Transparency and Disclosure Scores and their Determinants in the Istanbul Stock Exchange

• Published date: 01 July 2006
• Date: 01 July 2006
• DOI: http://doi.org/10.1111/j.1467-8683.2006.00507.x
• Author: Arman Kosedag,Mine Aksu

TRANSPARENCY AND DISCLOSURE SCORES AND THEIR DETERMINANTS IN THE ISTANBUL STOCK EXCHANGE

277

© 2006 The Authors

Journal compilation © 2006 Blackwell Publishing Ltd, 9600 Garsington Road,

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Volume 14 Number 4 July 2006

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CORGCorporate Governance: An International

Review0964-8410Blackwell Publishing Ltd. 2006

2006144••••ORIGINAL ARTICLES

TRANSPARENCY AND DISCLOSURE SCORES AND THEIR

DETERMINANTS IN THE ISTANBUL STOCK EXCHANGE

COPRORATE GOVERNANCE

*Address for correspondence:

Faculty of Management,

Sabanci University, 34952

Orhanli-Tuzla, Istanbul, Tur-

key. Tel:

+

90 (216) 483-9678;

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+

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Transparency and Disclosure Scores

and their Determinants in the Istanbul

Stock Exchange

Mine Aksu* and Arman Kosedag

Recent f‌inancial reporting and auditing scandals on both sides of the Atlantic have led

to a global realisation of the importance of sound corporate governance (CG) practices in

alleviating the agency problems in the corporate form of business and for eff‌icient allocation

of capital in international markets. Transparency and disclosure (T&D) practices followed by

f‌irms are an important component and a leading indicator of CG quality. Transparent and full-

disclosure of information is especially vital for Turkey where external capital is necessary

to sustain the high growth rate and the biggest agency problem centres on asymmetric

information and expropriation by majority shareholders.

We collaborate with Standard & Poor’s (S&P) and base our survey on their scoring

methodology, a customised version of the 98 desirable T&D attributes they used in several

other countries, and their classif‌ication of the attributes into three categories: ownership

structure and investor relations, f‌inancial transparency and information disclosure, and board

and management structures and processes. We evaluate the T&D practices of the 52 largest

and most liquid f‌irms in the Istanbul Stock Exchange (ISE), based on their English and local

language annual reports and websites. Our rankings provide a f‌irst time, objective assessment

of the corporate disclosure practices of ISE f‌irms and uncover that they are, at best, moderate

and vary with respect to the three sub-categories of T&D.

We also consider a simple model that sequentially links agency problems to CG/T&D

mechanisms in place, which in turn impact f‌irm-level and economy-wide f‌inancial perfor-

mance. Concentrating on the causal side of the model –

the determinants of T&D scores

– we

provide out-of-sample evidence that f‌irm size, f‌inancial performance and market-to-book

equity best explain the variation in T&D scores in the ISE. While our results provide consid-

erable support for prior f‌indings in developed markets, they also shed light on how specif‌ic

agency problems faced by ISE f‌irms impact their T&D scores.

Keywords: Corporate governance, transparency and disclosure index, Istanbul Stock

Exchange, agency conf‌licts

Introduction

he recent corporate governance and f‌inan-

cial reporting scandals on both sides of

the Atlantic have led to a global realisation that

sound corporate governance (CG) practices

including transparency and full disclosure

T

(T&D) are important for long-term viability of

companies as well as for eff‌icient allocation of

capital in the international f‌inancial markets.

Starting with the Sarbanes-Oxley Act in the US,

many countries have experienced an unprece-

dented amount of governmental and institu-

tional intervention and are now in the process

278

CORPORATE GOVERNANCE

© 2006 The Authors

Journal compilation © Blackwell Publishing Ltd. 2006

Volume 14 Number 4 July 2006

of restructuring their current laws, regulations

and enforcement capabilities within the frame-

work of best corporate governance practices.

1

Furthermore, academicians, investment and

data-base companies have started to construct

and evaluate ethical, socially responsible, and

strong CG indices,

2

and companies themselves

are paying hefty sums of money to have their

CG and T&D practices rated by rating agencies

such as Standard & Poor’s (S&P) and Institu-

tional Shareholder Services (ISS) to signal their

quality in their quest for external capital. Par-

allel to these developments, there has been a

proliferation of country-level (La Porta

et al

.,

1997; Shleifer and Wolfenzon, 2000; Gugler

et al

., 2004) and f‌irm-level (see for example,

Ashbaugh

et al

., 2004; Brown and Caylor, 2004)

evidence that better CG practices are associated

with lower cost of capital, higher f‌irm values

and thus easier access to external capital.

Full disclosure and transparency of f‌inancial

information are vital components of the CG

framework (OECD, 1999) and are regarded as

important indicators of CG quality.

3

Beeks and

Brown (2005) f‌ind that f‌irms with higher CG

quality make more informative disclosures.

Sadka (2004) provides theoretical and empiri-

cal evidence that the public sharing of f‌inan-

cial and analyst reports have enhanced factor

productivity and economic growth in 30

countries.

These relationships and the expected bene-

f‌its of good CG and T&D practices are es-

pecially important for emerging markets like

Turkey because they are in dire need of external

capital as their economies grow faster than that

of more developed nations. As a result, it is

important to investigate whether the historical

scarcity of external capital f‌low to Turkey is

related to the low quality of T&D. This study,

which provides a f‌irst-time, objective measure-

ment of T&D quality in the Istanbul Stock

Exchange (ISE), in a form suitable for time-

series and cross-sectional comparisons, includ-

ing comparison with other sample countries

surveyed by S&P, is a f‌irst step in this direction.

Turkey is a French origin civil law country

where corporate ownership structure can be

characterised by concentrated family owner-

ship and low f‌loat rates leading to certain types

of agency problems.

4

As a result of its highly

concentrated, pyramidal, family-based owner-

ship structures, substantive inter-corporate

shareholdings, and dual class shares, the main

agency conf‌lict centres around the expropria-

tion of minority shareholders’ rights by ulti-

mate owners with superior information even

in cases where they don’t hold a signif‌icant

amount of the cash-f‌low rights. The ensuing

information asymmetry between the insiders

and outsiders has resulted in low f‌loat rates

and dividend payments (for an in-depth

description of ownership structures of ISE

f‌irms, its disadvantages in terms of investment

returns and development of the capital mar-

kets, see Yurtoglu, 2000, 2003). Furthermore,

due to the concentration of ownership and

power in inf‌luential families and its French

legal origin, Turkey has also been slow in the

development and enforcement of CG and T&D

principles and best practices.

The potential for this special kind of agency

conf‌lict and the importance of T&D as a lead-

ing CG mechanism in alleviating its draw-

backs by reducing the asymmetry between

the insiders and outsiders have been an

important motivation of this study. This

agency problem was recently acknowledged

in a task force report of the Institute of Inter-

national Finance (4/12/2005, page 1) as the

following quote indicates: “Turkish compa-

nies are often controlled through the use of

founders’ shares that carry multiple voting

rights and/or board nominating rights. As a

result, the protection of minority shareholder

interests rests primarily on full disclosure and

accurate f‌inancial reporting”.

This study is the f‌irst attempt to create a

summary T&D index for the largest and most

liquid f‌irms trading on the ISE. We undertook

the project in collaboration with S&P, a presti-

gious, global rating and f‌inancial services

company that has been carrying out large-

scale research since 2001 to score the T&D

practices of a number of large and liquid

f‌irms they follow in the US, Latin America,

Europe, Japan, Russia and some emerging

Asian markets. We customised the 98 attrib-

utes used in these prior surveys and came up

with a f‌inal set of 106 attributes which not only

ref‌lects the expertise of S&P analysts and

researchers, but also the regulatory, institu-

tional and economic environment in Turkey.

We consider the 106 attributes in three sub-

categories, again using S&P’s classif‌ication

scheme: (i) Disclosure of ownership structure

and investor relations (OwnStr); (ii) Financial

transparency and disclosure in the f‌inancial

statements (FinDisc); and (iii) Disclosure of the

board and management structure and pro-

cesses (BrdMgmt). Next, the annual reports

and the websites (both English and local lan-

guage versions) of the 52 largest and most liq-

uid f‌irms listed in the ISE were searched for

the inclusion of these information attributes.

Each f‌irm was then graded and ranked in the

above-mentioned three categories as well as in

their overall T&D quality.

5

We f‌ind that the transparency and disclo-

sure scores of ISE companies are not impres-

sive, especially in terms of the board and

management structure and processes. Never-