholders by minimizing opportunistic behavior of the managers that
decreases firm value. Therefore, firms that implement corporate governance are more
likely to have a higher firm value.
Studies find results that support the contention that corporate governance improves
firm value. Durnev and Kim (2005) find firms with higher governance and
transparency rankings are valued higher in stock markets. Asbaugh et al. (2004) find
that firms with better governance have lower cost of equity capital resulting in higher
firm value. Gompers et al. (2003) analyze the empirical relationship of a governance
index with corporate performance and find that corporate governance is strongly
correlated with stock returns during the 1990s. They find that firms with stronger
shareholder rights have higher firm value, higher profits, and higher sales growth.
Mitton (2002) finds that corporate governance positively affects firm performance
during Asian crisis in five East Asian countries. Klapper and Love (2002) use
corporate governance rank data of firms in 14 developing countries and find evidence
7. that corporate governance is positively related to operating performance and market
value. Consistent with the above studies Alves and Mendes (2004) also find positive
impact of corporate governance on stock returns.
8. Beiner et al. (2006) find that corporate governance positively affect firm value but Corporate
they also find reverse causality; higher value firms adopt better corporate governancegovernance practices. They construct a broad CGI based on the Swiss Code of Best
Practice and find result that supports the hypothesis of a positive relationship
between firm-specific corporate governance and Tobin’s Q. They find a one standard
deviation increase in the CGI causes an increase of the market capitalization by at
least 12 percent of a company’s book asset value. Black et al. (2006) also develop a 7
CGI for all public firms in Korea for year 2001 and find evidence that higher CGI is
associated with higher Tobin’s Q.
The above studies show that corporate governance provides benefits to the
shareholders. It improves the quality and independence of the board of directors
and the committees and puts more monitoring and controls on the managers. As
a result, the managers are more likely to take actions that increase firm value.
We hypothesize the following (in alternative format):
H1. Firms with better corporate governance will have a higher value.
Asymmetry of information creates agency problems and increases the risks faced by
the
shareholders. To minimize the asymmetry of information, firms provide information
and
disclosure through financial reports that includes financial statements, notes to
financial
statements, and management discussion and analysis. In addition, firms release
information through voluntary disclosures and the shareholders can obtain
information
about firms through news and information intermediaries such as financial analysts.
Nagar et al. (2003) argue that managers avoid disclosing private information
because
such disclosure reduces their private control benefits. This is consistent with the
opportunistic behavior of the managers due to various motives. They further argue
that
disclosure problem is an important concern for investors and has a key role in capital
market allocation and corporate governance decisions. Healy and Palepu (2000)
state
that corporate disclosure is very important for the functioning of the capital market.
Managers have better information than the shareholders and information differences
give rise to “lemons” problem that can harm the functioning of capital market.
One possible solution to this problem is information intermediaries that provide
information to minimize the asymmetry of information. Another solution is
regulation
such as accounting standards. Regulators are concerned about the investors and issue
regulations that allow firms to provide sufficient information to the shareholders.
In 2002, the BAPEPAM issued the P3LKE that provides a list of items that need to
be reported and disclosed by firms that are publicly traded in the JSX. The purpose
is
to improve reporting quality that will result in better information for the users of the
financial statements. Agency theory states that managers do not always act in
the best interest of the shareholders. More transparency may mitigate some of the
agency problems faced by the firms. Shareholders will be more informed and
9. information gap between the shareholders and the managers can be reduced.
Investors will perceive lower investment risk that would lead to a higher firm value.
Better disclosures will also help the board of directors to perform its oversight
function and various board committees can work more effectively. All these benefits
will result in a higher firm value.
Several studies have examined the benefits of disclosures. Botosan (1997) finds that
greater disclosure is associated with a lower cost of equity capital for firms that
attract
low analyst following. This suggests that disclosure quality positively affects firm
value.
10. JAEE
3,1
8
Table I.
Sample selection
Lambert et al. (2007) show theoretically that information quality directly influences
firms’ cost of capital and that improvements in information quality unambiguously reduce
non-diversifiable risk. Sengupta (1998) finds lower cost of debt in firms with better
disclosures. Healy et al. (1999) investigate whether firms receive benefit from higher
voluntary disclosure by examining changes in capital market factors associated with
increases in analyst disclosure ratings. They find that the expanded voluntary disclosure is
accompanied by improved stock performance, increased institutional ownership, analyst
following, and stock liquidity even after controlling for contemporaneous changes in firm
characteristics including earnings performance, size, and risk. Gelb and Zarowin (2000)
find evidence that disclosure quality provides information benefit to the stock market and
affects stock price positively. They find that enhanced disclosure results in stock prices
that are more informative about future earnings.
Mitton (2002) find that during the Asian Crisis in 1997-1998 firms with high
quality of disclosures show better performance than firms with lower quality. He
finds that firms with higher disclosure quality have significantly better stock price
performance. Baek et al. (2004) also find that during Korean crisis in 1997 firms with
high disclosure quality experienced the lowest stock price decline. These studies
support the contention that disclosure is positively associated with firm value.
Because disclosures help in mitigating various agency problems, reducing investment
risk, and reducing cost of capital, we predict that firms with better disclosures will have
higher value. We hypothesize the following (in alternative format):
H2. Firms with more disclosures will have a higher value.
3. Research design
3.1 Sample selection
Our sample consists of 125 firms that are traded in the JSX in 2003 and 2004 that
submitted a P3LKE report to the BAPEPAM and had available CGI data. We obtain
the financial data from financial reports in the JSX database. We present the sample
selection process in Table I.
From the JSX database we were able to collect 411 firm-year of RQI data and 267
firm-year of CGI data. For the RQI, we collect the data from firms’ financial reports
and evaluate individually the quality of disclosure according to the P3LKE. We also
collect corporate governance data that are only available for some of the listed firms.
The intersection of the two groups of firms results in 248 firm-year. Our data are not
balance panel because not all firms have data for both years. We exclude observations
with negative book value of equity (25 observations), extreme outliers
Total
Firm-
year
Total firms or observations with RQI data 411
Total firms or observations with CGI data 267
Total firms or observation with both data 248
Total observations with negative book value (25)
Total observations with incomplete financial data (20)
Total observation that are considered outliers (15)
Total firm-year in the final sample 188
11. (15 observations), and observations with incomplete financial data (20 observations).
Our final sample includes 188 firm-year of data.
3.2 Empirical test
Our first hypothesis predicts that corporate governance is positively associated with
firm value. Our second hypothesis predicts positive association between reporting
quality and firm value. In our main test, we measure firm value using market to book
value ratio (PBV)[1]. We regress PBV on CGI score and RQI score while controlling
for variables that may affect firm value.
Miller (2005) argues that PBV ratio is an appropriate measure of company value.
Higher PBV ratio is perceived by the market as an indicator of an ability to give higher
economic profit. We calculate PBV by dividing price per share by book value per share.
The CGI score is calculated based on a CGI that we develop using the corporate
governance checklists from IICD, Num and Lam (2006), Standard & Poor’s and
National University of Singapore (2004) checklist, and the OECD principles[2]. This
checklist is completed using secondary data from the financial statements. The
questions are divided into five groups according to the OECD principles: rights of
shareholders, equal treatment of shareholders, role of stakeholders, disclosure and
transparency, and board responsibilities (OECD, 2004). For the main test we do not
put any weight on the group[3].
For the RQI, we follow the guidance issued by the BAPEPAM. The BAPEPAM issued
13 different guidance based on industry, so we develop 13 different checklists with
approximately 650 items in each checklist depending on the industry, which makes it a
comprehensive proxy to measure quality of reporting[4]. For each item, we read the notes
to financial statements to determine whether an item on the checklist is reported and
disclosed. There are three possible answers to the questions in the checklist: disclosed, not
disclosed, or not applicable (N/A). The score is calculated as the ratio of the total number
of applicable items that are disclosed and the total number of items that are applicable to
that firm (total number of items – N/A) as follows:
Corporate
governance
9
Score
¼
12. ð items
N =AÞ
For example, if a firm has 500
items and discloses all items
and does not have ten items
out of a total of 650 items on
the list, it will score 500/
(65010) ¼ 0.78. It means the
firms does not disclose a total
of 140 items and loses 0.22
disclosure points. In
calculating the RQI score we
realize the possibility of bias
because of the difficulty in
identifying whether an item
that is not disclosed or is not
applicable. For example,
P3LKE requires disclosure for
prepaid expense. We will not
ob
ser
ve
an
y
dis
clo
sur
e
ab
ou
t
pr
ep
aid
ex
pe
ns
e
in
t
h
e
fi
n
a
n
c
i
a
l
r
e
p
o
rt
o
f
fi
r
m
s
t
h
at
d
o
n
o
t
h
a
v
e
a
p
r
e
p
ai
d expense account and of firms
that do not want to disclose their
prepaid expenses. In the first
case, the score would not be
negatively affected by not
disclosing prepaid expense
because the firm does not have
the account. In the second case,
the firm should get a lower score
because of the lower numerator.
We include several control
variables that may affect firm
value in our regressions. We
specifically control for firm size,
growth, and leverage. We control
for size because it is expected to
be associated with firm value
(Yermack, 1996). We include
growth as an explanatory variable
because firm value depends on
future investment
13. JAEE
3,1
10
opportunities (Myers, 1977; Smith and Watts, 1992; Yermack, 1996). Finally, we also
control for the amount of leverage because it may have significant impact on firm
value (Ross, 1977). Ross suggests that the value of a firm will increase with leverage
because increasing leverage increases the market’s perception about value. Stulz
(1990) argues that debt can have both positive and negative impact on firm value. We
use debt-to-equity ratio as the proxy for firm leverage.
We estimate the following regression to test our hypothesis:
FIRMVALit ¼ a0 þ a1CGIit þ a2RQIit þ a3SIZEit
þ a4GROWTHit þ a5LEVit þ eit
where FIRMVAL is the firm value that we measure using PBV, CGI, RQI, SIZE,
GROWTH, LEV.
Our hypotheses predict that after controlling for variables that may affect firm
value there is a positive association between CGI score and firm value (a140) and
between RQI score and firm value (a240).
Table II presents the descriptive statistics for the variables that we use in our tests.
Panel A shows that the average of PBV is 1.307 with a high standard deviation (1.157).
This indicates that the PBVof the firms in our sample varies considerably. The average
CGI score is 0.670 with relatively low variation (standard deviations ¼ 0.072). RQI score
is also relatively small with an average of only 0.629 with standard deviation of 0.132.
Panel B of Table II shows an improvement in the average of the CGI score from 0.666 in
2003 to 0.676 in 2004. However, the difference is not statistically significant. We also find an
improvement in the score average of RQI from 0.623 in 2003 to 0.636 in 2004. However, our
mean-difference test shows that the improvement is not statistically significant. We believe that
there is still a room for improvement for both the CGI and RQI scores. Based on industry, we
find improvements in RQI scores from 2003 to 2004 in investment, toll road, hotels,
restaurants, transportation, and farm industries and deteriorations in manufacturing,
construction, trade, real estate, and forestry (not reported).
The average growth in the past three years is 11.3 percent with the average size of
about 71.8 million. The average debt-to-equity ratio is 1.752 that varies significantly
with standard deviation of 2.66.
4. Empirical results
In this section we report the results of our empirical tests. We first report the main
results then we discuss the sensitivity tests using alternative proxies. Table III
presents the Pearson correlation for variables in our main model. First of all, all our
proxies for firm value show significant positive correlations to each other. This
suggests that the three proxies are appropriate to represent firm value.
The correlation table shows that PBV is positively correlated with the CGI score,
firm size, and leverage. This suggests that firms that implement corporate
governance, larger firms, and firms with high debt tend to have higher market value.
We find that RQI and PBV are negatively correlated. This indicates that firms with
high RQI scores tend to be firms with low PBV and vice versa.
We find significant positive correlation between corporate governance and reporting
quality at 10 percent level. This suggests that firms that implement corporate governance
tend to have higher RQI scores. RQI is positively correlated with firm size suggesting that
large firms tend to adhere to the P3LKE more. Corporate
14. Mean SD Minimum Median Maximum
Panel A: descriptive statistics for all variables for both years
PBV 1.307 1.157 0.140 0.875 6.790
TQ 1.110 0.558 0.225 0.957 3.695
ROA 0.043 0.072 0.162 0.030 0.255
CGI 0.670 0.072 0.538 0.665 0.859
RQI 0.629 0.132 0.369 0.600 0.916
SIZE 27.329 1.605 23.874 27.258 31.661
GROWTH 0.113 0.215 (0.696) 0.088 0.913
LEV 1.768 2.661 0.020 1.065 18.490
Panel B: descriptive statistics for CGI and RQI by
year
Year ¼ 2003
CGI 0.666 0.068 0.538 0.657 0.858
RQI 0.623 0.133 0.389 0.597 0.916
Year ¼ 2004
CGI 0.676 0.077 0.541 0.675 0.859
RQI 0.636 0.131 0.369 0.627 0.907
Notes: FIRMVAL, firm value that we measure using PBV, Tobin’s Q, and ROA; PBV, price to book value ratio; TQ ¼ Tobin’s Q; ROA, return on assets;
CGI, non-weighted corporate governance index score; RQI, reporting quality index score; SIZE, log total assets; GROWTH, average growth of sales in the
last three years; LEV, debt-to-equity ratio
FIRMVALit ¼ a0 þ a1CGIit þ a2RQIit þ a3SIZEit þ a4GROWTHit þ a5LEVit þ eit
T
able
II.
Des
cript
ive
stati
stics
of
vari
able
s in
the
regr
essi
on
16. JAEE
3,1
12
Table III.
Correlation of variables
in the model
governance is also positively correlated with firm size. This finding indicates that
large firms tend to implement corporate governance.
To test our hypotheses we regress PBVon RQI and CGI while controlling for variables
that are known to affect firm value. We present the regression result in Table IV.
TQ ROA CGI RQI SIZE
GROWT
H LEV
PBV 0.84 0.41 0.28 0.13 0.28 0.08 0.26
(0.00)**
*
(0.00)**
*
(0.00)**
* (0.08)*
(0.00)**
* (0.25)
(0.00)**
*
TQ 0.46 0.29 0.14 0.29 0.09 0.01
(0.00)**
*
(0.00)**
* (0.05)*
(0.00)**
* (0.24) (0.89)
ROA 0.31 0.08 0.18 0.28 0.23
(0.00)**
* (0.28)
(0.02)*
* (0.00)***
(0.00)**
*
CGI 0.12 0.51 0.01 0.02
(0.09)*
(0.00)**
* (0.88) (0.76)
RQI 0.17 0.07 0.02
(0.02)*
* (0.36) (0.75)
SIZE 0.00 0.08
(0.94) (0.28)
GROW
TH 0.06
(0.44)
Notes: n ¼ 192. FIRMVAL, firm value that we measure using PBV; PBV, price to book value ratio;
RQI, reporting quality index score; CGI, unweighted corporate governance index score; SIZE, log
total assets; GROWTH, average growth of sales in the last three years; LEV, debt-to-equity ratio.
***,**,*Correlations significant at 0.01, 0.05, and 0.1 levels, respectively
FIRMVALit ¼ a0 þ a1CGIit þ a2RQIit þ a3SIZEit þ a4GROWTHit þ a5LEVit þ eit
Table IV.
Regression results using PBV as the
dependent variable and un-weighted
CGI as the independent variable
Variable
n
Intercept
CGI
RQI
SIZE
GROWTH
LEV
R
2
Adjusted R
2
Prob (F-statistic)
Notes: FIRMVAL, firm value that
we measure using PBV, PBV, price
to book value ratio; CGI,
unweighted corporate governance
index score; RQI, reporting quality
index score; SIZE, log total assets;
GROWTH, average growth of sales
in the last three years; LEV, debt-to-
equity ratio. *Test variables
significant at 10, 5, and 1 percent
levels, respectively
FIRMVALit ¼ a0 þ a1CGIit þ
a2RQIit þ a3SIZEit þ
a4GROWTHit þ a5LEVit þ
eit
17. Consistent with our first hypothesis we find positive association between PBV and Corporate
CGI score.
The CGI coefficient (a1) is positive and significant at 1
percent
level governance
suggesting that firms that implement better corporate governance are likely to have
a higher value. The magnitude of the slope (3.7) is large, suggesting that an increase
in
CGI score is associated with a large increase in firm value.
We find negative association between RQI and firm value. This finding does not
support our second hypothesis that predicts a positive association. It suggests that 13
firms with lower values tend to disclose more information that is consistent with the
P3LKE. One possible explanation is that low-value firms try to improve their values
by
disclosing more information that is consistent with the P3LKE. It is possible that
when
the BAPEPAM issue the P3LKE, the managers of low-value firms would follow the
guidance in order to influence market perception about the company. On the other
hand, high-value firms may not see this guidance as something important and
therefore, may not follow the guidance in determining what information to disclose.
Consistent with prior studies, we find size, growth, and leverage affect firm value.
The coefficient for SIZE is positive and significant suggesting that larger firms tend
to
have higher values. We also find positive and significant coefficient on GROWTH
suggesting that firms with higher growth have higher values. Leverage (LEV) is also
positively associated with firm value suggesting that these firms seem to be able to
benefit from their leverage.
4.1 Sensitivity analysis
4.1.1 Tobin’s Q and ROA for firm value. To test whether our results are sensitive to
how
we measure firm value, we also run multivariate regressions using Tobin’s Q and
return
on assets as our proxy for firm value. Earlier work on firm performance has used
Tobin’s
Q as the measure of firm value (Demsetz and Lehn, 1985; Morck et al., 1988;
Yermack,
1996; Gompers et al., 2003). We calculate Tobin’s Q by comparing the market value of
a
company’s stock (MVEQ þ BVDEBT) and the value of a company’s equity book
value
(BVEQ þ BVDEBT). MVEQ is market value of equity and BVEQ is book value of
equity.
We use book value of debt (BVDEBT) for both the numerator and denominator
because
market value of debt is not available in Indonesia. Table V shows the regression
results
of regressing Tobin’s Q and ROA on CGI, RQI, and the control
variables.
The coefficients on CGI are positive and significant for both regressions using
Tobin’s
18. Q and ROA. These results are consistent with the results of using PBV and support
our
first hypothesis that there is association between firm value and corporate
governance
even when we use different proxies for firm value. Consistent with our main test the
results show significant negative coefficients for RQI suggesting that firms with
lower
values tend to disclose more information that are consistent with the P3LKE.
In general, the results of our sensitivity tests support the results of the main test that
finds a negative association between firm value and RQI and positive association
between firm value and CGI. Our results also show that the independent variables
in our models explain the variation in ROA better than variation in PBV or Tobin’s
Q.
Th
e R
for
ROA
regression is 0.244, which is higher than that for
PBV (
R ¼
0.208)
and
¼
0.159).
for Tobin’s Q
(R
4.1.2 Weighted CGI. In our main test we use the non-weighted CGI. It means that we
do not put any weight on the five groups of items in the index. In this sensitivity analysis,
we follow the IICD recommendation and calculate the weighted CGI based on 20 percent
weight on rights of shareholders, 15 percent weight on equal treatment of shareholders, 15
percent weight on role of stakeholders, 25 percent weight on disclosure and transparency,
19. JAEE
3,1
14
Table V.
Regression results using
Tobin’s Q and ROA as
dependent variables
Variable Predicted sign TQ ROA
n 188 188
Intercept 1.494 0.189
þ
(0.023)** (0.019)**
CGI 1.572 0.297
þ
(0.012)** (0.000)***
RQI 0.884 0.077
(0.003)*** (0.033)**
SIZE 0.076 0.003
(0.007)*** (0.386)
GROWTH 0.265 0.095
(0.136) (0.000)***
LEV 0.003 0.006
R
2
(0.862) (0.002)***
0.159 0.243
Adjusted R
2
0.136 0.223
Prob (F-statistic) 0.000*** 0.000***
Notes: FIRMVAL, firm value that we measure using TQ and ROA; TQ, Tobin’s Q, ROA, return on
assets; CGI, unweighted corporate governance index score; RQI, reporting quality index score;
SIZE, log total assets; GROWTH, average growth of sales in the last three years; LEV, debt-to-
equity ratio. *Test variables significant at 10, 5, and 1 percent levels, respectively
FIRMVALit ¼ a0 þ a1CGIit þ a2RQIit þ a3SIZEit þ a4GROWTHit þ a5LEVit þ eit
and 25
percent
weight
on
board
responsi
bilities.
Table
VI
shows
the
result of
regressi
ng
various
proxies
for firm
value on
the
weighte
d CGI,
RQI,
and the
control
variable
s.
The tests using weighted CGI
scores provide consistent results
with the main tests that the CGI is
positively associated with firm value
and the RQI is negatively associated
with firm value. Consistent with our
main tests, our tests using the
weighted CGI also show that the
independent variables in our models
best explain the variation in ROA
(R
2
¼ 0.238).
5. Conclusions
After the severe crisis in 1997 and
1998, the Indonesian Government
initiated some efforts to improve
corporate governance and reporting
quality by Indonesian public firms.
One of the efforts by the
government is the issuance of
reporting and disclosure guidance
by the BAPEPAM in 2002. In this
study, we investigate whether
corporate governance and reporting
quality are associated with firm
value. We predict that the
associations are positive.
To test our hypotheses we use
PBV ratio, Tobin’s Q, and ROA as
our measures for firm value.
Consistent with our hypothesis we
find that corporate governance is
positively associated with firm value
and the results are consistent for the
different proxies of firm value. Firms
that implement better corporate
governance tend to have higher
value. We also find that size, growth,
and leverage are positively associated
with firm value suggesting that larger
firms, firms with more investment
opportunities or high growth, and
firms that have higher leverage are
likely to have higher values.
We find negative associations
between reporting quality and our
various proxies of firm value. These
findings suggest that firms that firms
with lower values tend to disclose
more information that adhere to the
P3LKE. One possible explanation is
that
20. Variable Predicted sign PBV TQ ROA
n 188 188 188
Intercept 3.239 1.437 0.178
þ
(0.015)** (0.029)** (0.027)**
CGI 3.474 1.370 0.278
þ
(0.005)*** (0.025)** (0.000)***
RQI 1.710 0.871 0.075
(0.004)*** (0.003)*** (0.038)**
SIZE 0.112 0.079 0.003
(0.048)** (0.005)*** (0.363)
GROWTH 0.625 0.267 0.096
(0.081)* (0.135) (0.000)***
LEV 0.116 0.002 0.006
R
2
(0.000)*** (0.866) (0.002)***
0.205 0.153 0.238
Adjusted R
2
0.183 0.129 0.217
Probablity (F-statistic) 0.000*** 0.000*** 0.000***
Corporate
governance
15
N
o
te
s:
F
I
R
M
V
A
L
,
fi
r
m
v
al
u
e
Table
VI.
Regr
essio
n
result
s
using
weig
hted
CGI
score
as
indep
ende
nt
varia
ble
with
differ
e
n
t
d
e
p
e
n
d
e
n
t
v
a
r
i
a
b
l
e
s
f
i
W
e
W
e
e
of
the
dif
fic
ult
ies
in
de
cid
ing
wh
eth
er
an
ite
m
is
not
ap
pli
ca
ble
or
is
ap
pli
ca
ble
but
i
s
n
o
t
d
i
s
c
l
o
s
e
d
.
B
e
c
a
u
s
e
i
n
b
oth
situ
atio
ns
the
info
rma
tion
is
not
obs
erv
able
we
use
jud
gm
ent
in
deci
din
g
whe
ther
an
ite
m is
not
app
lica
21. ble or not disclosed.
For future
research, it is
important to
investigate why
firms with high
value do not
disclose information
that is required by
t
h
e
P
3
L
K
E
.
It is also important to
examine whether there
are improvements in
the CGI and RQI
scores in the long run.
It is possible that
public firms reacted to
the issuance of the
guidance in 2002 but
fail to improve in the
follo
wing
years
.
Final
ly, it
is
also
impo
rtant
to see whether in the
following years, the
negative association
between reporting
quality and firm value
change into positive
that would suggest that
adherence to the
P3LKE is value
relevant.
22. JAEE
3,1
16
Notes
1
.
For sensitivity test, we also use Tobin’s Q and ROA as our proxies for firm value. We
explain
the detail in the sensitivity test section.
2
. We report the CGI in Appendix.
3
. For sensitivity test we calculate the weighted CGI using different weights for different
groups based on the IICD recommendation. We show the detail calculation and the
regression results using the weighted CGI in the sensitivity analysis section.
4.We do not report the index in Appendix because of the length of the document even when
we summarize the list. A P3LKE for one industry consists of more than 100 pages.
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Corporate
governance
17
24. JAEE
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18
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States”, Journal of Law and Economics, Vol. 60, pp. 1-22.
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Review of Financial Studies, Vol. 22 No. 8, pp. 3245-85.
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risk, and value”, Journal of Small Business Management, Vol. 39 No. 1, pp. 31-49.
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value”, Journal of Financial Economics, Vol. 27 No. 2, pp. 595-612.
Suehiro, A. (2001), “Family business gone wrong? Ownership patterns and corporate performance in
Thailand”, Working Paper No. 19, Asian Development Bank Institute (ADBI), Tokyo, May.
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from Thailand”, Hawaii International Conference on Business, Honolulu, Hawaii, May.
Appendix
Rights of shareholders
1.Assess the quality of the notice to call the annual general shareholders’ meeting (RUPS)
in the past one year. Does the notice include:
1) Appointment of directors and commissioners
2) Appointment of auditors
3) Dividend payment
2.Is the decision on the remuneration of the board members (commissioners and directors)
approved by the shareholders annually?
3.Is the remuneration of the board (commissioner and director) presented individually?
4.Do board members hold more than 25% of outstanding shares?
Equitable treatment of shareholders
1.Have there been any cases of insider trading involving the company directors and commissioners
in the past two years?
2.Does the company provide rationale/explanation for related-party transactions affecting the
corporation?
3.Has there been any non-compliance case regarding related-party transaction in the past two years?
4.How many days in advance does the company send out the notice of general shareholders’
meeting?
Role of stakeholders
1.Does the company explicitly mention the safety and welfare of its employees?
2.Does the company explicitly mention the role of key stakeholders such as customers or the
community at large (or creditors or suppliers)
3.Does the company explicitly mention environmental issues in its public communication?
4.Does the company provide an ESOP (Employee Stock Option Plan) or other long-term employee
incentive plan linked to shareholder value creation to employees?
Disclosure and transparency
1.Does the company have dispersed ownership structure?
2.Assess the quality of financial report in each of the following areas:
1) Financial performance
2) Business operations and competitive position
4) Basis of board remuneration
5) Operating risk
26. 5.Are there any accounting qualifications in the audited financial statements apart from the
qualification on uncertainty of situation?
6.Does the company offer multiple channels of access to information, include:
1) Company website
2) Analyst briefing
3) Press conference/press briefing
7.Is the financial report disclosed in a timely manner?
8.Does the company have a website disclosing up-to-date information, include:
1) Business operation
2) Financial statement
3) Press release
4) Shareholding structure
5) Organization structure
6) Corporate group structure
7) Downloadable annual report
8) Downloadable interim report
9) Available of both Indonesian and English
9.Does the company disclose fees paid to external auditors?
10. Does the company’s Annual Report include a section devoted to the company’s
performance in implementing corporate governance principles?
11. If the complete list of BOC members is disclosed, is detailed information on each
commissioner disclosed?
12. If the complete list of BOC members is disclosed, does it include details of previous
employment?
13. If the complete list of BOC members is disclosed, are educational qualifications of
commissioners disclosed?
14. If the complete list of BOC members is disclosed, are other commissionerships of
commissioners
disclosed?
Responsibility of the board
1.Does the company have its own written corporate governance rules that clearly describe its value
system and board responsibility?
2.Does the board of commissioner provide code of ethics or statement of business conduct to all
directors and employees to ensure that they aware of and understand the code?
3.Is there disclosure of company’s guidelines of matters that require approval by the board of
commissioner?
4.Does the annual report include report from board of commissioners?
5.Does the company have a corporate vision/mission?
6.Does the JSX/Bapepam have any evidence of non-compliance of the company with
JSX/Bapepam rules and regulation over the last two years?
7.Have board members participated in corporate governance training?
8.Does the company report board meeting attendance of individual board of commissioner members?
9.How many times board of commissioner meet in the calendar year?
10. Does the company report board meeting attendance of individual board of director
members?
11. How
many times
board of
director meet
in the
calendar
year?
12. Amon
g board of
commissione
rs, how many
are
independent
commissione
rs?
13. Is the
board of
commissione
r chairman
an
independent
commissione
r?
14. Does
the company
state in its
annual report
the definition
of
independenc
e?
15. What
is the size of
board of
commissione
r?
16. Is
individual
performance
of BOC
members
evaluated?
17. Is
criteria for
evaluating
board of
director
performance
disclosed?
18. Does
the board
appoint
independent
committees
with
independent
members to
carry out
various
27. critical responsibilities such as:
1) Audit committee
2) Compensation committee
3) Director or nomination committee
Corporate
governance
19
(con
tinu
ed)
Table
AI.
28. JAEE
3,1
20
Table AI.
19. Assess the audit committee based on following criteria:
1) Audit committee size
2) Independent members
3) Financial/accounting background
4) Chairman
20. Is disclosure made of the basis of selection of audit committee members?
21. Does the company disclose audit committee report in the annual report
22. Assess the quality of the audit committee report in the annual report, include the following
items:
1) Frequency of meetings
2) Internal control
3) Management control
4) Proposed auditors
5) Financial report review
6) Legal compliance
7) Scope, results, and effectiveness of audits
8) Adequacy of internal audit function
9) Conclusion or opinion
23. Is the complete list of audit committee members disclosed?
24. Does the corporate secretary attend all board of directors meetings?
25. Does the company provide contact details for a specific investor relation person?
26. Does/did the company have an option scheme for top management?
Corresponding author
Ferdinand Siagian can be contacted at:
fsiagian@maine.edu
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