Risk Committee, Firm Life Cycle, and Market Risk Disclosures

• Author: Mostafa Monzur Hasan,Ahmed Al‐Hadi,Ahsan Habib
• DOI: http://doi.org/10.1111/corg.12115
• Published date: 01 March 2016
• Date: 01 March 2016

Risk Committee, Firm Life Cycle, and Market Risk

Disclosures

Ahmed Al-Hadi*, Mostafa Monzur Hasan and Ahsan Habib

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This study investigates whether the existence of a separate risk committee and risk committeechar-

acteristics are associated with market riskdisclosures. It also tests whether the role of a risk committee in affecting market risk

disclosures varies for different firm life cycle stages.

Research Findings/Insights: Using 677 firm-year observations of financial firms from Gulf Cooperation Council (GCC) coun-

tries during the years 2007–2011, we find that firms witha separate risk committee are associatedwith greater market risk dis-

closures, an effect that is more pronounced for mature-stage firms. Furthermore, findings suggest that risk committee

qualifications and size have a significant positive impact on market risk disclosures.

Theoretical/Academic Implications: This study complementsthe corporate governanceliterature by incorporatingagency the-

ory, legitimacy theory, stakeholder theory, and the resource-based theory to provide more robust evidence of the impact of a

separaterisk committee and the firm life cycle onmarket risk disclosures.Our results support the monitoringeffect of a separate

risk committeeand suggest that a separate risk committeecan improve “firm-levelcorporate governance”in the GCC countries

characterized by a poor informational environment.

Practitioner/Policy Implications: Findings from this study provide evidence that the existence, qualifications, and size of risk

committees may be used as a channel to improve the disclosure level, suggesting a policy prescription for regulators and

policymakers. Investors may also find these results useful in forming their own expectations about firm-level risk disclosures.

Keywords: Corporate Governance, Risk Committee, Firm Life Cycle, Market Risk Disclosure

INTRODUCTION

Numerous academic studies (e.g.,Jorion, 2002; Linsmeier,

Thornton, Venkatachalam, & Welker, 2002; Rajgopal,

1999; among others) and professional surveys (e.g., Basel

Committee on Banking Supervision (BCBS), 2002, 2003; CFA,

2013) have articulated the usefulness of the information

content of market risk disclosures (hereafter MRDs). These

studies and surveys show that MRDs helpinvestors to under-

stand the risksassociated with on- and off-balance sheet items

and forecast financial statement and cash flow effects when

key inputs, such as interest rates, prices, and exchange rates,

change betweenreporting periods. MRDs thus improvetrans-

parency regarding risk exposures (Rajgopal, 1999), increase

investors’confidence in financial statements (Dobler, 2008),

reduce the mispricing of risk and misallocation of capital

(Jorgensen & Kirschenheiter, 2003), and enhance investors’

ability to provide market discipline on a timely basis (Jorion,

2002). Prior studies (Dobler, 2008; Subramaniam, McManus,

& Zhang, 2009; among others) also indicate that the existence

of a risk committee(hereafter RC) can ensurecredible commu-

nication and effective oversight of organizational risk man-

agement strategies, policies, and processes. However, the

majority of these studies and surveys are conducted from

the perspective of the US and other developed markets. One

logical question is whether the findings relating to MRDs are

peculiar to the US or developed markets or whether they are

also prominent in countries where the disclosure regime

and/or institutional and economic characteristics are signifi-

cantly different.

The purpose of this paper is to investigatethe impact of RC

concentrationand specialization on market risk disclosures in

the Gulf Cooperation Council (hereafter GCC) region. In

particular, we test whether the existence of an RC has any

impactontheextentofMRDs.Wealsoexaminetherelevance

and significance of RC characteristics in explaining the MRD level.

Several importanteconomic and institutionalfeatures make

the GCC a unique and interesting environmentfor examining

the impact of stand-alone RCs, the characteristics of RCs,

and the firm life cycle in relation to MRDs. First, the

GCC countries are characterized by limited disclosure and

*Address for correspondence: Ahmed Al-Hadi, College of Applied Science at Nizwa,

IBS, Sultanate of Oman, Oman. Tel: +61 4 22020993 (Australia); +96898999651 (Oman),

Fax: +61 8 9266 7196; E-mail: alhadisam@yahoo.com

© 2015 JohnWiley & Sons Ltd

doi:10.1111/corg.12115

145

Corporate Governance: An International Review, 2016, 24(2):145–170

transparency, resulting from loose corporate disclosure re-

quirements (Islam, 2003). Although all the GCC countries

have adopted the IAS/IFRSs, listed firms are largely reluctant

to comply with risk disclosure requirements (Al-Shammari,

Brown, & Tarca, 2008). Prior studies (e.g.,Kamla & Roberts,

2010) also document that firms in the GCC publish less

operational and risk information. The IFC/Hawkamah

(2008) survey finds that only 9.1 percent of listed banks and

26 percent of non-bank firms in the GCC disclose material

foreseeable risk factors. The GCC also features a scarcity of

professional financial analysts and management forecasts

(Al-Yahyaee, Pham, & Walter, 2011). Furthermore, the GCC

lacks credible media to disseminate financial information,

which in most developed countries are providedby a special-

ized part of thepress and the electronic media.Thus, investors

in the GCC have very limited sources of information, making

annual reports the most important source of information on

market risk exposures. The above analysis implies that if the

existence and qualifications of RCs truly have any positive

impact on MRDs, the formation of qualified RCs can be used

as a channel to promote the disclosure level in this area.

Second, most firms in the GCC are owned by a small num-

ber of investors who have controlling interests (Al-Yahyaee

et al., 2011). The NationalInvestor (TNI) (2008) survey reveals

that the top five families in Dubai control between 10 and 33

percent of all board seats and the top 15 families between 18

and 50 percent. This survey also reports that royal family di-

rectors represent 60 percent of the GCC equity capitalization.

Thus, a fairlysmall and tightly knit economicelite remarkably

controls the financial markets in the GCC, which results in a

power imbalance and a greater level of information asymme-

try (Al-Sehali & Spear, 2004; Mazaheri, 2013).

Third, the risk disclosure requirements are not well covered

in the GCC code of corporate governance(Hawkamah, 2010).

In the Kingdom of Saudi Arabia (KSA), and the United Arab

Emirates (UAE), the corporate governance code is largely

silent regarding risk disclosure. The IFC/Hawkamah (2008)

survey documents that 76 percent of banks and 69 percent of

non-banking listed firms do not consider disclosure as an

effective tool to maintain shareholder value. Thus, the

prevailing situation provides us with a unique opportunity

to test the role of stand-alone RCs in enhancing MRDs. If we

find that MRDs correspond to the existence of a separate RC,

then this will shed light on risk disclosure in emerging

markets and thefindin gs could be particularl y useful to inves-

tors, regulators, and policymakers in the GCC and other

emerging marketsin terms of understanding the contributing

factors of MRDs.

Whether or not separate RCs can improve the risk disclo-

sure in the GCC is an empiricalquestion. Studies in developed

markets suggest that a traditional audit committee (hereafter

AC) is insufficient for overseeing financial and non-financial

risks in today’s complex and high-risk environments

(e.g., Brown, Steen, & Foreman, 2009). Since an RC concen-

trates on, and specializesin, risk monitoring and risk manage-

ment, it strengthens a firm’s risk management system, which

eventually leads to an improvement in the firm’srisk

reporting abilities (Dobler, 2008; Subramaniam et al., 2009).

However, the picture is less clear in the GCC region. On the

one hand, the lack of disclosure, professional analysts, and

reliable media, the existence of concentrated ownership, and

the silence of thecorporate governance rules regardingdisclo-

sure suggest that dedicated RCs may have little impact on

MRDs in the GCC. On the other hand, the voluntary forma-

tion of an RC reflects firms’willingness to improve their risk

managementand risk-related disclosureand thus, in a relative

sense, stand-alone RCs may still be an important channel to

enhance the disclosure of risk-related information.

Our findings suggest that an RC significantly improves

MRDs. Moreover, when RC characteristics are taken into ac-

count, we find that their qualifications and size significantly

improve MRDs. In addition, we show that RCs play a more

dominant role in enhancing the MRDs of mature-stage firms

than those of younger-stage firms. We use instrumental

variable (IV) techniques together with ordinary least squares

(OLS) estimation to mitigate the possible endogeneity

between theRC and the error term. The IVresults indicate that

endogeneity cannot explain away the positive relationship

between RCs and MRDs.

This study contributes to the governance and disclosure

literature in several important ways. First, it extends the

corporate governance literature by providing evidence that

separate RCs have a significant impact on improving firms’

MRDs. While prior research (e.g.,Klein, 2002; Vafeas, 2005)

extensively documents that AC characteristics have a posi-

tive impact on improving the disclosure process and moni-

toring effectiveness of firms, the question of whether RCs

can improve MRDs has not been examined. Our study

explicitly examines this relationship and thus sheds light

on an aspect of reporting that is growing in importance.

Second, given the recent emphasis of regulatory bodies on

strengthening the risk management and risk reporting sys-

tems of financial firms and the overwhelming trend of firms

to form a separate RC, an empirical study on the association

between the formation of RCs and MRDs is worthwhile and

timely. Our study responds to this call by investigating this

relationship, suggesting that a separate RC can enhance

shareholder interests through effective oversight of risk

management and risk reporting. Third, we extend the prior

studies that document a positive association between firm

size and risk disclosure. Our results show that RCs play a

more significant role in enhancing the MRDs of mature-

stage firms than those of young-stage firms. Thus, firm life

cycle stages have important implications for MRDs. Finally,

despite the pivotal role of disclosure in enhancing firm

value and the shareholder relationship (Beyer, Cohen, Lys,

& Walther, 2010; Healy & Palepu, 2001), there has been

comparatively little research on this issue from a developing

country perspective. Hence, we draw our sample from the

GCC, which is an economically emerging region. This pro-

vides an important opportunity to investigate the role of a

separate RC in enhancing the risk disclosure level in the

presence of significant ownership concentration and a poor

level of disclosure, the findings of which can be extrapolated

to other developing countries.

The remainderof the paper is organizedas follows. The next

section provides an overview of the institutional settings of

the GCC. The third section reviews the relevant prior studies

and develops testable hypotheses. The fourth section de-

scribes the research design, data sources, and sample selec-

tion. The fifth section discusses the results of the study, and

the final section concludes the paper.

146 CORPORATE GOVERNANCE: AN INTERNATIONAL REVIEW

© 2015 JohnWiley & Sons LtdVolume 24 Number 2 March 2016