Moderating effect of ownership concentration on firms governance and accounting conservatism

Transcription

1 Moderating effect of ownership concentration on firms governance and accounting conservatism ahimah Mohamed Yunos and Syahrul Ahmar Ahmad Universi Teknologi Mara Johor Abstract This study investigates the effect of ownership concentration and firms governance on accounting conservatism and whether ownership concentration moderates the effect of firms governance on conservatism. The results show that concentrated ownership is associated wh lower accounting conservatism. Firms that have stronger governance mechanisms led to high accounting conservatism but the moderating effect of concentrated ownerships leads the firms governance to adopt less conservatism. The findings suggest that accounting conservatism is not a useful agency tool because the controlling shareholders influence governance mechanisms in the firm to adopt lower conservatism. Keywords: Concentrated ownership, Corporate governance, Conservatism. Corresponding author: ahimah Mohamed Yunos Faculty of Accountancy Universi Teknologi Mara KM12 Jalan Muar Segamat Johor Telephone: rahim221@johor.um.edu.my 1

2 1.0 INTODUCTION Conservatism is tradionally defined as accounting practices that anticipate no prof but anticipate all losses (Bliss, 1924). Basu (1997) depicts conservatism as the asymmetric timeliness of earnings which requires higher verification to recognise good news as gains than to recognise bad news as losses. Posive accounting theory suggests the use of conservative accounting to control the opportunistic behaviour of the managers including the controlling shareholders. The abily of conservatism to lim manager s opportunistic behaviours could increase firms value, and thus protect the interests of minory shareholders (Watts, 2003). Previous studies argued that corporate governance in Asian countries generally, is not effective due to the influence of controlling shareholders. There is concern that highly concentrated ownership in Malaysian firms may apply less conservatism as they do not need a mechanism that lim or disclose their opportunistic behaviour. Though evidence exists to show that conservatism is effective in reducing agency conflict, less is known about s applicabily in Malaysia. So far, no evidence is documented for Malaysian firms in this area as most evidence was from the developed countries where the firms ownership structure is widely dispersed. UK and US studies examined accounting conservatism wh board of directors, aud commtee and managerial ownership (Ahmed & Duellman, 2007; Krishnan & Visvanathan, 2008; LaFond & oychowdhury, 2008). The results of this study will add to the lerature as no study for Malaysian samples has directly tested the moderating effect of ownership concentration on the effectiveness of firms governance. This study uses asymmetric timeliness to measure accounting conservatism; and examines the effect of ownership concentration in Malaysian firms on conservatism and whether changes the relationship between the firms governance mechanism and conservatism. The results show that concentrated owners negatively moderate the relationship between firms governance and conservatism. The remainder of the paper is organised as follows. Section 2 discusses previous evidence on earnings conservatism, ownership concentration and moderating relationships. Section 3 presents the research methodology. Section 4 presents the results and section 5 concludes the paper wh suggestions for future research. 2.0 LITEATUE EVIEW The presence of concentrated ownership in Malaysia and in many East Asian countries has long been published (see: Claessens, Djankov, & Lang, 2000; Tam & Tan, 2007; Zhuang, Webb, Edwards, & Capulong, 2001). It was reported that Malaysian managers and audors have low incentives for transparent reporting especially for losses (Ball, obin, & Wu, 2003). Bhattacharya, Daouk and Welker (2003) examined 34 countries including Malaysia showed that Malaysian firms were ranked in 9 th place as having severe earnings opacy. Their evidence suggests that the presence of the concentrated ownership may have influence on the qualy of the Malaysian financial reports. As major shareholders in Malaysian firms are entrenched (Tam & Tan, 2007), is unlikely that the controlling shareholders, who have decision making power in the firms, employ a mechanism that can lim or disclose their opportunistic behaviour. As concentrated ownerships are associated wh the risk of expropriation, they may practice less conservatism, consistent wh Korczak and Korczak (2009) argument that controlling shareholders not only expropriated but also concealed their behaviour through self-interested accounting choices and concealed firm performance from outsiders to avoid disciplinary action. Concentrated owners have lower demand for conservatism because they have easy access to managers private information, and hence put less reliance on financial reports (Dargenidou, McLeay, & aonic, 2007). Competing arguments, for example, the entrenchment effect and the substution effect suggest that majory shareholders would lead to less conservatism eher because they do not need a governance 2

3 tool to control their behaviour; or their presence to monor the management substutes for the governance mechanism. Empirical evidence showed that inside concentrated owners adopted a weak governance structure (Horner, 2010; Lasfer, 2006), associated wh low firm performance (Abdullah, 2006; Ming & Gee, 2008; Schiehll, 2006), involved wh low level of corporate social responsibily (Ghazali, 2007) and leading to high earnings management (Sanchez-Ballesta & Garcia-Meca, 2007; Sarkar, Sarkar, & Sen, 2008). The outside concentrated owners however, were good monors in reducing earnings management (Azofra, Castrillo, & Delgado, 2003; Yeo, Tan, Ho, & Chen, 2002). The following hypotheses are presented, H1: The proportion of inside concentrated ownership is inversely related to accounting conservatism. H2: The proportion of outside concentrated ownership is posively related to accounting conservatism. esearchers have raised concerns that the corporate governance model adopted from developed countries does not work well in emerging economies due to s different instutional environment notably concentrated ownership structure. In particular, previous studies suggested that the board of directors or aud commtee in emerging economies are ineffective due to the dominant role of the concentrated owners of whom the majory are insiders. Moderating effects provide direct indication of whether or not the firms governance mechanisms are effective in influencing the concentrated owners behaviour; or whether s function is limed by the controlling shareholders. Cho and Kim (2007) examined the effect of large shareholders on the relationship between independent directors on the board and firm performance. They reported that inially the proportion of independent directors is posively related to firm performance. However, the performance reduced when the independent directors interacted wh the large shareholders. Board independence in the emerging system was ineffective relative to the Anglo-American system (Garcia-Meca & Sanchez-Ballesta, 2009) while concentrated owners in Chinese listed firms hindered the monoring duties of the board of directors and supervisory board from improving financial performance (Hu, Tam, & Tan, 2010). Similarly, board meeting, CEO dualy, independent directors and supervisory board could not moderate the adverse effect of the concentrated owners on firm performance (Chen, Li, & Shapiro, 2011). The Malaysian Code on Corporate Governance stated that Malaysian firms should adopt the best practice of corporate governance to ensure better monoring abily. Therefore, is expected that firms that practice strong governance would use more conservatism to assist in the governance role. However, since evidence showed that controlling shareholders have an adverse effect on the firms governance; is likely that the shareholders would influence them to adopt lower conservatism. The following hypotheses are to be tested, H3: There is a posive relationship between firm s governance and conservatism. H4: The power of the concentrated owners, represented by the percentage of ownership, negatively moderates the posive effect of the firms governance on conservatism. 3.0 ESEACH METHODOLOGY The sample study extends from 2001 to 2007 of 2021 firm-year observations from the population of all companies listed on Bursa Malaysia excluding finance related companies. This study uses asymmetric timeliness to measure accounting conservatism introduced by Basu (1997). Share returns are used as a proxy for news about firm performance. Timeliness in earnings is measured using reverse-regression between earnings and contemporaneous returns that capture the difference in the effects of negative 3

4 returns and posive returns on earnings. A dummy variable (D) interacts wh the return variable () to proxy for bad news ( D) whilst the main effect on return () is a proxy for good news. The regression model is presented as follows: E /P D 3 D ε (1) Where: For each firm (i) and each year (t), E /P 1 = Net Income before extraordinary ems divided by beginning of fiscal year market value of equy; = fiscal year share return; D = dummy variable is equal to 1 if returns are negative; 0 if otherwise. *D = Interaction between and D The sensivy of earnings to good news is measured by the β 1 estimate while sensivy of earnings to bad news is measured by β 1 + β 3. Posive coefficients are predicted for intercept (β 0 ) and return (β 1 ). The posive sign for the intercept reflects the realised gain (good news) from previous periods recognised in the current year (Basu, 1997). The value of β 3 reflecting the incremental sensivy of earnings to bad news compared to good news, and thus measures the accounting conservatism. The coefficient of β 3 is commonly referred to as asymmetric timeliness. Under greater conservatism, earnings will have higher sensivy to bad news as compared to good news. Accordingly, β 3 is expected to be larger than zero. The following models were adopted to test the hypotheses. egression model 1 to test hypotheses 1 to 3 E / P D GOV Controlvariables 6 (2) egression model 2 to test hypotheses 4 E /P D 3 * D GOV 13 GOV 14 GOV 15 GOV Controlvariables ε (3) The measurements of variables are: E /P 1 = Net Income before extraordinary ems divided by beginning of fiscal year market value of equy; = fiscal year share return; D = dummy variable is equal to 1 if returns are negative; 0 if otherwise. *D = Interaction between and D =Percentage of concentrated ownership held by executive and non-executive directors. 4

5 = Percentage of concentrated ownership held by outsiders independent from the management. GOV = Percentile ranking of average rank values of eight governance attributes: board composion, board size, CEO dualy, financial expertise on the board and aud commtee, aud commtee composion, aud commtee meeting and audor. Control Variables: TA = Natural logarhm of total assets. POF = Cash flow from operations Total assets. LEV = Noncurrent liabilies Total assets. MTB = Market to book value. To test Hypothesis 1, 2 and 3,,, GOV and the control variables, were interacted wh variables in Basu s original model, as in (1). The coefficient of the interaction term *D wh the variable, represents the effect of the respective variable on asymmetric timeliness. For instance, the effect of on asymmetric timeliness, is observed on β 7, which is the coefficient of the interaction term of *D wh inside concentrated ownership (**D). If inside concentrated ownership employ more conservatism, β 7 is expected to be posive. Similar interactions were made wh the remaining independent variables; but are not shown for clary purposes. 4.0 FINDINGS In Table 1, had a negative but weak effect on asymmetric timeliness while was not associated wh asymmetric timeliness. GOV had a strong posive association wh asymmetric timeliness suggests that firms wh stronger governance mechanisms were associated wh early recognion of bad news relative to good news into earnings. Hypothesis 1 and 3 was supported. The negative coefficient on outside substantial shareholders was oppose of that expected. This finding suggests that outside substantial shareholders in Malaysia did not exercise their governance role through higher demand for accounting conservatism. Coefficients of GOV* and GOV**D in Table 1 represent firms governance whout the influence of the concentrated owners. The posive coefficient on GOV**D indicates that GOV led to more conservatism where the firms governance led to faster recognion of bad news relative to good news into earnings. The interaction effects between GOV wh and are shown in Table 2. The variables of interest are *GOV**D and *GOV**D. When GOV was interacted wh and, the sign of coefficients changed suggesting that the controlling shareholders led the firms governance to employ less conservatism. Table 1: The Main Effect of concentrated ownership and governance on accounting conservatism Predicted signs Coefficients t-statistic constant D ** *D *** *D *** *** *D *** GOV GOV*D

6 * **D * * **D GOV* *** GOV**D *** Control Variables included Yes F-value 9.08*** 2 whin.1767 N 2021 eported t-value was estimated based on Driscoll and Kraay (1998) method, robust to cross-sectional dependence, heteroskedasticy and autocorrelation. ***p<0.01; **p<0.05;* p<0.10 = Stock return, D= dummy 1 if is negative; 0 otherwise, =Inside concentrated ownership, = Outside concentrated ownership, GOV= Firms aggregate governance measure. Table 2: Moderating Effect of ownership concentration on the association between firms governance and accounting conservatism Predicted signs Coefficients t-statistic constant ** D *D ** *** *D *** *D *** GOV GOV*D *** *GOV *GOV*D *** *GOV *GOV*D *** * *** **D *** * ** **D GOV* *** GOV**D *** *GOV* *** *GOV**D *** *GOV* *** *GOV**D ** Control Variables included Yes F-value 66.34*** 2 whin.1984 N

7 eported t-value was estimated based on Driscoll and Kraay (1998) method, robust to cross-sectional dependence, heteroskedasticy and autocorrelation. ***p<0.01; **p<0.05;* p<0.10 = Stock return, D= dummy 1 if is negative; 0 otherwise, =Inside concentrated ownership, = Outside concentrated ownership, GOV= Firms aggregate governance measure. The negative effect of the controlling shareholders on conservatism may enable them to pursue their personal agenda and conceal their expropriation activies from the financial reports. This is consistent wh the evidence that firm value was higher when the firms boards were independent of controlling shareholders (Dahya, Dimrov, & McConnell, 2009) and concentrated owners hinder the firms governance from function effectively (Chen et al., 2011; Cho & Kim, 2007). The finding confirms the argument that corporate governance in Asian countries is ineffective due to their highly concentrated ownership (Allen, 2000; Globerman, Peng, & Shapiro, 2011) and copying the corporate governance code from the developed countries does not work in countries where firms ownership is highly concentrated (Chen et al., 2011). Though firms follow best practice but in actual fact the firms governance is ineffective as they are subject to the control of the concentrated owners. The limed power of the Bursa Malaysia listing rules to only suspend or delist firms for breaking s rules, will only compound the damage already suffered by minory shareholders (Thillainathan, 1999). The insiders who are the actual offenders remain safe. Evidence in this study suggests that the authories should consider refining the law to increase the punishment of controlling shareholders who violate their fair share of wealth relative to minory shareholders. The regulators should strengthen the enforcement of legal protection of shareholders as s poor enforcement is one of the reasons for highly concentrated ownership in Asian countries (La Porta, Lopez-De-Silanes, Shleifer, & Vishny, 1998; Shleifer & Vishny, 1997). 5.0 CONCLUSION The results suggest that accounting conservatism is not a useful tool for monoring the controlling shareholders because they determine the application of conservatism in the financial reports. Though they have no direct impact on conservatism, the controlling shareholders influence governance mechanisms in the firm to adopt lower conservatism. esults from this study suggest that the regulators must first emphasise the market tools to control agency conflicts in Malaysian firms before strengthening the internal governance structure. Particularly, the relevant authory should focus on enforcing the law, a system that already exists in Malaysia, rather than implementing mechanisms that can be manipulated by the controlling shareholders. EFEENCES Abdullah, S. N. (2006). Board structure and ownership in Malaysia: The case of distressed listed companies. Corporate Governance, 6(5), Ahmed, A. S., & Duellman, S. (2007). Accounting conservatism and board of directors characteristics: An empirical analysis. Journal of Accounting and Economics, 46(2/3), Allen, J. (2000). Code convergence in Asia: Smoke or fire? Corporate Governance International, 3(1),

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