The Effect of National Governance Codes on Firm Disclosure Practices: Evidence from Analyst Earnings Forecasts

• Date: 01 November 2008
• DOI: http://doi.org/10.1111/j.1467-8683.2008.00707.x
• Author: John Nowland
• Published date: 01 November 2008

The Effect of National Governance Codes on

Firm Disclosure Practices: Evidence from

Analyst Earnings Forecasts

John Nowland*

ABSTRACT

Manuscript Type: Empirical

Research Question: This study examines whether voluntarynational governancecodes have a signif‌icant effect on company

disclosure practices. Two direct effects of the codes are expected: 1) an overall improvement in company disclosure

practices, which is greater when the codes have a greater emphasis on disclosure; and 2) a leveling out of disclosure

practices across companies(i.e., larger improvements in companies that were previously poorer disclosers) due to the codes

new comply-or-explain requirements. The codes are also expected to have an indirect effect on disclosure practices through

their effect on company governance practices.

Research Findings/Results: The results show that the introduction of the codes in eight East Asian countries has been

associated with lower analyst forecast error and a leveling out of disclosure practices across companies. The codes are also

found to have an indirect effect on company disclosure practices through their effect on board independence.

Practical Implications: This study shows that a regulatory approach to improving disclosure practices is not always

necessary. Voluntary national governance codes are found to have both a signif‌icant direct effect and a signif‌icant indirect

effect on company disclosure practices. In addition,the results indicate that analystsin Asia do react to changes in disclosure

practices, so there is an incentive for small companies and family-owned companies to further improve their disclosure

practices.

Keywords: Corporate Governance Codes, Board Policy Issues, Transparency, Asia, Financial Disclosure, Financial

Auditing Issues, Corporate Governance

INTRODUCTION

In the years since the Asian crisis there has been consid-

erable pressure placed on Asian companies to improve

their corporate governance. This has included calls for

improved transparency, stronger external monitoring, and

heightened investor protection. However, rather than taking

a regulatory approach (such as the Sarbanes-Oxley Actin the

U.S.), Asian countries have implemented voluntary corpo-

rate governance codes advising companies how to improve

their governance and disclosure practices. The codes, while

not mandatory, do encourage companies to implement

stronger corporate governance structures and release more

information in a timelier manner to market participants.

These improvements in governance and disclosure practices

are expected to reduce agency costs between corporate

insiders and outside investors. However, as the codes are

voluntary there has been considerable debate as to whether

all companies are making adequate improvements.

Prior research on the regulatory approach, such as the

introduction of the Sarbanes-Oxley Act or Regulation Fair

Disclosure (FD) in the U.S., f‌inds a signif‌icant effect on

governance and disclosure practices (Bailey, Li, Mao, and

Zhong, 2003; Hef‌lin, Subramanyam, and Zhang, 2003; Irani

and Karamanou, 2003; Linck, Netter, and Yang, 2006). The

key research question posed by this study is whether the

introduction of voluntary governance codes has a similarly

signif‌icant impact on companies as the regulatory approach.

Previous studies on voluntary corporate governance codes

have focused on the degree of compliance, the disclosure

of compliance-related information, or the market reaction

to compliance announcements (Fernandez-Rodriguez,

*Address for Correspondence: School of Economics & Finance, Queensland Univer-

sity of Technology,GPO Box 2434, Brisbane 4001, Australia. Tel: +61-7-3138-4241; Fax:

+61-7-3138-1500; E-mail: j.nowland@qut.edu.au

THE EFFECT OF NATIONAL GOVERNANCE CODES ON FIRM DISCLOSURE PRACTICES 475

Volume 16 Number 6 November 2008

© 2008 TheAuthor

Journal compilation © 2008 BlackwellPublishing Ltd

doi:10.1111/j.1467-8683.2008.00707.x

Gomez-Anson, and Cuervo-Garcia, 2005; Werder, Talaulicar,

and Kolat, 2005; Arcot and Bruno, 2006; Goncharov, Werner,

and Zimmermann, 2006). This is the f‌irst study to examine

the effect of voluntary corporate governance codes on the

overall disclosure practices of companies. This is broader

than previous research as the codes encourage com-

panies to improve their disclosure practices in general, as

well as mandating the disclosure of compliance-related

information.1

This study predicts that the introduction of voluntary cor-

porate governance codes has two direct effects on company

disclosure practices. First, as the codes encourage all com-

panies to improve their disclosure practices, an overall

improvement in company disclosure practices is expected,

which is greater when the codes have a greater emphasis on

disclosure. Second, as the codes have introduced new

comply-or-explain requirements (i.e., a new minimum level

of mandatory disclosure), a leveling out of disclosure prac-

tices is expected across companies (i.e., larger improvements

in companies that were previously poorer disclosers). In

particular, a greater improvement is expected in smaller and

family-owned companies, as previous research indicates

that these companies generally have the poorest disclo-

sure practices (Durnev and Kim, 2005; Ali, Chen, and

Radhakrishnan, 2006). The codes are also expected to have

an indirect effect on disclosure practices through their effect

on company governance practices. Specif‌ically, the codes are

predicted to improve board independence and an increase

in board independence is expected to lead to improved dis-

closure practices. This study also tests for improvements in

disclosure practices in the years after the crisis, but before

the introduction of the codes, as companies could have

started improving their disclosure practices in preparation

for the codes.

As a direct measure of corporate disclosure is not avail-

able, this study follows the work of Lang and Lundholm

(1996) by using the characteristics of analyst forecasts

(analyst forecast error and dispersion) to measure company

disclosure practices. This approach has been used exten-

sively in prior literature to measure the effects of new dis-

closure regulations in the US and other countries (Bailey

et al., 2003; Brown, Taylor, and Walter, 1999; Chang, Cho,and

Shin, 2007; Hef‌lin et al., 2003; Huang, Marsden, and Poskitt,

2006; Irani and Karamanou, 2003). Furthermore, the benef‌it

of this approach is that an overall picture of company

disclosure practices can be examined, which covers all

types of disclosures – operating, f‌inancial, and corporate

governance.

Examining companies from Hong Kong, Indonesia,

Malaysia, the Philippines, Singapore, South Korea, Taiwan,

and Thailand during the period from 1993 to 2005 – exclud-

ing the crisis years of 1997 and 1998, – the results suggest

that disclosure practices have improved since the introduc-

tion of voluntary corporate governance codes. The forecast

error of the average company has dropped by 10.07 per cent

since the introduction of the codes. However, further testing

shows that improvements in analyst forecast error are

limited to countries with codes that have specif‌ic sections

designated to disclosure. This indicates that the degree of

emphasis on disclosure is the driver of the relationship

between the codes and improved disclosure practices. The

lack of a signif‌icant effect of the codes on analyst forecast

dispersion suggests that there is still variation in the way that

analysts process information.

There is also evidence of a leveling out of disclosure prac-

tices across companies, i.e., larger improvements in compa-

nies that were previously poorer disclosers. The forecast

error and dispersion of smaller companies have improved

relative to bigger companies after the crisis and the intro-

duction of the codes. Notably, the forecast error of family-

owned companies has improved relative to other companies

after the introduction of the codes. Finally, the codes have

also had an indirect effect on company disclosure practices

through their effect on company governance practices. Indi-

vidually, the codes are found to have a signif‌icant effect on

board independence and a lagged relationship is found

between board independence and analyst forecast error. A

Sobel test then conf‌irms that the combined effect is signif‌i-

cant. Thissuggests that the codes have had both a signif‌icant

direct effect and a signif‌icant indirect effect, through

increased board independence, on company disclosure

practices.

HYPOTHESIS DEVELOPMENT

In fulf‌illing their duties to shareholders and other providers

of capital, companies are encouraged to disclose all material

information in a timely manner. In reality, companies have

considerable choice as to when and how much information

they disclose. Company disclosure practices are comprised

of two components – mandatory and voluntary. Mandatory

disclosures are those required by legislation or stock

exchange listing requirements. Voluntary disclosures are

those made by choice over and above mandatory require-

ments. While mandatorydisclosures are normally consistent

across companies in the same jurisdiction, there can be sub-

stantial variation in voluntary disclosure practices. Prior

studies show that voluntary disclosure practices are endog-

enously determined within the f‌irm by weighing the costs

and benef‌its of additional disclosure. The benef‌its of addi-

tional disclosure include reduced information asymmetry

and agency costs, which can lead to a lower cost of capital

and higher f‌irm value (Botosan, 1997; Healy, Hutton, and

Palepu, 1999; Verrecchia, 2001). The costs of additional dis-

closure include product market considerations and a loss of

private benef‌its of control (Clarkson, Kao, and Richardson,

1994; Dahya, Dimitrov, and McConnell, 2006).2

In the aftermath of corporate crises (e.g., the Asian crisis),

outside investors generally demand improvements in

company governance and disclosure practices. In these

instances there are two ways forward – the introduction of

new mandatory requirements (regulatory approach) or the

introduction of voluntary recommendations (market-based

approach). Previous research examining the effect of new

mandatory disclosure regulations, such as the introduction

of Regulation FD in the U.S. (Bailey et al., 2003; Hef‌lin et al.

2003; Irani and Karamanou, 2003), f‌ind a signif‌icant increase

in the amount of information available to the public. Simi-

larly, the introduction of the Sarbanes-Oxley Act in the U.S.

is found to have had a signif‌icant impact on company gov-

ernance practices (Linck et al., 2006).

476 CORPORATE GOVERNANCE

Volume 16 Number 6 November 2008 © 2008 TheAuthor

Journal compilation © 2008 BlackwellPublishing Ltd