Accounting Conservatism And Ownership Concentration: Evidence From Malaysia

Transcription

1 Journal of Business and Policy Research Volume 5. Number 2. December 2010 Pp Accounting Conservatism And Ownership Concentration: Evidence From Malaysia Rahimah Mohamed Yunos *, Malcolm Smith and Zubaidah Ismail Evidence showed that conservative accounting acts as a governance mechanism to reduce agency conflict. Also, evidence documented the adverse effect of concentrated ownership on financial reporting and firm performance. This study finds that both inside and outside substantial shareholders encourage lower degrees of conservatism. Control variables that significantly influenced asymmetric timeliness measure of conservatism are board independence, board tenure, board size, auditor and market to book ratio. As for accrual-based measure of conservatism, only profitability is found significant. The findings imply that accounting conservatism is not an effective governance tool if it is under the control of the substantial shareholders. Field of research: Financial accounting, Corporate governance. 1. Introduction Accounting conservatism should be considered an important mechanism in controlling opportunistic behaviour among dominant shareholders in Malaysian firms. Many previous studies have reported high ownership concentration in Malaysia (e.g.claessens, Djankov, & Lang, 2000; Lim, 1981; Tam & Tan, 2007; Zhuang, Edwards, & Capulong, 2001) and this trend continues. Haniffa and Hudaib (2006) reported a mean of 31% for a single largest shareholders and 62% for five largest shareholders. This study finds a mean substantial shareholding of 53%. A mean substantial shareholding by insiders is about 31% which shows that firms are closely held by their managers. According to Hannsmann, cited in Rachagan (2006), the traditional agency conflict between managers and shareholders is not relevant to Malaysian firms due to its highly concentrated ownership structure. Accordingly, the dominant role of shareholders in firms allows the controlling shareholders (including managers) to expropriate the interest of the minority shareholders for their own private advantage (Fan & Wong, 2002). The role of hostile takeover to discipline opportunistic managers is almost non-exist in Malaysia because the large shareholder group often includes the CEO or has an affiliation with top management * Rahimah Mohamed Yunos, PhD candidate, Edith Cowan University, Australia. rahimahm@our.ecu.edu.au Professor Malcolm Smith, Faculty of Business and Law, Edith Cowan University, Australia. malcolm.smith@ecu.edu.au Dr Zubaidah Ismail, Faculty of Business and Law, Edith Cowan University, Australia. z.ismail@ecu.edu.au

2 (Haniffa & Hudaib, 2006). Emphasizing the role of conservatism to reduce agency problems in Malaysian companies may compensate for ineffective enforcement of well established legal protections. Conservatism is traditionally defined as accounting practices that anticipate no profit but anticipate all losses (Bliss, 1924). Basu (1997) depicts conservatism as the asymmetric timeliness of earnings which require higher verification to recognise good news as gains than to recognise bad news as losses. Financial Accounting Standard Board (FASB) SFAC No.2 noted that assets and liabilities are frequently measured in the context of significant uncertainties. Hence, managers are allowed to apply their own discretion within GAAP; which includes expensing stock options, valuing inventory, estimating depreciation, bad debt and warranty expenses (Bagnoli & Watts, 2005). Some papers criticised the bias imposed by conservative accounting on financial information (e.g.penman & Zhang, 2002; Sen, 2005) but an important aspect of conservatism acting as a governance mechanism had been suggested by empirical studies. Watts (2003) stated that the ability of conservatism to limit manager s opportunistic behaviours could increase firms value, and thus protect the interests of minority shareholders. In the context of concentrated ownership, however, they may also use their power to determine information in the financial reports. Dargenidou et al.(2007) argued that when agency conflict is controlled through close monitoring by large shareholders, these shareholders put less reliance on financial reporting, and thus adopt less conservative accounting. Alternatively, major shareholders would not employ more conservatism as they might want to conceal their expropriation activities from outsiders. In the light of these observations, accounting conservatism might be lower in firms with high concentrated ownership. The objective of this study is to examine the effect of ownership concentration on conservatism practices. A related objective of this study is also to establish the influence of board of directors and audit committee of Malaysian firms on conservatism. This study uses two measures of conservatism: one based on asymmetric timeliness and one on accrual-based, and examines if ownership concentration determines conservatism practices in Malaysian firms. The results show that substantial shareholders, regardless of whether they are insiders or outsiders, are less conservative based on the accrual-based measure of conservatism. No significant findings are found for both inside and outside substantial shareholders based on the asymmetric timeliness measure. Results of this study may benefit government policy makers and regulatory agencies such as Bank Negara Malaysia, Securities Commission and Malaysian Institute of Corporate Governance; to evaluate the current listing requirements, assess the effectiveness of ownership structure in Malaysian firms and evaluate the strength of the firms governance structure. Creditors will also benefit from the findings because they would understand factors that contributed to lower conservatism, assisting them to evaluate their client effectively. The remainder of the paper is organised as follows. Section 2 discusses findings from previous studies on earnings conservatism and ownership concentration. Section 3 covers research methods, which explains the sample used in the study and measurements of the variables. Section 4 presents the descriptive analysis, empirical results and discussions. Lastly, section 5 concludes the paper with limitations of the study and suggestions for future research. 2

3 2. Literature review The importance of controlling managers opportunistic behaviour is based in managers privilege of holding asymmetric information and receiving asymmetric payoffs (LaFond & Watts, 2008) and having limited liability and limited tenure (LaFond & Roychowdhury, 2008). Managers moral hazard may reduce firms value if they forego profitable investment in order to obtain excessive compensation. Ahmed and Duellman (2007) stated that managers may also accept negative net present value projects in order to foster empire-building or to manipulate the stock price. Bushman and Smith (2001) established that financial information, produced as a result of conservative accounting, disciplines managers on project selection and prevents expropriation activities. Therefore, accounting conservatism benefits corporate governance as losses are recognised immediately, and quick action can be taken to identify underlying reasons. Evidence showed that conservative accounting is more useful in controlling the cost of sub-optimal managerial decisions than if earnings are reported neutrally or liberally (Kwon, 2005). LaFond and Watts (2008) reported that conservatism constrains managers from hiding unfavourable information because accounting conservatism provides hard information on verifiable gains and possible losses. This findings is supported by Lara et al.(2009) who found that conservatism levels among UK bankrupt firms decreased prior to firm failure. Their results suggest that management conceal their opportunistic behaviour leading to a sacrifice in the firms wealth. In addition to reducing managers opportunistic behaviour, conservatism ultimately improves the quality of the financial information. For instance, conservatism increased ability of current earnings to forecast future cash flows (Kim & Kross, 2005); and conservatism increased value relevance of the earnings since it prevented opportunistic managers from using accounting choices that favoured their personal interest (Brown, He, & Teitel, 2006). Also, conservatism reduced managers incentive to manage earnings because timeliness in incorporating losses into earnings reduces the impact of bad news on the share price (Chen, Hemmer, & Zhang, 2007); and creditors reward firms that employ higher conservatism with lower interest because conservatism provides an early signal to the lender of any possible debt violation (Zhang, 2008). Despite these benefits, the prevalence of conservatism practices relies on the management, particularly in firms controlled by large shareholders. Fan and Wong (2002) found that controlling owners produced less information, either because they want to conceal their activities through aggregate earnings numbers or to avoid leakage of specific knowledge about the business to competitors or the public. Chin et al. (2006) found that Taiwanese firms with concentrated ownership structure issued less accurate and more optimistically biased forecasts. Rachagan (2006) found that controlling shareholders in Malaysia increased their profit through related party transactions or earnings management. Empirical findings show that managers with high concentrated ownership expropriate firm s wealth for private benefit (Schiehll, 2006); both low and high managerial ownerships lead to financial distress status (Abdullah, 2006a), high earnings management (Sanchez-Ballesta & Garcia- Meca, 2007) and low firms financial performance (Ming & Gee, 2008). Since shareholding and conservatism are both mechanisms to reduce agency conflict, it implies that the demand for one mechanism is substitution to the other. This is 3

4 confirmed by the findings of LaFond and Roychowdhury (2008) that managerial ownership and conservatism are inversely related. The entrenched effect of major shareholders in Malaysian firms, noted by Tam and Tan (2007), leads to anticipation that majority shareholders in Malaysia employ lower conservatism. Also, consistent with the findings that Malaysian managers have low incentive for transparent reporting, especially for losses (Ball, Robin, & Wu, 2003) and Malaysian firms ranked amongst countries that have aggressive earnings and ranked 9 th out of 34 countries as having severe earnings opacity (Bhattacharya, Daouk, & Welker, 2003). Arguably, concentrated owners in Malaysia might not employ higher conservatism, not only because they had a close monitor over the firm but to conceal their activities. However, previous evidence suggested that outside large shareholders provide efficient governance: Yeo et al.(2002) revealed that outside large shareholders improved informativeness of earnings and suggested that they are effective in reducing earnings management. Dogan and Smyth (2002) showed that outside large shareholders were effective in controlling managers compensation. Given the contrasting results, it may imply that the demand for conservative accounting differs depending on whether the concentrated owners are insiders or outsiders. The insiders may employ lower conservatism to conceal their activities but outsiders demand higher conservatism because they demand better governance. Therefore, the following hypotheses are presented: H1: Higher proportions of substantial shareholding held by inside directors are inversely related to conservative accounting. H2: Higher proportions of substantial shareholding held by the outsiders are positively related to conservative accounting. 3. Methodology 3.1. Sample and data The initial sample in this study consists of 300 non-financial Malaysian listed firms over the period (2100 firm-year observations). The initial sample is derived after excluding PN4 companies, companies that change their financial yearend during the period of study, companies involved with mergers and reconstructions, missing data on share price in and unavailability of online annual report. Due to deletion of outliers, the initial sample is further reduced to 2037 firm-year observations (300 firms) for accrual-based conservatism regression model. The asymmetric timeliness conservatism model involves 2011 firm-year observations (297 firms) for its three-year estimates and 1997 firm-year observations (297 firms) for its one-year estimate. The two methods of estimates of asymmetric timeliness are explained in section Year 2001 is chosen as a starting period because it was a year in which Malaysian listed firms were required to make a mandatory disclosure of the extent of compliance (or non-compliance) with the Malaysian Code on Corporate Governance adopted in Other than to ensure availability of governance data in the annual report, it will ensure uniformity of corporate governance practices of all Malaysian companies. Data was collected from two separate sources: Datastream and annual reports. The Datastream database was used to retrieve financial accounting data including share 4

5 prices and market values; any missing financial figures from Datastream were acquired from the annual report. Data on ownership concentration was hand collected from the annual report under the analysis of shareholding section. Data on board of directors and audit committee are extracted from director s profile and audit committee section Conservatism measures This study uses two measures of earnings conservatism, a) Asymmetric timeliness; and b) Accrual-based. Similar measures have been adopted by Ahmed and Duellman (2007) and Lara et al.(2009) as Givoly et al.(2007) affirmed that relying on a single measure might lead to an incorrect conclusion Asymmetric timeliness (AT) Basu (1997) introduces asymmetric timeliness to measure earnings conservatism. Share returns are used as a proxy for news about firm performance that is publicly available. Timeliness in earnings is measured using reverse-regression between earnings and contemporaneous return that capture the difference in the effects of negative returns and positive returns on earnings. The dummy variable (D) interacts with the return variable (R) to proxy for bad news (RD) whilst the main effect on return (R) is a proxy for good news. Basu s regression model is as follows: E it /P it 1 = β 0 + β 1 R it + β 2 D it + β 3 RD it + ε it (1) where: E it /P it 1 = Net income before extraordinary items divided by beginning of aggregated year market value of equity; β 0 = the intercept across all firms and years; R = Annual stock returns D = Dummy variable equal to 1 if returns are negative and 0 otherwise; The sensitivity of earnings to good news is measured by β 1 estimate while sensitivity of earnings to bad news is measured by (β 1 + β 3 )/β 1. The value of β 3 reflects the incremental sensitivity of earnings to bad news compared to good news, commonly referred as asymmetric timeliness. Therefore, under greater conservatism, β 3 is expected to be more positive. All independent variables interact with each component in Basu s original regression model to identify their effect on the conservatism. The following model illustrates the interaction of inside shareholders (OCIN) with each component in equation (1). Similar interactions are made with the remaining explanatory variables. E it /P it 1 = β 0 + β 1 R it + β 2 D it + β 3 RD it + β 4 OCIN it + β 5 R it OCIN it + β 6 D it * OCIN it + β 7 RD it * OCIN it ε it The earnings and returns in the original Basu specification are based on one year. One year horizon, however are affected by firms failure to record asset write-downs, due to conservatism that previous increase in assets were unrecorded. This is 5

6 referred as buffer problem (LaFond & Watts, 2008). Pae et al.(2005) stated that Basu s annual coefficient understate the degree of conservatism. Roychowdhury and Watts (2007) noted that single period asymmetry is not a measure of aggregate conservatism but is an implication of asymmetric verification standards. They argued that asymmetric timeliness measure estimated over several years would progressively eliminate time lags between returns and earnings. Following this suggestion, Ahmed and Duellman (2007), LaFond and Watts (2008) and LaFond and Roychowdhury (2008) are amongst others who accumulated the returns and earnings over the past three years, in addition to the one-year estimate. Similar approach is employed in this study Accrual-based measure (CONACCR) According to Givoly and Hayn (2000), conservatism leads to persistently negative accruals. More conservative accounting is reflected by more negative average accruals. Averaging over a number of years will mitigate the effects of any temporary large accruals, since accruals will likely reverse within one to two years (Richardson, Sloan, Soliman, & Tuna, 2005). This measure is computed as income before extraordinary item and discontinued operations plus depreciation expenses minus operating cash flows and deflated by total asset. The accrual value is then averaged over 3 years centered in year t, and is multiplied by -1 and refers as CONACCR. Higher values of CONACCR indicate more conservatism. The following regression model tests the influence of ownership concentration (OCIN and OCOUT) and the control variables on accrual measure of conservatism. CONACCR it = β 0 + β 1 OCIN it + β 2 OCOUT it + control variables it + ε it 3.3. Measures of ownership concentration This study measures ownership concentration based on substantial shareholders, which is a percentage of shares own by substantial shareholders over the firm s outstanding shares. This proxy is more appropriate as many of Malaysian firms are controlled by certain parties via nominee names to remain anonymous (Chu & Cheah, 2006). This study separates the substantial shareholders into two categories which are insiders (OCIN) and outsiders (OCOUT). Survey carried out by Bursa Malaysia and PricewaterhouseCoopers in 2002 reported that directors involved in management are also substantial shareholders of the company (Satkunasingam & Shanmugam, 2006). This study defines OCIN as substantial shareholders who are executive and non-executive directors (or his family members) of the firms or firms in which the executive or non-executive directors (or his family members) have an indirect interest. OCOUT are substantial shareholders independent from management either individuals or firms. Additionally, ownership is defined as disperse if the substantial shareholding is less than or equal to 20%; and as concentrated if it is more than 20% (Chu & Cheah, 2006) Control variables Control variables included in the analysis are internal governance namely, board composition (BID), board tenure (BT), board size (BS), audit committee composition 6

7 (ACID) and financial expertise in audit committee (ACF). Controlling for firm characteristics are type of auditor (AUD), sales growth (SGROW), firm size (TA), profitability (PROF) and leverage (LEV) and market to book ratio (MTB). Evidence showed that internal governance with strong attributes promotes better governance (Abbott, Parker, & Peters, 2004; Ahmed & Duellman, 2007; Bedard, Chtourou, & Courteau, 2004; Krishnan & Visvanathan, 2008; Lara, Osma, & Penalva, 2007; Saleh, Iskandar, & Rahmat, 2007), hence may employ higher conservatism. Also, firms that vary in characteristics influence the conservatism level (see:ahmed, Billings, Morton, & Stanford-Harris, 2002; Chung, Firth, & Jeong-Bon, 2003; Givoly et al., 2007). Table 1 presents the measurements of all variables. Table 1: Variables and measurements Variables Measurements Accounting conservatism 1) Asymmetric timeliness (Basu, 1997); 2) Accrual-based (Givoly & Hayn, 2000). Ownership concentration 1) OCIN= Percentage of substantial shareholding held by executive and non-executive directors over outstanding shares. 2) OCOUT= Percentage of substantial shareholding held by outsiders over outstanding shares BID Proportion of independent directors in board. BT Average number of year independent directors served on the board. BS Log of total directors in the board. ACID Proportion of independent directors in audit committee. ACF Proportion of directors with financial expertise in audit committee AUD Dummy variable, coded 1 if big-4 auditor, 0 otherwise. SGROW Percentage of annual sales growth TA Log of total assets PROF Cash flow from operation divided by total assets LEV Noncurrent liabilities divided by total assets MTB Market value of equity divided by book value of equity 4. Findings 4.1. Descriptive analysis Table 2 provides a summary of the descriptive statistics of the firms examined. The mean CONACCR is The negative value indicates that Malaysian firms practice lower conservatism as compared to those found by Ahmed and Duellman (2007) and Krishnan and Visvanathan (2008) for US firms which was Different in institutional factors such as ownership structure might have driven the discrepancy as Malaysia firms ownership structure is highly concentrated to large shareholders as compared to widely held ownership structure in US. The mean ownership by OCIN is 30.85% and OCOUT is 22.70%. Mean value of share ownership found in this study (and previously documented by other Malaysian studies) is far higher than those reported by studies in other countries. For instance, LaFond and Roychowdhury (2008), examined US firms, reported a mean ownership of 4.5% for top five managers and Korczak and Korczak (2009) examined Polish- 7

8 listed firms reported a mean management ownership of 9.1%. High shareholdings by the insiders, impose concerns on whether they used their power for personal benefit as argued by Yeo et al. (2002). Table 3 reports the descriptive statistics of firms with dispersed and concentrated ownership. Based on the full sample, only 3.24% of the distributions have dispersed ownership whilst the remaining 96.76% have concentrated ownership. Of the firms with concentrated ownership, 52.33% are dominated by insiders, 24.79% are dominated by outsiders and 17.28% are dominated by both insiders and outsiders. The yearly distributions show that firms with concentrated ownership remain around 90%. Table 2: Descriptive statistics Mean Median Std. Dev. Min Max EP R EP R CONACCR OCIN (%) OCOUT (%) BID BT BS ACID ACF SGROW (%) TA PROF LEV MTB AUD=1 (big audit firm) 65.80% 8

9 Full sample (N=2037) Table 3: Percentage of firms with concentrated ownership Disperse ownership Concentrated ownership Dominant by insiders Dominant by outsiders Dominant by insiders & outsiders Yearly 2001 (n=290) 2002 (n=292) 2003 (n=292) 2004 (n=290) 2005 (n=294) 2006 (n=296) 2007 (n=283) The mean value of BID and ACID indicate that Malaysian listed firms complied with the Malaysian Code on Corporate Governance (MCCG). Non presence of independent directors occurred in 2001 and 2002, which were the transition periods before firms fully complied with MCCG implemented in In fact, the compliance deadlines set then by KLSE (now known as Bursa Malaysia) was extended three times during 31 March 2002 to 31 March 2003 (Haron, Jantan, & Pheng, 2005). The non-presence of an accounting qualified member in the audit committee however not only appeared in 2001, but continues until In 2001, there were 50 firms with audit committee without financial expertise, while in 2007 this was reduced to 12 firms. About 66% of the sample was audited by a big four audit firm. The average tenure for independent directors on the board was 7 years, the longest being 31 years. The average board size is 7 directors Empirical results Results for asymmetric timeliness (AT) are presented in Table 4 and accrual-based (CONACCR) in table 5. Table 4 are divided into two columns. Column (a) is oneyear estimate and column (b) is three-year backward accumulation estimate. As explained in section 3.2.1, in addition to Basu s one-year estimate of earnings and returns, this study also estimate these items on three-year backward accumulation as suggested by Roychowdhury and Watts (2007). Similar approach had been taken by Ahmed and Duellman (2007), LaFond and Roychowdhury (2008) and LaFond and Watts (2008). The coefficient sign of OCIN on asymmetric timeliness (OCIN*RD) are as expected. The effect of OCOUT on asymmetric timeliness (OCOUT*RD) is oppose to 9

10 prediction, suggesting that outside substantial shareholders also adopt lower conservatism. However, their coefficients are not significant. Based on CONACCR measure in table 5, the sign of coefficient for OCIN and OCOUT are similar to the AT measure but they are significant at 1% and 5% level respectively. This result confirmed that substantial shareholders in Malaysia, regardless of whether they are insiders or outsiders, adopt less conservative accounting. This supports Hypothesis 1 but not Hypothesis 2. Table 4:Fixed effects regression model of asymmetric timeliness measure on concentrated ownerships and control variables. Predicted sign (a) One-year estimate (b) Three-year estimate Variables Coefficient t-statistic Coefficient t-statistic Constant *** R D ** RD OCIN *** *** OCIN*D *** *** OCOUT *** *** OCOUT*D *** *** OCIN*R ** OCIN*RD OCOUT*R OCOUT*RD F-value 36.79*** *** N ***p<0.01; **p<0.05;* p<0.10. LaFond (2005) and LaFond and Roychowdhury (2008) argued negative relationship between insiders ownership and conservatism as a substitution effect. As managers become owners, their interest is aligned with the shareholders, thus demand lower conservatism as a monitoring tool. They made this contention on the view of dispersed ownership structure in US with high agency conflict between managers and shareholders. However, for firms with concentrated ownership, conflict between the majority and minority shareholders is more relevance. This is consistent with Bebchuk, Cohen and Ferrell (2009) that managerial ownership is a tool for managerial entrenchment hypothesis. Therefore, the inverse effect of inside substantial shareholders on the conservatism practices could be interpreted as an entrenchment effect. Also, consistent with Korczak and Korczak (2009) and Kothari et al.(2009) findings that insiders conceal their expropriation activities, this study argues that insiders do not employ higher conservatism to avoid constraint on their opportunistic activities. The negative effect of OCOUT on conservatism is opposed to the expectation. It suggests that outsiders do not employ higher conservatism to promote better governance. Thus, findings of Yeo et al. (2002) and Dogan and Smyth (2002), on 10

11 the governance role of outside large shareholders, do not apply to Malaysian firms. However, this finding may also consistent with the substitution effect that as firms are closely monitored by the outside shareholders; there is less need to apply higher conservatism practices. Nevertheless findings carried out on Malaysian firms have shown that outside majority shareholders are not effective in their monitoring roles (e.g. Abdullah, 2006b; Ming & Gee, 2008), suggesting that the former argument precede the later argument on the governance role of outside shareholders. The results also show that concentrated owners have a strong influence on the CONACCR relative to the AT measure. This supports the point made by Dalton and Dalton (2005) that accounting based measures are subject to managerial manipulation. The motive to conceal opportunistic behaviour through lower conservatism is consistent with Haniffa and Hudaib s (2006) finding that higher managerial ownership led to lower accounting performance. Also supporting their suggestion that necessary actions need to be taken to ensure that insiders do not misappropriate firm resources, thus damaging firms value. Table 5: Fixed effects regression model of accrual-based measure on concentrated ownerships and control variables. Variables Predicted Sign Coefficient t-statistic constant OCIN *** OCOUT ** BID BT BSIZE ACID ACF AUD TA SGROW PROF *** LEV F-value 5.01*** N 2037 ***p<0.01; **p<0.05;* p<0.10. For brevity, table 4 reports coefficients only on the ownership concentration and discuss the other coefficients in the text. Control variables examined in asymmetric timeliness is similar to the accrual-based measure regression except market to book ratio (MTB) replaced the sales growth (SGROW). Board independence and big audit firms significantly lead to higher conservatism when asymmetric timeliness is estimate using three-year backward accumulation. Surprisingly, longer board tenure leads to lower conservatism which inconsistent with the argument that longer tenure reflects strong governance attributes. Negative effect of board size on AT measure is consistent with previous evidence that larger board reflect weak governance, thus reduced the conservatism practices. The negative sign on MTB supports the findings of Roychowdhury and Watts (2007) and LaFond and Roychowdhury (2008) 11

12 that firms with growth opportunities are less conservative. Based on one-year estimate, total asset as a proxy of firm size is positively related to asymmetric timeliness. This suggests that larger firms employ more conservative accounting. Nevertheless, it is only marginally significant at 10% level. The negative effect of leverage on asymmetric timeliness is contradict with the contention that debt holder prefer conservatism to constraint managers behaviour from distributing firms wealth unnecessarily for the benefit of managers or shareholders. None of the board or audit committee attributes are found significant with the accrual-based measure. However, firms with higher profitability employ higher accrual-based conservatism. 5. Conclusions Previous studies documented the role of conservatism in reducing agency conflict but none has investigated if higher conservatisms are employed in firms with concentrated ownership. Based on two measures of conservatism: a) asymmetric timeliness and b) accrual-based, it is revealed that both inside and outside substantial shareholders employ lower conservatism. The implication from this finding is the great power that the controlling owners exert may diminish the role of financial reports in controlling and monitoring the management. The merit of conservatism as a governance mechanism does not seem to work when its application is determined by the controlling parties, who are supposed to be subject to control. With the exception of board independence on the asymmetric timeliness, other attributes of board of directors and audit committee examined in this study seems not effective in determining conservatism practices of Malaysian firms. These results highlight the importance of strong and effective corporate governance mechanisms as their impact on financial reporting is evaluated. The authority especially Malaysian Institute of Corporate Governance and Bursa Malaysia must not tolerate firms that do not comply with the Malaysian Code on Corporate Governance. The authority should also play an active role to ensure that firms governance structures function effectively rather than merely being a disclosure. The Bursa Malaysia might consider changing the rules on share ownership so that Malaysian businesses are in line with the emerging market to attract more and diverse investors, promote quality financial reports and protect the interest of the minority shareholders. Despite these findings, this study suffers from the following limitations. Firstly, ownership concentration was classified into insiders and outsiders. Future studies may classify based on individual, family and institutional factors to observe if these categories provide different results. Secondly, this study controlled only five attributes of internal governance. Other attributes, such as number of board meetings and audit committee meetings, CEO duality and directors multiple directorship also contribute to effective governance. 12

13 6. References Abbott, L. J., Parker, S., & Peters, G. F Audit committee characteristics and restatements. Auditing, 23(1): Abdullah, S. N. 2006a. Board structure and ownership in Malaysia: The case of distressed listed companies. Corporate Governance, 6(5): Abdullah, S. N. 2006b. Directors' remuneration, firm's performance and corporate governance in Malaysia among distressed companies. Corporate Governance, 6(2): Ahmed, A. S., Billings, B. K., Morton, R. M., & Stanford-Harris, M The role of accounting conservatism in mitigating bondholder-shareholder conflicts over dividend policy and in reducing debt costs. The Accounting Review, 77(4): Ahmed, A. S., & Duellman, S Accounting conservatism and board of directors characteristics: An empirical analysis. Journal of Accounting and Economics, 46: Bagnoli, M., & Watts, S. G Conservative accounting choices. Management Science, 51(5): Ball, R., Robin, A., & Wu, J. S Incentives versus standards: Properties of accounting income in four East Asian countries. Journal of Accounting & Economics, 36(1-3): Basu, S The conservatism principle and the asymmetric timeliness of earnings. Journal of Accounting & Economics, 24(1): Bebchuk, L., Cohen, A., & Ferrell, A What matters in corporate governance? The Review of Financial Studies, 22(2): Bedard, J., Chtourou, S. M., & Courteau, L The effect of audit committee expertise, independence, and activity on aggressive earnings management. Auditing, 23(2): Bhattacharya, U., Daouk, H., & Welker, M The world price of earnings opacity. The Accounting Review, 78(3): Bliss, J. H Management through accounts. New York: The Ronald Press Company. Brown, W. D., He, H., & Teitel, K Conditional conservatism and the value relevance of accounting earnings: An international study. European Accounting Review, 15(4): Bushman, R. M., & Smith, A. J Financial accounting information and corporate governance. Journal of Accounting & Economics, 32(1-3): Chen, Q., Hemmer, T., & Zhang, Y On the relation between conservatism in accounting standards and incentives for earnings management. Journal of Accounting Research, 45(3): Chin, C.-L., Kleinman, G., Lee, P., & Lin, M.-F Corporate ownership structure and accuracy and bias of mandatory earnings forecast: Evidence from Taiwan. Journal of International Accounting Research, 5(2): Chu, E. Y., & Cheah, K. G Does ownership structure matter? Evidence from Malaysian equity market. Corporate Ownership & Control, 4(1): Chung, R., Firth, M., & Jeong-Bon, K Auditor conservatism and reported earnings. Accounting & Business Research, 33(1): Claessens, S., Djankov, S., & Lang, L. H. P The separation of ownership and control in East Asian corporations. Journal of Financial Economics, 58(1/2):

14 Dalton, C. M., & Dalton, D. R Boards of directors: Utilizing empirical evidence in developing practical prescriptions. British Journal of Management, 16(s1): S91-S97. Dargenidou, C., McLeay, S., & Raonic, I Ownership, investor protection and earnings expectations. Journal of Business Finance & Accounting, 34(1/2): Dogan, E., & Smyth, R Board remuneration, company performance, and ownership concentration: Evidence from publicly listed Malaysian companies. ASEAN Economic Bulletin, 19(3): Fan, J. P. H., & Wong, T. J Corporate ownership structure and the informativeness of accounting earnings in East Asia. Journal of Accounting & Economics, 33(3): Givoly, D., & Hayn, C The changing time-series properties of earnings, cash flows and accruals: Has financial reporting become more conservative? Journal of Accounting & Economics, 29(3): Givoly, D., Hayn, C. K., & Natarajan, A Measuring reporting conservatism. Accounting Review, 82(1): Haniffa, R., & Hudaib, M Corporate governance structure and performance of Malaysian listed companies. Journal of Business Finance & Accounting, 33(7/8): Haron, H., Jantan, M., & Pheng, E. G Audit committee compliance with Kuala Lumpur Stock Exchange Listing Requirements. International Journal of Auditing, 9: Kim, M., & Kross, W The ability of earnings to predict future operating cash flows has been increasing-not decreasing. Journal of Accounting Research, 43(5): Korczak, A., & Korczak, P Corporate ownership and the information content of earnings in Poland. Applied Financial Economics, 19(9): Kothari, S. P., Shu, S., & Wysocki, P. D Do managers withhold bad news? Journal of Accounting Research, 47(1): Krishnan, G. V., & Visvanathan, G Does the SOX definition of an accounting expert matter? The association between audit committee directors' accounting expertise and accounting conservatism. Contemporary Accounting Research, 25(3): Kwon, Y. K Accounting conservatism and managerial incentives. Management Science, 51(11): LaFond, R The influence of ownership structure on earnings conservatism and the informativeness of stock prices: An international comparison. Working paper, Massachusetts Institute of Technology. LaFond, R., & Roychowdhury, S Managerial ownership and accounting conservatism. Journal of Accounting Research, 46(1): LaFond, R., & Watts, R. L The information role of conservatism. Accounting Review, 83(2): Lara, J. M. G., Osma, B. G., & Neophytou, E Earnings quality in ex-post failed firms. Accounting and Business Research, 39(2): Lara, J. M. G., Osma, B. G., & Penalva, F Board of directors' characteristics and conditional accounting conservatism: Spanish evidence. European Accounting Review, 16(4): Lim, M. H Ownership and control of the one hundred largest corporations in Malaysia: Oxford University Press. 14

15 Ming, T. C., & Gee, C. S The influence of ownership structure on the corporate performance of Malaysian public listed companies. ASEAN Economic Bulletin, 25(2): Pae, J., Thornton, D. B., & Welker, M The link between earnings conservatism and the price-to-book ratio. Contemporary Accounting Research, 22(3): Penman, S. H., & Zhang, X.-J Accounting conservatism, the quality of earnings, and stock returns. The Accounting Review, 77(2): Rachagan, S Agency costs in controlled companies. Singapore Journal of Legal Studies: Richardson, S. A., Sloan, R. G., Soliman, M. T., & Tuna, I Accrual reliability, earnings persistence and stock prices. Journal of Accounting & Economics, 39(3): Roychowdhury, S., & Watts, R. L Asymmetric timeliness of earnings, marketto-book and conservatism in financial reporting. Journal of Accounting & Economics, 44(1/2): Saleh, N. M., Iskandar, T. M., & Rahmat, M. M Audit committee characteristics and earnings management: Evidence from Malaysia. Asian Review of Accounting, 15(2): Sanchez-Ballesta, J. P., & Garcia-Meca, E Ownership structure, discretionary accruals and the informativeness of earnings. Corporate Governance: An International Review, 15(4): Satkunasingam, E., & Shanmugam, B The consequences of culture on shareholder activism in Malaysia. Journal of Applied Management Accounting Research, 4(1): Schiehll, E Ownership structure, large inside/outside shareholders and firm performance: Evidence from Canada. Corporate Ownership & Control, 3(3): Sen, P. K Reported earnings quality under conservative accounting and auditing. Journal of Accounting, Auditing & Finance, 20(3): Tam, O. K., & Tan, M. G.-S Ownership, governance and firm performance in Malaysia. Corporate Governance: An International Review, 15(2): Watts, R. L Conservatism in accounting part I: Explanations and implications. Accounting Horizons, 17(3): Yeo, G. H. H., Tan, P. M. S., Ho, K. W., & Chen, S Corporate ownership structure and the informativeness of earnings. Journal of Business Finance & Accounting, 29(7/8): Zhang, J The contracting benefits of accounting conservatism to lenders and borrowers. Journal of Accounting & Economics, 45: Zhuang, J., Edwards, D., & Capulong, M. V. E Corporate governance and finance in East Asia: A study of Indonesia, Republic of Korea, Malaysia, Philippines and Thailand, Asian Development Bank, Vol