samaha and dahawy - 2011 - an empirical analysis of cg structures and voluntary corporate disclosure in egyptian

ownership structure, board composition and audit committee presence of voluntary corporate disclosure in the annual reports of the largest 100 companies listed on the Egyptian stock exc

An empirical analysis of corporate governance structures and voluntary corporate disclosure in volatile capital markets: the Egyptian experience

Khaled Samaha*

Department of Accounting, School of Business, The American University in Cairo (AUC), Room 2058 – BEC Building,

P.O Box 74, New Cairo 11825, Egypt E-mail: ksamaha@aucegypt.edu

*Corresponding author

Khaled Dahawy

Department of Accounting, School of Business, The American University in Cairo (AUC), Room 2001 – BEC Building,

P.O Box 74, New Cairo 11825, Egypt E-mail: dahawy@aucegypt.edu

Abstract: This paper examines the level and determinants (i.e ownership

structure, board composition and audit committee presence) of voluntary corporate disclosure in the annual reports of the largest 100 companies listed on the Egyptian stock exchange (EGX) Our results indicate that overall voluntary disclosure was low at just 13.43% with a large variation range This score places Egypt at a lower level than other emerging capital markets (e.g

Singapore, Hong Kong and Malaysia) The variances of these results support the need for individual country level studies and comparative analysis

Multivariate results show audit committee presence as the most significant variable influencing voluntary disclosure Also, companies with a higher ratio

of independent non-executive directors have a higher extent of voluntary disclosure It was also evidenced that voluntary disclosure increases with decreases in block-holder ownership Results show that two other ownership aspects – managerial and government – are not related to voluntary disclosure

Finally, the analysis shows profitability and internationality significantly impact voluntary disclosure On the other side, that number of shareholders, type of auditor, size, liquidity, leverage and industry type of the firm do not affect the extent of voluntary disclosure

Keywords: corporate governance; corporate disclosure; voluntary disclosure;

volatile capital markets; Egypt

Reference to this paper should be made as follows: Samaha, K and

Dahawy, K (2011) ‘An empirical analysis of corporate governance structures and voluntary corporate disclosure in volatile capital markets: the Egyptian

experience’, Int J Accounting, Auditing and Performance Evaluation, Vol 7,

Nos 1/2, pp.61–93

Biographical notes: Khaled Samaha is an Assistant Professor in the

Department of Accounting at the American University in Cairo (AUC) He has

a PhD (Manchester Business School – UK) and an MSc (Birmingham Business School – UK) He is a Certified Public Accountant (CPA) from the Egyptian Society for Accountants and Auditors (ESAA) and is certified by the Egyptian Accounting Syndicate He has extensive practical experience in the application

of International Financial Reporting Standards (IFRSs) and he has recently published three papers about progressing Egypt towards convergence with IAS/IFRS His research interests include harmonisation and compliance with IAS/IFRS, financial reporting and corporate governance mechanisms, audit procedures and methodologies, financial reporting on the internet and the implementation of accounting information systems in small and medium size enterprises (SMEs) Currently, he is serving as a Member on the Editorial

Board of the Afro Asian Journal of Finance and Accounting Currently, he is

serving as an Audit Consultant on various projects with the Egyptian Ministry

of Transport and the government of the Italian Republic

Khaled Dahawy is the Director of MBA programs and an Associate Professor

in the Department of Accounting at the American University in Cairo (AUC)

He has a PhD (University of North Texas) and an MBA (Pennsylvania State University) He is a Certified Public Accountant (CPA) in the State of Illinois, USA, certified from the Egyptian Society for Accountants and Auditors (ESAA) and is certified by the Egyptian Accounting Syndicate He has several papers and cases published in academic accounting journals and presented at academic and practitioner conferences His research interests include corporate governance disclosure, disclosure in the developing countries, the role of the audit profession in strengthening transparency and disclosure, the use of information technology in accounting and the implementation of computerised accounting information systems He teaches financial accounting, international accounting, tax accounting and auditing He has extensive practical experience

as an expert in the Capital Market Authority (CMA) and has served as a Consultant in many missions with the World Bank and the National Democratic Party (NDP)

1 Introduction

The move towards a free market economy characterised by free trade and working of a market pricing mechanism in the 1990s represented challenges to the Egyptian government, private sector institutions and the accounting profession This was the case because historically Egyptian accounting was not capital-market oriented but followed the principles of macro accounting, with strong government intervention to control the economy and was closely connected with tax accounting (Hegazy, 1991) As a result, the Egyptian government has adopted several far-reaching measures aimed at improving the local and foreign investment environments in order to cope with the recent changes that Egypt witnessed These measures include the introduction of the International Accounting Standards (IASs) This was parallel with a programme to privatise state-owned companies as part of a more comprehensive movement towards capitalism, as well as promotion of economic democracy and widespread of stock ownership

That change in orientation meant that the country had to change its whole environment including the political, economic, social and legal environments to accommodate private enterprises (Tesche and Tohamy, 1994) Thus, this was followed by the Egyptianisation of these standards in 1997, originating the so-called Egyptian accounting standards that became mandatory starting from 1998 The Egyptian Society of Accountants and Auditors (ESAA) translated the IASs, organised many conferences which argued for the introduction of the standards and helped in the regulation of accounting in Egypt These accounting changes were coupled with devaluation of the currency, revision of the tax and customs structure and rates and revision of the investment law The adoption of IASs benefited Egypt in several aspects

1 it facilitated Egyptian access to international capital markets

2 it saved time and effort that might have been spent developing the national accounting standards from scratch

3 ensured the fairness and meaningfulness of financial statements prepared

by Egyptian enterprises for international investors

4 increased the importance of accounting as a profession, due to the introduction of the professional code and objectives

Hofstede (1984) cultural variables model shows Egypt as a collectivist society, with large power distance and strong uncertainty avoidance According to Gray’s (1988) model linking Hofstede’s cultural variables with accounting variables, Egyptian accounting should be characterised by statutory control, uniformity, conservatism and secrecy

HassabElnaby and Mosebach (2005) argued that these accounting variables are in conflict with the capitalistic model that IASs is based on In other terms, the Egyptian cultural variables may conflict with the application of IASs (Dahawy and Conover, 2007) This argument is confirmed by the findings of Samaha and Stapleton (2008) which

focused on the practice (de facto) compliance with IASs in Egypt and revealed that there

is evidence of very low levels of compliance To the extent that this evidence is indicative

of poor transparency, and/or the use of creative accounting techniques, it is problematic for investors Overall, these results may be seen to confirm the view taken by the World Bank report (World Bank, 2002) that Egyptian financial reporting lacks reliability

Egypt’s case presents a classical confrontation between a historically secretive society and the requirement for high disclosure levels to attract direct foreign investments

Researchers have, historically, found Egypt’s business society to be highly secretive (Dahawy et al., 2002) However, the Egyptian government, business world and media have consistently reported the need for direct foreign investment and hence the increase

in disclosure levels This has resulted in increased significance of the Egyptian Stock Exchange (EGX) (Samaha and Stapleton, 2008) as an important venue for attracting foreign investments and to encourage local residents to invest in shares Therefore, Egyptian companies may engage in voluntary disclosure1 to enhance the value of their stocks

This confrontation highlighted above between secretive culture and need for disclosure presents an interesting motivation to investigate whether the traditional high secrecy level outweighed the reforming efforts of government to establish a climate of greater accountability and transparency

Furthermore, understanding why firms disclose information voluntarily is useful to both preparers and users of accounting information, as well as to accounting policy makers (Buzby, 1975; Meek et al., 1995) Previous studies on the determinants of voluntary disclosure have focused mainly on the USA and other developed countries (e.g Buzby, 1975; Camfferman, 1997; Cerf, 1961; Choi, 1973; Cooke, 1989; Depoers, 2000; Ferguson et al., 2002; Firth, 1979; Frost and Pownall, 1994; Gray et al., 1995;

Inchausti, 1997; Malone et al., 1993; Meek and Gray, 1989; Meek et al., 1995; Mitchell

et al., 1995; Raffournier, 1995; Turpin and DeZoort, 1998) In contrast, a limited number

of research studies examined disclosure practices of companies in the developing economies (Needles, 1997).2 Some studies have examined institutional mechanisms (i.e corporate governance) that may influence voluntary disclosure practice Corporate governance attributes examined in relation to voluntary disclosure in these studies include ownership structure, the proportion or existence of independent directors, the appointment of a non-executive director as chairman and the existence of an audit committee However, most of the previous research in the developing countries focused

on the effect of a single corporate governance attribute (see e.g Chau and Gray, 2002) and very few examining different governance attributes in a single study (see e.g Ghazali and Weetman, 2006) It is worth noting that Okeahalam and Akinboade (2003) reviewed the corporate governance literature in the African context, and concluded that: “there has been limited published research on corporate governance in Africa and even less rigorous academic or empirical research There is an urgent need to embark on a meaningful analysis of corporate governance [research] in Africa” (p.28) Therefore, an additional motivation of this paper is to fill a void of research that explains the impact of corporate governance on voluntary disclosure in Egypt as an African nation In light of the above, our main research questions are:

1 What is the level of voluntary disclosure in the annual reports of listed Egyptian companies?

2 To what extent are aspects of corporate governance statistically significant in explaining the level of voluntary disclosure in the annual reports of listed Egyptian companies?

Therefore, this paper has three aims Firstly, to examine voluntary disclosure of companies listed on the EGX Secondly, to examine whether corporate governance variables that were found to be significant in explaining voluntary disclosure practices in developed nations would have the same significance in developing nations Finally, to compare the results with other research conducted in other developing nations This study adds to the literature on voluntary disclosure in the developing countries and extends that literature by including corporate governance variables as possible explanatory variables

of voluntary disclosure Also, the results of this research may be useful for regulators in Egypt as they continue to deliberate the appropriate corporate governance requirements

This study should also help investors who are interested in investing in Egypt in understanding the Egyptian corporate governance and disclosure environment This study extends academic research by comparing findings with results from other studies on developing nations If the results are the same then we can address developing nations as

a group If the results of this study are different it will give support for the need to do research at the individual country level

An overview of the Egyptian economy and the Egyptian corporate governance framework is provided in Section 2 Section 3 provides a literature review and develops and formulates the research hypotheses Data selection and collection, and the research techniques, are described in Section 4 Results and analysis are presented in Section 5, with conclusions in Section 6

2 Overview of the Egyptian economy and corporate governance framework

Over the past several years, Egypt has actively reviewed and improved its regulatory frameworks, in particular, corporate governance, transparency and disclosure However, the mandatory adoption of International Accounting Standards/International Financial Reporting Standards (IAS/IFRS) starting from 1997 is not sufficient to resolve the transparency problem or grantee the quality of disclosure (Samaha and Stapleton, 2008)

Mandatory disclosure rules ensure equal access to basic information (Lev, 1992), but this information has to be augmented by firms’ voluntary disclosures and information production (Cheng and Courtenay, 2004) There are major market incentives to disclose information voluntarily Managers’ attitudes to voluntary disclosure change according to the perceived relationship of costs and benefits involved (e.g see Gray et al., 1990; Healy and Palepu, 1995)

The Egyptian government reform measures have dramatically improved the outlook for Egyptian foreign investments, instigated and sustained high levels of growth and employment creation The current increase of the number of newly established companies and the expansions undertaken by companies already in operation, are the results of the streamlining investment procedures that have been undertaken Inflows of foreign direct investment (FDI) have also significantly increased, particularly starting in the financial year 2003/2004.3 Net FDI inflows increased from US$509.4 million in FY 2000/2001, to reach US$6.1 billion in FY 2005/2006 and US$11.1 billion in FY 2006/2007 According

to the World Investment Report, published in 2007 by the United Nations Conference on Trade and Development (UNCTAD), Egypt has emerged as the lead FDI recipient country in the African continent On the monetary side, net international reserves reached US$31.7 billion in December 2007, achieving an increase nearly by 21.9% compared with December 2006 In addition, the inflation rate has dropped from 12.4% in 2006 to 6.9% in 2007 The primary capital market reports that the total value of share issuances has increased from 83.62 billion Egyptian pounds to 102.93 billion Egyptian pounds which is an increase of 23% in one year On the secondary market the general index of the stock market in points has increased from 2,500 to 3,500 during 2007 (www.investment.gov.eg)

The Egyptian Ministry of investment through the Egyptian Institute of Directors (EIOD)4 introduced the general framework of corporate governance via an Egyptian Corporate Governance Code (ECGC) in 2005 The code is based on the Organisation for Economic Cooperation and Development (OECD) corporate governance principles The intention was to enhance the quality of information issued by listed companies, improve decision making, attract investors and stimulate economic development through increased competition and enhance the level of confidence of foreign portfolio investors in the Egyptian capital market (Carana, 2000; MOFT, 2007)

This code represents the general framework for corporate governance of Egyptian enterprises The corporate governance code was published in Arabic, setting out principles of best practice for good corporate governance Compliance with the EIOD code is not mandatory The guide is prepared in accordance with the corporate governance principles issued by the OECD and a number of countries including South Africa, Malaysia and the Philippines These rules are primarily applicable to joint stock companies listed on the stock market, especially those being actively traded As stated in guideline (3–4), the board should comprise a majority of non-executive directors with the technical or analytical skills to benefit the board and the company All of the non-executive directors should dedicate the time and attention necessary to fulfil their obligations to the company and not to accept assignments that could be seen to be a conflict of interest In addition, guideline (6–1) stated that the audit committee should consist of not less than three non-executive members One member should be a financial and accounting expert In case of an insufficient number of non-executives, one or more members may be appointed from outside the company A critical aspect of the new EGX listing rules is that companies must form an audit committee of the board The audit committee is responsible for the oversight of internal auditing and control procedures and reviews annual reports and prospectuses The audit committee does not propose the external auditor The members of the committee should be non-executives, unless there are no non-executive directors on the board, in which case outsiders can be hired (EGX, 2006)

Since 2005, the activities of the EGX have indeed increased considerably: market capitalisation has increased dramatically reaching 46% by the end of 2006 (EGX, 2006);

there were 1.65 million investors in 2005, compared with only 25,000 ten years earlier (EGX, 2006); and the number of registered companies increased from 218 in 1991 to 1,150 by the end of 2002 (CMA, 2003) and down to 800 companies by the end of 2006 (EGX, 2006) The EGX has raised its international profile and is one of the leading markets in the Middle East North Africa region Foreign participants, who enjoy full market access and suffer no restrictions on capital mobility or convertibility, represented approximately 17% of value traded in 2001 (Abdel Shahid, 2003) and reaching 31% by end 2006 (CMA, 2006) This level of growth and the increase in international profile suggest that the government’s reform process has met with some success, and it has been argued that the Egyptian Exchange is prepared for the globalisation era (Omran, 2002;

Samaha and Stapleton, 2008) However, as it was seen in the Far East financial crisis in countries such as Thailand such rapid growth is not necessarily accompanied by increases

in the quality of corporate reporting

Since best practices in corporate governance and greater disclosure are just being promoted, there is probably a cross-sectional variance in corporate governance Hence, Egyptian firms provide an appropriate sample to examine the issue of corporate governance and disclosure at this time We ask whether the subsequent actions of reform

by the Egyptian government increased the awareness of disclosure as a tool of corporate governance Examining company annual reports after the introduction of new corporate governance recommendations in 2005 by the EIOD also gives us the opportunity to assess transparency by companies that adopted the best practices recommended in the Egyptian Code of Corporate Governance (ECCG)

In Section 3, we review literature which suggests association between voluntary disclosure and corporate governance based on theories of reporting, including mainly agency and political costs theories We then consider the empirical evidence and draw out six hypotheses for testing on Egyptian companies

3 Prior literature and development of hypotheses

Corporate governance is aptly defined by Denis and McConnell (2002, pp.1–2) as “…the set of mechanisms – both institutional and market-based – that induce the self-interested controllers of a company … to make decisions that maximise the value of the company to its owners…” Recent empirical work on the association between disclosure and corporate governance in the developing countries include Ghazali and Weetman (2006), Barako et al (2006), Cheng and Courtenay (2004), Chau and Gray (2002), Eng and Mak (2003), Haniffa and Cooke (2002) and Ho and Wong (2001) We extend prior work by examining corporate governance from three aspects Specifically, this paper examines the association between the various categories of ownership structure, board composition, existence of audit committees and voluntary disclosure

3.1 Ownership structure

Structure of ownership determines the level of monitoring and thereby the level of disclosure As in previous research, we introduce ownership structure by including

1 number of shareholders

2 block-holder ownership: the proportion of ordinary shares held by substantial

shareholders which is represented by shareholdings of 5% or more

3 managerial ownership: the proportion of ordinary shares held by the CEO and

executive directors

4 government ownership

The number of shareholders is used as a measure of dispersion of shareholder control

Schipper (1981) proposed that monitoring problems that could be solved by issuing public accounting reports would increase with the number of owners As the number of shareholders increases, one would expect disclosure to increase if it can provide a solution to the additional monitoring problems associated with dispersion in ownership

Previous studies have found a significant positive association between the number of shareholders and the extent of financial disclosure (e.g Chau and Gray, 2002; Cooke,

1989, 1991; Malone et al., 1993)

Block-holder ownership is the percentage of ordinary shares held by substantial shareholders (i.e shareholdings of 5% or more) Additional monitoring is required in cases when share ownership is diffused Hence, it is expected that voluntary disclosure increases with decreases in block-holder ownership Previous research has indicated the presence of a negative relation between block-holder ownership and disclosure (McKinnon and Dalimunthe, 1993; Mitchell et al., 1995; Schadewitz and Blevins, 1998)

Managerial ownership is the percentage of ordinary shares held by the CEO and executive directors Excessive management ownership could be counter-productive to the firm’s long-term value, as management could effectively wield external threats This contention is found in the entrenchment theory (Fan and Wong, 2002; Morck et al., 1988) which predicts that high management interest leads to lower voluntary disclosure

Further, the controlling owner of the firm effectively decides “… the accounting reporting policies” (Fan and Wong, 2002, p.403) It is predicted that this leads to a low level of disclosure, driven primarily by the controlling owner’s motive to hold

up minority shareholders (Fan and Wong, 2002) In line with this, prior research (e.g Eng and Mak, 2003; Ghazali and Weetman, 2006) argues that greater agency problems exist when managerial ownership is low In other terms, executives who own a smaller portion of the company would have high incentives to consume bonuses and low incentives to maximise job performance In this instance, outside shareholders may need

to increase monitoring of a manager’s behaviour to reduce the associated increase in agency costs The required monitoring by outside shareholders will increase firm costs

However, these costs can be reduced if managers provide voluntary disclosure

In this context, voluntary disclosures can act as a substitute for costly monitoring

Previous studies show managerial ownership to be negatively related to disclosure levels (e.g Eng and Mak, 2003; Ghazali and Weetman, 2006; Ruland et al., 1990) Based on the previous arguments and findings, we expect that voluntary disclosure increases with decreases in managerial ownership

There has been no agreement on the impact of governmental ownership on disclosure

Eng and Mak (2003) argue that agency costs are higher in government-owned companies because of conflicting objectives between pure profit goals of a commercial enterprise and goals related to the interests of the nation, resulting in a need for communication with other shareholders in the form of disclosures However, Ghazali and Weetman (2006) argued that companies with government ownership may not need to give extensive disclosure because of the presence of additional separate monitoring by the government

In addition, government-controlled companies can obtain cheaper funds from local banks; therefore, they may not need to attract potential investors As a result, less disclosure can be expected in government-controlled companies It may be expected in a developing country like Egypt that government-controlled companies are strongly politically connected and these companies may disclose less information to protect their political linkages or interests or beneficial owner Therefore, we expect that companies with a higher proportion of government ownership will disclose less voluntary information

Based on the previous discussion, we introduce the following hypothesis:

H1: There is a positive association between the number of shareholders and the level of voluntary disclosure

H2: There is a negative association between block-holder ownership and the level of voluntary disclosure

H3: There is a negative association between managerial ownership and the level of voluntary disclosure

H4: There is a negative association between government ownership and the level of voluntary disclosure

3.2 Board composition: independent non-executive directors on the board

Healy and Palepu (2001) argue that the agency problem can be solved by having the board of directors monitor and discipline management on behalf of the external owners

The board of directors provides monitoring as it is elected by the shareholders to monitor their interests The board of directors is the central internal control mechanism for monitoring managers Non-executive directors can be regarded as “professional referees whose task is to stimulate and oversee the competition among the firm’s top management” (Fama, 1980, p.294) The perceived importance of the outside directors as

a powerful tool for constraining management behaviour is largely attributed to their being independent of management (Rosenstein and Wyatt, 1990) The presence of a higher proportion of non-executive directors on corporate boards should result in more effective monitoring of managerial opportunism (Chau and Leung, 2006; Fama and Jensen, 1983;

Leftwich et al., 1981; Weir and Laing, 2003) Thus, the firms whose boards are dominated by outside directors and they are expected to disclose more voluntary information

Previous studies report that companies that have more outside directors on the board have more voluntary disclosures (e.g Adams and Hossain, 1998; Chen and Jaggi, 2000;

Cheng and Courtenay, 2004; Leung and Horwitz, 2004; Williams, 2002) However, some researchers, did not find significant relationship between the level of voluntary disclosure and board independence (Ghazali and Weetman, 2006; Haniffa and Cooke, 2002; Ho and Wong, 2001) Other researchers report the presence significant negative association between the level of voluntary disclosure and board independence (Barako et al., 2006;

Eng and Mak, 2003; Gul and Leung, 2004)

In terms of board composition, duality and board of director’s size can be seen as important factors that impact disclosure However, the information related to duality is non-existent in the Egyptian environment and cannot be collected Given the Egyptian environment the board size may not be an indicator of monitoring and disclosure

Appointment of independent non-executive directors is a new governance initiative recommended in ECCG Currently, there is no empirical research that has linked board independence to voluntary disclosure in Egypt The ECCG guidelines specifically define

an independent director as a person who is not involved in the management of the company and does not have any direct or indirect interest in the company Our expectation is that with the introduction of the ECCG, independent directors will play a more proactive role in ensuring greater corporate transparency and accountability This increased awareness may be partly discharged by more voluntary information disclosure

in annual reports The expectation is expressed in the following hypothesis:

H5: There is a positive association between the proportion of independent non-executive directors and the level of voluntary disclosure

3.3 Existence of an audit committee

Audit committees, among other functions, ensure the quality of financial accounting and control system (Collier, 1993) Since an audit committee consists mainly of non-executive directors, it should reduce the amount of withheld information Agency theory predicts that audit committees should lower agency costs Bradbury (1990) views audit committees as a monitoring mechanism which is formed voluntarily in high agency cost

situations to improve the quality of information flow between principal and agents Audit committees may improve internal control and thus act as an effective monitoring device for improving disclosure quality Forker (1992) found a positive but weak relationship between the disclosure of the audit committee and the quality of share option disclosure for UK companies McMullen (1996) found significant association between the presence

of audit committees and more reliable financial reporting Barako et al (2006) also found strong positive relationship between the presence of an audit committee companies’

voluntary disclosure practices in Kenya

Both ECCG and listing rules in Egypt require the presence of an audit committee, to enhance the level of information produced by companies The quality and meetings of the audit committee can be seen as factors that impact the monitoring role of the audit committee However, given the secretive Egyptian culture and the novice status of the audit committee requirements, it is impractical, if not impossible, to have the access to this type of detailed information Since this is a new requirement Therefore, it is hypothesized that:

H6: There is a positive association between the existence of audit committees and the level of voluntary disclosure

3.4 Other control variables

Following the practice in prior research5 we include size, financial leverage, industry type, type of auditor, profitability, liquidity and internationality as control variables in the multiple regression models for testing the main hypotheses

4 Data collection and research design

4.1 Sample selection and data sources

Despite the increased market capitalisation of the Egyptian Stock Market, trades remain concentrated in few companies that exhibit real strong fundamentals (EGX, 2006) In

2006, the EGX had 800 listed companies of which 30 are the most actively traded companies as measured by the EGX 30 index The information on the market capitalisation of all 800 listed companies is found in the EGX Bulletin that is published monthly Therefore, we based our sample selection on the largest 100 firms according to market capitalisation for the year 2006 This approach is used due to data limitations

Voluntary disclosure is measured by the amount and detail of non-mandatory information that is contained in the management discussion and analysis in the annual report In Egypt, there is no Data Stream from which the annual reports could be obtained However, all the annual reports in addition to board of director’s reports of listed companies are filed with the Egyptian Company for Information Dissemination (EGID) which follows the EGX, and are available for a fee The annual reports and the Board of Directors reports of the sample companies for the year ending 2006 were obtained from EGID

There is no information in the annual reports of listed Egyptian companies about the number of shareholders, block-holder ownership, managerial ownership, government ownership, proportion of non-executive independent directors and the existence of audit

committees However, recently the EGX requires listed companies to file this information with EGID Therefore, information on these variables for the sample companies for the year ending 2006 was also obtained from EGID

4.2 Scoring voluntary disclosure: index construction

The voluntary disclosure checklist was constructed based on the ones used by Chau and Gray (2002) in Hong Kong and Singapore, and Ghazali and Weetman (2006) in Malaysia This provides a useful yardstick for comparison with earlier research The major reason for adapting these two checklists is that the original checklist used in these studies was based on Meek et al (1995) that was compiled ‘‘based on an analysis of international trends and observations of standard reporting practice, taking into account the relevant research studies as well as other comprehensive international surveys of accounting and reporting’’ (Meek et al., 1995, p.561) The items on the checklist were checked against the mandatory disclosure requirements of Egypt that are based on the EASs in order to make sure that there are no mandatory items.6

The disclosure list (see Appendix) is divided into 12 sub-parts representing the categories of voluntary disclosure, resulting in a total of 80 disclosure items These categories are: general corporate information; corporate strategy; future prospects;

information about directors; review of operations; product/service information; segmental information; research and development; employee information; social and environmental reporting; financial review and market-related information

A separate index is calculated for each sub-part to enable a finer exploration of changes in the indices, and which improves statistical and descriptive analysis In addition, we also calculated three partial indices for the disclosure items in line with Ghazali and Weetman (2006) and Meek et al (1995), corresponding to the type of voluntary information These are: financial (FIN); strategic (STRAT) and corporate social reporting (CSR) (see Appendix) This resulted in calculating 15 voluntary disclosure indices (3 partial and 12 sub-indices) In addition to have partial and sub-indices, two overall indices for voluntary disclosures (VDIS 1 and VDIS 2) were calculated in line with Street and Gray (2002) VDIS 1 assigned an equal weighting to each of the sub-indices VDIS 2 assigned equal weighting to each item of disclosure required by the sub-indices

Each item of disclosure was scored without weighting on a dichotomous basis taking the commonly used approach of giving the item a score of 1, 0 or not applicable (N/A) (see e.g Chau and Gray, 2002; Cooke, 1989, 1991; Ghazali and Weetman, 2006; Haniffa and Cooke, 2002; Ho and Wong, 2001) To ensure that companies were not penalised for non-disclosure of irrelevant items each annual report was read in its entirety, following Cooke (1989, 1991) The voluntary disclosure index was derived by computing the ratio

of actual scores awarded to the maximum possible score attainable for items appropriate (applicable) to that company

Following recommendations in the literature (see e.g Samaha and Stapleton, 2008);

the annual reports of three companies in the sample were randomly drawn and were given

to three independent persons to score The result of the Spearman rho correlation test (not reported) suggest that scores obtained by the independent scorers and those of the present investigators are in substantial agreement; indicating minimal subjectivity in scoring the disclosure items in the annual reports of the sample companies In Section 4.3, we present our empirical findings

4.3 Regression models and definition of variables

A multiple ordinary least squares (OLS) regression model was used to test the association between the dependent variables of voluntary disclosures (VDIS, FIN, STRAT and CSR) and the independent variables Table 1 provides a summary of the operational definition

of independent variables and their sources Because tests of normality on the continuous independent and dependent variables suggest non-symmetrical distribution, all continuous variables were transformed into normal scores based on the Van der Waerden approach to avoid violating the regression assumptions (a method proposed by Cooke, 1998)

Table 1 Operational definitions of independent variables

Independent variables and code on SPSS Operational definition Source of information Test variables

1 Ownership structure

Number of shareholders (SHARE) In line with Ghazali and Weetman (2006), it is calculated as the

number of the owners holding the total number of shares issued

Ownership structure information (EGID)

Block-holder ownership (BLKOWN) In line with Eng and Mak (2003), it is calculated as the percentage of

shares owned by the block-holders–

shareholders whose ownership is equal to or exceeds 5% to the total number of shares issued

Ownership structure information (EGID)

Managerial ownership (MANOWN) In line with Eng and Mak (2003), it is calculated as the percentage of

shares owned by the CEO and executive directors to the total number of shares issued

Ownership structure information (EGID)

Government ownership (GOVOWN) Percentage of the shares owned by the public sector (holding

companies, companies, banks, insurance companies and other institutions) to the total number

of shares issued

Ownership structure information (EGID)

2 Board composition

Independent non-executive directors on the board (INDEP) In line with Ghazali and Weetman (2006), it is calculated as the ratio

of the number of non-executive directors to the total number of the directors

Board of directors’

report (EGID) www.egyptwatch.com

3 Existence of audit committees (ACOM) Dichotomous, 1 or 0 Board of directors’ report (EGID)

www.egyptwatch.com

Control variables

1 Type of auditor (AUDIT) Dichotomous, 1 for big 4 or 0

otherwise Annual report: auditor report section

2 Industry type (IT1, IT2, IT3) Categorised into: manufacturing IT1, trade/service IT3 and financial

IT2

EGX Bulletin (December 2006)

Table 1 Operational definitions of independent variables (continued)

Independent variables and code on SPSS Operational definition Source of information

3 Internationality (INTER) In line with Zarzeski (1996), a firm

is defined as international based on the following: foreign business transactions (foreign sales or exports), or being an MNC affiliation, trading of firm’s shares

on foreign stock exchanges (however, this is very rare in listed Egyptian companies)

Annual report: footnotes Board of directors’

report (EGID)

4 Leverage (LEVG) Defined as total debt to total

stockholders’ equity Annual report: financial statements

5 Firm size (ASSETS, SALES) Log (base 10) of total assets Log (base 10) of total sales Annual report: financial statements

6 Profitability (PROF) Return on equity defined as net

income before tax to the total stockholders’ equity

Annual report: financial statements

7 Liquidity (LIQD) Is a quick ratio and defined as

current asset – after deducting the inventory – to the current liabilities

Annual report: financial statements

Based on the information in Table 1 the following four models are estimated:

VDIS = EO + E1 SHARE +E2 BLKOWN + E3 MANOWN + E4 GOVOWN

+E5 INDEP + E6 ACOM + E7 AUDIT + E8 IT1 +E9 IT2 + E10 IT3 +E11 INTER + E12 LEVG + E13 ASSETS +E14 SALES + E15 PROF +E16 LIQD + e

FIN = EO + E1 SHARE +E2 BLKOWN + E3 MANOWN + E4 GOVOWN +E5 INDEP + E6 ACOM + E7 AUDIT + E8 IT1 +E9 IT2 + E10 IT3 +E11 INTER + E12 LEVG + E13 ASSETS +E14 SALES + E15 PROF +E16 LIQD + e

STRAT = EO + E1 SHARE +E2 BLKOWN + E3 MANOWN + E4 GOVOWN

+E5 INDEP + E6 ACOM + E7 AUDIT + E8 IT1 +E9 IT2 + E10 IT3 +E11 INTER + E12 LEVG + E13 ASSETS +E14 SALES + E15 PROF +E16 LIQD + e

CSR = EO + E1 SHARE +E2 BLKOWN + E3 MANOWN + E4 GOVOWN +E5 INDEP + E6 ACOM + E7 AUDIT + E8 IT1 +E9 IT2 + E10 IT3 +E11 INTER + E12 LEVG + E13 ASSETS +E14 SALES + E15 PROF +E16 LIQD + e

where VDIS represents overall voluntary disclosure index, FIN represents financial disclosure partial index, STRAT represents strategic disclosure partial index, CSR represents corporate social disclosure partial index, E0, }, E16 represent regression

coefficients, Independent variables are defined in Table 1 and e represents the error term

5 Empirical results and discussion

5.1 Descriptive statistics and correlation analyses

Table 2 presents the descriptive statistics of the explanatory variables.7 The average firm size in terms of total assets is 4 billion Egyptian pounds (approximately, 747 million US dollars) with the maximum total assets being 40 billion Egyptian pounds (approximately 7.4 billion US dollars) The range of the total assets indicates that the sample firms are widely distributed Number of shareholders ranges from 3 to 99 shareholders with an average of 19 shareholders, implying that ownership structure is highly concentrated in listed Egyptian companies Only 21 companies (21%) have an audit committee The average managerial holding (MANOWN) is very high at 89.6% The level of block-holder ownership (BLKOWN) is high with a mean of 59% On average, slightly more than one-third of the board of directors (39%) is outside directors (INDEP) The level of government ownership (GOVOWN) is lower than MANOWN and BLKOWN with a mean of 29%

Table 3 (Panel A) shows the distribution of the dependent variable (i.e extent of voluntary disclosure measured by VDIS) and the partial categories of information (FIN, STRAT and CSR) The total voluntary disclosure scores range from 4% to 62%

with a mean score of 13.43% in the case of VDIS 1, and range from 3% to 58% with a mean score of 10.53% in the case of VDIS 2 Thus, there were large variations in voluntary disclosure practices among the sample companies in Egypt The indices and their ranges suggest that the overall voluntary disclosure level is very low, which is in line with prior research on disclosure in the developing countries, specifically Egypt (Dahawy and Conover, 2007; Samaha and Stapleton, 2008) No company obtained an overall compliance rate above 80% Consistent with Ho and Wong (2001) in Hong Kong, the low levels of voluntary disclosure ratio implies that analysts in Egypt may search for information outside of annual reports (e.g via investor relations department)

Table 2 Descriptive statistics of the independent variables

Panel A: continuous explanatory variables

Table 3 Descriptive statistics of the voluntary disclosure overall, partial and sub-indices

Panel A: voluntary disclosure overall and partial indices

Total disclosure VDIS 1 VDIS 2

Financial information partial index

Strategic information partial index

Corporate social responsibility partial index

Panel B: voluntary disclosure sub-indices

High level of disclosure (80% or more)

No sub-index

Moderate level of disclosure (60–79.9%)

No sub-index

Low level of disclosure (40–59.9%)

General corporate information

Very low level of disclosure (below 40%)

Market-related information

Product/service information

Social and environmental

Research and development

Information about directors

**Significant at the 1% level

The voluntary mean disclosure in 2006 varied from 4.17% in the case of corporate social reporting information to 15.73% for financial information, with strategic information in between at 10.8% Voluntary disclosure that relate to corporate social reporting is lower than the strategic and financial indices The range of the STRAT index (0.69) is wider than the range of the FIN and CSR indices (0.55 and 0.50, respectively) The minimum of the CSR and STRAT indices (0.00 and 0.03) is lower than the minimum index of the FIN indices (0.04)

This result is well below the recent results reported by Ghazali and Weetman (2006) who reported that the voluntary mean disclosure varied from 20.2% in the case of CSR information to 39.3% for strategic information, with financial information in between at 35.6% The total voluntary disclosure scores in Malaysia range from 6.3% to 74.0% with

a mean score of 31.4% However, the results is much higher than Hong Kong and Singapore (Chau and Gray, 2002) who reported that the voluntary mean disclosure for Singapore in 1997 varied from 10.68% for financial information to 16.76% for non-financial information, with strategic information in between at 16.00% The overall mean disclosure in 1997 was at 13.83% For the Hong Kong companies, the voluntary mean disclosure in 1997 varied from 9.77% in the case of financial information to 18.49% for strategic information, with non-financial information in between at 10.45% The overall mean disclosure in 1997 was 12.23%

Only four companies (4%) disclosed 40% or more of the 80 items included in the index The results are well below the Malaysian results (Ghazali and Weetman, 2006) which indicated that 26 companies out of 87 (30%) disclosed 40% or more of the items included in the index In contrast to the Malaysian study, these results show that even among the biggest companies on the EGX, there is insignificant variability in the amount

of information voluntarily disclosed in annual reports and only four companies can be said to be ‘good disclosers’ according to the classification of Samaha and Stapleton (2008) Table 3 also shows that the scores are not normally distributed as indicated by the significance of the non-parametric Kolmogrov–Smirnov test (or K–S Lilliefors)

Table 3 (Panel B) shows that the voluntary disclosure sub-indices range from a low of 2.86% in the case of information about directors to a high of 43.65% on general corporate information disclosures Table 4 also shows that the mean score of the general corporate disclosure sub-index is higher than all other sub-indices Table 3 (Panel B) also shows that the mean score of seven sub-indices (future prospects, employee, financial review, products and services, research and development, information about directors and social and environmental reporting) is below 10% which is indicative of poor voluntary disclosure in Egypt The very low disclosure level on Information about directors is corroborated in the World Bank report (2002);

it is up to company statutes to determine what level of disclosure relating to the board should be divulged to shareholders at the AGM For example, the names

of directors and their remuneration is disclosed at the AGM but not published

in the annual report The remuneration of board members consists of sitting fees and travel expenses on the one hand and an annual share of profits not exceeding ten percent of net income (after deducting five percent for legal reserves and five percent of paid in capital for dividends) Executive remuneration is not disclosed (p.13)