Determinants of Voluntary Disclosure in the Banking Sector: An Empirical Study

Determinants of Voluntary Disclosure in the Banking Sector: An Empirical Study Dr. Madan Lal Bhasin Professor of Accounting Bang College of Business KIMEP University, Almaty, Kazakhstan. Rashid R. Makarov & Nurlan S. Orazalin Senior Lecturers of Accounting and DBA Scholars Bang College of Business, KIMEP University, Almaty, Kazakhstan. ABSTRACT This study investigates the extent and determinants of total voluntary disclosure and disclosure categories in financial and non-financial reports of banking companies listed on the Kazakhstan Stock Exchange. In particular, we examine the association between voluntary disclosure and governance factors, such as board size and board composition. We also examine how bank size and age explain variation in voluntary disclosure index. The empirical results suggest that the number of outside directors has the most significantly positive impact on disclosure score. Increase in bank size also leads to higher degree of voluntary reporting. However, the findings provide evidence that voluntary reporting does not improve over time. Keywords: Determinants of Voluntary Disclosure, Disclosure Index, Banking Sector, Kazakhstan, KASE INTRODUCTION The effective functions of capital markets depend on how corporate information is shared among stakeholders (Ho, 2001). For the last few decades, the quality of information provided by corporate companies in their annual reports has attracted a significant interest among scholars, regulators and market participants around the world. Corporate disclosure is considered as one of the major challenges facing the implementation of corporate governance especially in emerging economies. It has been argued that the Asian financial crisis was not only the result of loss in investor confidence, but more importantly a lack of effective corporate governance and transparency in many Asian economies (Tan, 2000; Ho and Wong, 2001; Mitton, 2002). Specifically, the lower transparency in emerging markets leads to higher levels of asymmetric information and therefore decreases firm value (Jensen and Meckling, 1976). On the other hand, firm value is largely influenced by the extent of corporate disclosures. For instance, Lobo and Zhou (2001) conclude that the comprehensive disclosure of information enhances a firm value. It is apparent that global investors and creditors make their decisions based on information provided 60

in financial, non-financial, and economic reports issued by public companies (Yuen et al. 2009). In other words, investors and creditors are interested not only in evaluating profitability, liquidity, and financial conditions of a firm, but also in assessing non finance conditions such employee information, directors remuneration, social responsibility, and internal share transactions. Over the last several years, most Asian economies have been actively advancing their regulatory frameworks, especially in terms of corporate governance, transparency and corporate disclosure. In this regard, Kazakhstan is not an exception. Unlike mature capital markets in the developed economies, the capital market of Kazakhstan is still at a developing stage and faces with certain challenges in building a more diversified market economy. Since gaining independence in 1991, Kazakhstan has been in transitional changes from a traditional planned economy to a market economy by carrying out large scale privatization and financial market reforms. Being as the ninth largest country in the world by its territory, Kazakhstan is among the world s top oil and gas producers. Its estimated GDP per capita is $12,500, which is far larger than $1,647 in 1990 (CIA World Fact book, 2011). During these 20 years of independence, Kazakhstan has attracted over $130 billion dollars of investments, and is currently regarded as a one of the most attractive countries for foreign investors. The aim of this study to investigate the current state of voluntary disclosure practices by the representatives of the banking sector listed on the Kazakhstan Stock Exchange (KASE) for the years 2007-2010. In addition, it reports the results of the relation between company specific characteristics and voluntary disclosure of the sample companies. The banking sector of Kazakhstan has a two tier banking system. The National Bank is the central bank of Kazakhstan and represents the first tier while other commercial banks represent the second tier. Since 1993, the banking sector has undergone significant changes as a result of banking reforms and restructuring external debts of three banks in 2009-2010 (BTA bank, Alliance Bank, and TemirBank). Currently, this sector is one of the most developing segments of the financial system of the country. LITERATURE REVIEW Corporate disclosure plays a crucial role in mitigating information asymmetry and reducing agency problems. In particular, by releasing both mandatory and voluntary information to the capital market, companies can lower capital costs, gain investor confidence, and improve marketability of their shares (Meek et al., 1995, Kristandl and Bontis, 2007). Einhorn (2005) provides a model that indicates that a firm s voluntary disclosure strategy is significantly affected by mandatory disclosure requirements in its home country. Diamond and Verrecchia (1991) conclude that disclosing more voluntary information to reduce information asymmetry can reduce a firm s cost of capital. In studies dealing with changes in disclosure levels, Lang and Lundholm (1996) believe that firms with more detailed voluntary disclosures provide more accurate and less dispersed analyst earnings forecast. In addition, Welker (1995) and Healy, Hutton and Palepu (1999) find that firms increasing their voluntary disclosures lower their bid-ask spreads, a measure of cost related to information asymmetry. Botosan and Plumlee (2002) document a negative relation between the voluntary disclosures in annual reports and the cost of equity for firms. As is apparent from above literature, voluntary disclosure has been extensively examined in prior studies and remains as an abundant area for future research. It is noteworthy that extensive research on voluntary disclosure has been conducted in developed and developing countries. Examples can be found in works of Cerf (1961), Kahl and Belkaoui (1981), Malone et al. (1993), Hossain et al. (1994), Wallace et al. (1987), Ahmed and Nicholls (1994), Ling and Lundholm, (1996), Inchausti (1997), Ferguson et al. (2002), Metha (2003), Akhtaruddin (2005) 61

and many more. Some of these studies focus on voluntary disclosure in banking institutions. For instance, Kahl and Belkaoui (1981) investigate the disclosure practices by 70 banks in 18 countries and find that the extent of disclosure is different among those countries. They conclude that the level of disclosure is positively associated with the bank size. Chipalkatti (2002) examines the relation between the quality of corporate disclosures provided by Indian banks and the market microstructure variables. The results indicate that larger banks provide more transparent disclosures and banks with higher levels of leverage have significantly higher disclosure scores. Although there are numerous empirical and analytical studies on voluntary disclosures both in developed countries and emerging markets, there is a lack of such studies in Kazakhstan. This study contributes to the existing corporate governance and disclosure literature. First, we assess the extent of total voluntary disclosure and its categories in financial and non-financial reports of banking companies listed on KASE. Second, we provide the empirical results of association between voluntary disclosure practices by the banking sector of Kazakhstan and specific characteristics of the banks. HYPOTHESIS DEVELOPMENT Based on the results of prior empirical research reviewed in the previous section we have developed five hypotheses related to asset size, age, and board composition. Size Most researchers in the area identify that the size of the bank is an important explanatory variable in regards to the extent of corporate disclosure. For example, Kahl and Belkaoui (1981), Cooke (1989a, 1992), Ahmed and Nicholls (1994), Hossain et al. (1994), Wallace et al. (1994), Craig and Diga (1998) find a positive relationship between company size and the extent of disclosure. However, only limited number of works attempts to justify this relationship on a theoretical ground. Singhvi and Desai (1971, p. 131) offers three justifications for size impact on disclosure. First, economies of scale the cost of accumulating certain information is greater for small firms than large firms. Second, larger firms have a greater need for disclosure because their securities are traded more intensively via diverse stock exchanges. Third, management of a smaller company is supposed to believe to a higher degree that the full disclosure could endanger firm s competitive position than management of a larger company. Thus, the following hypothesis is tested for Kazakhstani sample of banks: H1: Total assets of banks are positively associated with amount of disclosed financial information. Age The extent of a firm s disclosure can be influenced by its maturity age, stage of development, and growth (Owusu-Ansah, 1998; Akhtaruddin, 2005). However, the results up to date are controversial. On one hand, Owusu-Ansah (1998, p. 605) points out numerous factors that suggest lower level of disclosure by younger firms: competition, cost, and ease of information gathering, and finally, lack a historical record on which to rely for public disclosure. On the other hand, Kakani et al (2001) argues that newer and smaller firms, in spite of disadvantages (i.e lack 62

of capital, brand names and corporation reputation) are willing to compete with older firms at least via better disclosure. Thus, it is not possible to reach a consensus over the issue without testing the following hypothesis for Kazakhstani banks: H2: Long-established banks disclose more information than newly established banks. Board Composition Board composition is defined as the proportion of outside directors to the total number of directors, thereby drawing a clear cut between executive and non-executive directors. The agency theory stipulates that board of directors is aimed to control and monitor opportunistic behavior of the managers (Berle and Means, 1932; Jensen and Meckling, 1976). The previous research acknowledges that outside directors can bring in external decision expertise (Fama and Jensen, 1983), can reduce managerial consumption of perquisites (Brickley and James, 1987), are more independent in general from the CEO (Weisbach, 1988) and, thus, create a positive influence over the directors decisions (Pearce and Zahra, 1992). Moreover, Mangel and Singh (1993) demonstrate that outside directors have advanced opportunities for control and incentives development due to their status augmented by equity position. Overall, a better control over firm s managers stemming from board composition can have impact on the enacted disclosure policies and amount of publicly disclosed information: H3.1: Number of directors on the board positively affects the extent of voluntary disclosure of information. H3.2: Number of non-executive (outside) directors on the board positively affects the extent of voluntary disclosure of information. H3.3: Proportion of non-executive (outside) directors on the board positively affects the extent of voluntary disclosure of information. METHODOLOGY Variable measurement Dependent Variable Y = bank s disclosure score. Following research of Cooke (1992, 1993) on disclosure for Japanese companies, we used 65 items measuring voluntary disclosure (see Table 1). Value of each particular item (d j ) is set to one if it is present in financial report, and set zero otherwise. Similar to Cooke (1992, 1993) and Hossain et al. 1994 we used non-weighted approach for computing total disclosure score for each bank: Independent Variables Size = Natural Log of total assets; 63

Age = Age of a bank in years; However, only experience in post soviet era is relevant, therefore, we age of a bank after 1985 ignoring age before this year. BSize = board size: number of directors; OSize = number of outside directors on the board; Ratio = ratio of outside directors on the board; Applied Model OLS: (1) where: Size, Age, BSize, OSize, and Ratio are measured as described above. We test independent variables for correlation (in Appendix; not included in the paper). Most of the variables are significantly correlated with each other. Therefore, we conduct factor analysis with varimax rotation and principal components extraction to verify that our variables represent independent factors (constructs). Moreover, ordinary least square (OLS) regression model with a stepwise forward method is used to test the relation between total voluntary disclosure and company specific characteristics as stated in H1-H3. This approach allows adding one variable at a time starting from a variable with the highest explanatory power. We use cut-off significance level of 10% due to small sample size (39 banks). Table 1: Determinants of Voluntary Disclosure. A. Background about the bank/ general E. Risk management (12): corporate information (06): 32 Information on risk management committee 1 Brief narrative history of the bank 33 Information on assets-liability management committee 2 Basic organization structure/ chart/ description 34 Information on risk management structure of corporate structure 35 Information on credit risk management 3 General description of business activities structure 4 Date of establishment 36 Quantitative information on gross loan 5 Official address/ registered address/ address for positions correspondence 37 Amount and details of problem loans and 6 Web address of the bank/ email address other assets or details by internal risk ratings 38 Disclosure of credit rating system/ process B. Corporate strategy (02): 39 Ageing schedule of past due loans and 7 Managements objectives and strategies/ advances (NPA) corporate vision/ motto / statement of corporate goals or objectives 40 General descriptions of market risk segments 8 Future strategy - information on future expansion (capital expenditures)/ general development of business C. Corporate governance (11): 41 Disclosures on value-at-risk (VAR) for interest rate exposure 42 Maturity of foreign currency assets and 43 liabilities Maturity information about deposits and other liabilities 64

9 Detail about chairman (other than name/ title)/ background of the chairman/ academic professional/ business experience 44 F. Accounting policy review (02) Discussion on accounting policy 10 Detail about directors (other than name/ title)/ background of the chairman/ academic professional/ business experience 45 Disclosure of accounting standards uses for its accounts 11 Number of shares held by directors G. Key non-financial statistics (08): 12 List of senior managers (not on the board of 46 Age of key employee directors)/ senior management structure 47 Details of branch location 13 Background of senior managers 48 Number of branch 14 Details of CEO s contact address 49 No. of branch expansion during the current year 15 Are the independent directors well defined? 50 Information of brunch computerizations 16 Nature of chairman of the board of directors 17 Directors engagement/ directorship of other 51 Information on ATM companies 52 Location of ATM and their address 18 Picture of all directors/ board of directors 53 List of top five shareholders of the bank 19 Picture of chairperson only H. Corporate social disclosure (04) D. Financial performance (12): 54 Sponsoring public health, sporting or recreational projects 20 Brief discussion and analysis of a bank s financial position 55 Information on donations to charitable organizations 21 Qualitative forecast of earnings 56 Supporting national pride/ government.- sponsored campaigns 22 Return on equity 57 Information on social banking activities/ banking for the society 23 Net interest margin 24 Cost-to-income ratio I. Others (08): 25 Earning per share 58 Chairman s/ MD s report 26 Risk-weighted assets 59 On-line banking facilities 27 Debt-to-equity ratio 60 Information on credit card business 28 Total liquid assets to assets ratio 61 Information on international banking facilities 29 Total liquid assets to deposit ratio 62 Information on welfare of employees 30 Loan to deposit ratio 63 Information on ISO 9001: 2000 certification 31 Dividend per share 64 Graphical presentation on performance indicators 65 Performance at a glance - 3 year In addition, we perform several robustness checks. First, we test our model using Natural Log of Equity as an alternative proxy for size and obtain consistent results. Second, we test different definitions of Age variable. In particular, we measure ages of banks since 2003 because since that year banks in Kazakhstan had been required to report under IFRS. Therefore, amount of voluntary disclosure could be affected by this reporting requirement change and no previous reporting practices matter. Using natural log of Age provides consistent model results. Finally, we test an alternative specification of disclosure score by taking its natural logarithm. 65

Population and Sample Population is thirty-nine banks operating in Kazakhstan 1 ; sample consists of twenty-three banks listed on KASE and other banks, which provide annual report available from their sites, home pages, press, or media (our sample covers all the thirty-nine banks). The sample includes both public sector and private sector banks. KASE has been in operation since 1993. Being as a main unit of the Almaty Financial Center, KASE represents four major sectors: the market of shares and corporate bonds, the government securities market, the foreign currency market and the derivatives market. Currently, there are more than 110 public companies listed in KASE, even though the list of KASE index is represented by only seven companies mainly from the banking and oil and gas industries. The capital market in Kazakhstan can be considered as unique compared to other industrialized markets. The country s economic growth and exports significantly depend on its natural resources sector and banking sector. Therefore, the composition of the listed companies in the KASE matches the economic representations. Unlike other mature capital markets, corporate issuers representing various manufacturing sectors in KASE are relatively small whereas unusually heavy representations can be observed in the banking and natural resource sectors. DATA COLLECTION METHOD The annual reports for 2010 have been collected via internet in pdf format and checked for availability of information on voluntary disclosure. An annual report plays central role in organization's construction of its public image (Gray et al., 1995) and, therefore, only annual reports disclosures are included in the current study. Two main sources of bank specific information are the Agency of Financial Control and monitoring over financial market and financial institutions of Republic of Kazakhstan (http://www.afn.kz/) and Depositary of Financial Statements (http://www.dfo.kz/). RESULTS Table 2 reports descriptive statistics for the distribution of the disclosure scores and independent variables. The highest and lowest overall disclosure scores are 53 and 14 respectively, and the mean value is 24.95 with a standard deviation of 7.77. The mean of proportion of outside directors to total directors is 32.16 %, which indicates that a significant number of directors are outside directors. The average board size is 4.67 with a range from 2 to 8. The statistics on age (Age Years) indicate that the average age of the sample banks is 16.46 years. Table 2: Descriptive Statistics. Disclosure Outside Total Score AgeYears LnAssets2010 LnEqty2010 directors directors RatioOut_to_Total N Valid 39 39 39 38 39 39 39 Missing 0 0 0 1 0 0 0 Mean 24.95 16.4615 17.8625 16.5763 1.56 4.67.3216 Median 24.00 17.0000 17.8297 16.2760 1.00 5.00.3333 Mode 24 17.00 a 14.81 a 14.59 a 1 3.33 1 sources: http://kazbank.org/banks.php, http://allbanks.kz/ 66

Std. Deviation 7.773 17.77024 1.98780 1.37239.940 1.737.13661 Skewness 2.543 3.167.320.881.406.355 -.772 Minimum 14.00 14.81 14.59 0 2.00 Maximum 53 87.00 21.71 19.81 4 8.67 a. Multiple modes exist. The smallest value is shown Ordinary least square (OLS) regression model with a stepwise forward approach is used to test the relation between total voluntary disclosure and company specific characteristics as stated in H1-H3. This approach allows adding one variable at a time starting from a variable with the highest explanatory power. As is apparent from Table 3, size variable (Ln Total Assets) has the highest explanatory power and significance level, while board composition (RatioOut_to_Total) has the lowest ones. However, age variable is significant only at 0.876 level and therefore has been filtered out by stepwise forward process. The adjusted R 2 in the model is 0.545. This implies that 54.5 % of the variation in total voluntary disclosure is explained by independent variables in the model. Compared to R 2 statistics from similar studies using disclosure indices, the R 2 is relatively higher than those reported by Wallace (1988) at 0.07, Malone et al. (1993) at 0.29, Ahmed (1996) at 0.332, Haniffa and Cooke (2002) 0.479, Barako, et al (2006) at 0.534; but it is lower than that documented by Hassan et al. (2006) at 0.863. Table 3. Model Summary. Model R R Square Adjusted R Square Std. Error of the Estimate.770 a.593.545 5.245 ANOVA e Model Sum of Squares df Mean Square F Sig. Regression 1360.545 4 340.136 12.364.000 a Residual 935.352 34 27.510 Total 2295.897 38 a. Predictors: (Constant), LnAssets2010, Outside directors, Total directors, RatioOut_to_Total b. Dependent Variable: Disclosure Score The coefficients of independent variables indicate both the magnitude and the direction of the relationship with dependant variable (Table 4). The number of outside directors on the board has a positive association and the most significant impact on disclosure score (adding one outside director increases the score by 13.82 points). Size measured by LnTotalAssets has a positive and significant association with disclosure score. These findings suggest that a bank size affect voluntary disclosure levels in case of banks in Kazakhstan. Total number of directors and board composition measured by RatioOut_to_Total have a negative and significant association with the dependent variable. This is inconsistent with a result reported by Hossain and Reaz (2007). There is no association between age and voluntary disclosure. In other words, the age of the bank does not affect the level of disclosure. A similar result was reported by Akhtaruddin (2005). 67

Table 4. Regression Coefficients. Model 4 Unstandardized Coefficients Standardized Coefficients B Std. Error Beta T Sig. (Constant).269 9.412.029.977 LnAssets2010 2.159.512.552 4.213.000 Outside directors 13.823 3.777 1.672 3.660.001 Total directors -4.617 1.427-1.032-3.236.003 RatioOut_to_Total -43.400 16.434 -.763-2.641.012 We performed a robustness check to test the model in regards to an alternative measure of size (LnTotalEquity) and obtained consistent results. We also tested an alternative specification of the dependent variable by taking natural logarithm of disclosure score. The results indicate that size and outside directors are still positively and significantly associated with the dependent variable. CONCLUSIONS AND LIMITATIONS The development of corporate reporting in Kazakhstan is recognized as an important long-term strategy due to its potential contribution to competitive advantage through better corporate governance, business transparency, innovations, protection of the environment, and social and cultural values. It this regard, the implementation of voluntary disclosure systems certainly enables companies to attract more potential investors by improving corporate governance and transparency, and thereby strengthening their investment attractiveness in the world market. The aim of this study is to examine the extent and determinants of voluntary disclosure in the banking sector of Kazakhstan. Uniqueness of this study comes from the absence of similar studies in the banking sector of emerging economies such as Kazakhstan that performs corporate disclosure practices. There are several limitations of this study. First, we expect moderate external validity of results. The regulatory frameworks and economic situations in the capital market of Kazakhstan are different from those of other markets. Therefore, this study reflects the specific characteristics of the market of Kazakhstan. Second, the study is limited to only one specific sector. The banking system is one of the main drivers of the economy of Kazakhstan. However there are other important industries such as oil and gas, mining, and construction industries which should be addressed by future research. Third, there are limitations in terms of sample size. The study examines 29 banks out of total 39 banks registered in Kazakhstan due to data unavailability. Moreover, the study examines the 2009 and 2010 disclosure practices of selected banks. Hence, future research should extend a study window to 5-10 years. Finally, our study does not include some variables examined in previous literature. For example, Haniffa and Cooke (2002) conclude that structural complexity, defined as the number of subsidiaries of a particular bank, has a significant influence on the extent of voluntary disclosure. Some studies argue that cross listing also affects the nature of voluntary disclosure. Licht (2001) finds a positive relation between cross listing and disclosure index. Hence, further research 68

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