Copyright is owned by the Author of the thesis. Permission is given for a copy to be downloaded by an individual for the purpose of research and private study only. The thesis may not be reproduced elsewhere without the permission of the Author. POLITICAL INFLUENCE, CORPORATE GOVERNANCE AND FINANCIAL REPORTING QUALITY: EVIDENCE FROM COMPANIES IN MALAYSIA A thesis presented i n partial fulfilment of the requirements for the degree of Doctor of Philosophy m Accountancy at Massey University, Wel l ington, New Zealand Mohd Fairuz Bin Md Salleh 2009 ABSTRACT This study investigates the relationship between political influence, corporate governance and financial reporting quali ty using Malaysian data spanning 1 999-2003 . The study builds upon agency theory, analysing the conflicting incentives of politic ians, shareholders and managers, and how they affect governance and financial reporting. Four hypotheses are put forward: ( 1 ) Pol itical influence is associated with lower financial reporting quality; (2) Pol itical influence is associated with weaker corporate governance; ( 3 ) After controlling for pol itical influence, weak corporate governance is assoc iated with low financial reporting quality; and ( 4) Corporate governance mediates the relat ionship between political influence and financial reporting qual ity. In addition, knowledge obtained from interviews of top managers from several companies is used to look further at the influence of pol it ics in managerial decision-making, particularly in relation to governance structure, accounting and reporting. Malaysia offers an interesting and important case study of relationship-based capital ism. Malaysian companies are regarded as political ly sensitive, they are highly concentrated, and government participation in equity ownership is s ignificant. One advance is that this study uses three observable proxies for pol itical influence: government ownership, the presence of politician/s on the board, and the exi stence of a golden share giving special rights to the government. It appears that pol itical influence is not a single construct. The findings support previous studies only if pol itical influence is defined as the presence of pol itic ian/s on the board. Government ownership improves both governance and reporting quality, contrary to the findings of most previous studies. Having a golden share is not associated with governance or financial reporting qual ity. These findings suggest that institutional detai ls matter when considering the effect of pol it ical influence on corporate governance and financial reporting. Findings from interviews provide a rich source of support for some of the quantitative findings, and new detai ls on the complexity of the relationship between governments, boards and managers. 11 Overal l , the study provides insights and additional guidance for regulators and policy makers, for improving the design of corporate governance features and financial reporting frameworks as well as for deciding on the level of involvement of government and pol it icians in business. The contrasts with findings of earl ier studies in Western economies suggest opportunities for future research to understand the sources of the differences. lll ACKNOWLEDGEMENTS I am greatly indebted to my supervisors Professor Paul V Dunmore and Dr Nives Botica Redmayne for their support and encouragement throughout my PhD journey. They have provided i nvaluable critical evaluation and guidance throughout all stages of the study and thi s thesis. My grateful thanks to you both. I grateful ly acknowledge the contribution of Associated Professor Agus Yusof from the Political Science Department Universiti Kebangsaan Malaysia, who helped to verify the presence of politicians on board of directors; Edmond Lim as a second scorer of corporate governance and disclosure quality; Encik Farid Omar and Dato' Haji Mat Ali , who made it easier for me to access most of the top management personnel through their personal connections and networks. Thank you to all the pa11icipants of the interviews. This study could not have been completed without your interest and participation. I wou ld l ike to thank the Universiti Kebangsaan Malaysia and the Ministry of Higher Education of Malaysia for the granting of a scholarship which enabled me to undertake study leave and pursue my doctoral studies. Special thanks to members of the School of Accountancy, Massey University for their friendship and moral support, and to Hana Craig for patiently reading and editing the manuscript. Final ly and most importantly, my deepest appreciation goes to my parents, Hajjah Zaharah Man and Haji Md Salleh Bin Abd Wahab. This thesis is dedicated to both of you for sacrifices made to teach me what l ife is al l about. This thesis is also dedicated to my grandmother, I shah and my late grandfather, Abdul Rahman. Both of you have been a source of great encouragement and inspiration throughout my l ife. Thank you so much for having always bel ieved in me and the unconditional love that I have received. Fairuz Sal leh Wel l ington, 2009 IV TABLE OF CONTENTS Page Abstract 11 Acknowledgements IV Table of Contents V L i st of Tables XI L i st of F igures XIII List of Abbreviat ions XIV CHAPTER ONE INTRODUCTION 1.0 INTRODUCTION, MOTIVATION FOR AND SIGNIFICANCE OF THE RESEARCH 1.1 RESEARCH PURPOSE, OBJECTIVES AND 5 QUESTIONS 1.2 MAJOR FINDINGS 6 1.3 THESIS ORGANISATION 8 TWO INSTITUTIONAL BACKGROUND 2.0 INTRODUCTION 10 2.1 POLITICS AND BUSINESS IN MALAYSIA 10 2.2 CORPORATE GOVERNANCE IN MALAYSIA 15 2.3 MALA YSIAN REPORTING ENVIRONMENT 22 2.4 CHAPTER SUMMARY 26 THREE LITERATURE REVIEW 3.0 INTRODUCTION 28 3.1 AGENCY THEORY 28 3.2 MERITS AND DEMERITS OF GOVERNMENT ,.., ,.., _).) INFLUENCE V 3.2.1 The Importance to the Malaysian Government of Control over or I nfluence on Companies 34 3.3 F INANCIAL REPORTING QUALITY 37 3.3.1 Disclosure Quality and Its Measurement 41 3.3.2 Earnings Quality and Its Measurement 44 3.3.3 Financial Reporting Quality in Relation to 48 Certain Characteristics or Attributes 3.3.4 Prior Studies on Determinants of Financial 49 Reporting Quali ty 3.4 CORPORATE GOVERNANCE 52 3.4.1 What Makes Strong or Weak Corporate 54 Governance? 3.5 PRIOR STUDIES ON POLITICAL INFLUENCE, 56 CORPORATE GOVERNANCE AND FINANCIAL REPORTING QUALITY 3.6 CHAPTER SUMMARY 63 FOUR HYPOTHESES DEVELOPMENT 4.0 INTRODUCTION 64 4.1 THE STUDY FRAMEWORK 64 4.2 HYPOTHESES DEVELOPMENT 69 4.2.1 Political Influence and Financial Reporting 69 Quality 4.2.2 Polit ical Influence and Corporate 71 Governance Strength 4.2.3 Corporate Governance and Financ ial 73 Reporting Quality 4.2.4 Mediat ing Role of Corporate 74 Governance on Polit ical Influence- F inancial Reporting Qual ity Relationship 4.3 CHAPTER SUMMARY 75 VI FIVE RESEARCH DESIGN 5 .0 INTRODUCTION 76 5.1 MIXED-METHOD DESIGN 76 5.2 SAMPLE SELECTION AND DATA COLLECTION 79 5 .2.1 Quantitative Data Collection 79 5.2.2 Qual i tative Data Collection 81 5.2.2.1 Ethical Issues 84 5.3 MEASUREMENT AND MEASURES OF 84 VARIABLES 5.3.1 Disclosure Qual i ty 85 5.3.2 Earnings Quality 90 5.3.3 Pol i tical Influence 91 5.3.4 Corporate Governance Strength 94 5.3.5 Control Variables 96 5.4 DATA ANALYSIS 96 5.4.1 Quantitative Data Analysis 96 5.4.2 Qualitative Data Analysis 99 5.5 CHAPTER SUMMARY 1 02 SIX QUANTITATIVE FINDINGS AND DISCUSSION 6.0 INTRODUCTION 1 03 6.1 DEFINITION AND MEASUREMENT OF 1 03 VARIABLES 6.2 DESCRIPTIVE ANALYSIS 1 06 6.2.1 Sample Characteristics 1 06 VII 6.2.2 Financial Reporting Quali ty and Corporate 107 Governance Strength 6.3 UNIV ARIA TE AND BIV ARIATE ANALYSES 109 6.3.1 Analysis of Mean Values Between Listed 109 and Non-l isted Companies 6.3.2 Analysis of Mean Values Between 110 Pol i tically Influenced and Other Companies 6.3.3 Correlation Analysis 112 6.4 MUL TIV ARIA TE ANALYSIS 115 6.4.1 Direct Relationship between Pol itical I nfluence and F inancial Reporting Qual i ty -Disclosure Quali ty 116 -Earnings Quality 119 6.4.2 Direct Relationship between Political Influence 121 and Corporate Governance Strength 6.4.3 Relationship between Corporate Governance 124 S trength and Financial Reporting Qual ity and the Mediating Effect of Corporate Governance Strength 6.5 ROBUSTNESS OF RESULTS 128 6.5.1 S tatistical Assumptions 128 6.5.2 Multicoll inearity 137 6.5.3 Heterocedastic i ty Test 139 6.5.4 Sensitivity Analysis 141 6.5.4.1 Alternative Measure for 141 Disclosure Qual ity 6.5.4.2 Alternative Measure for Earnings 143 Quali ty 6.5.4.3 Different Model Specifications for 145 Pol i tical Influence 6.5.4.4 Serial Correlation 147 V Ill 6.5.4.5 Moderating Effect of Corporate 149 Governance Strength on the Relat ionship between Poli tical Influence and F inancial Reporting Quality 6.6 SUPPLEMENTARY ANALYSIS 151 6.6.1 Analysis According to Government 151 Ownership S tructure 6.6.2 Analysis of the Relationship Between 154 Corporate Governance and F inancial Reporting Quality 6.7 DISCUSSION AND CONCLUSION 155 6.8 CHAPTER SUMMARY 158 SEVEN INTERVIEW FINDINGS AND DISCUSSION 7.0 INTRODUCTION 159 7.1 BACKGROUND INFORMATION ON THE 160 INTERVIEWEES AND THE COMPANIES 7.2 INTERVIEW FINDINGS 1 62 7.2.1 Why Earnings Targets Are Missed 163 7.2.2 How Do Managers Respond When Earnings 166 Are Threatened? 7.2.3 Earnings Forecasts and Achieving Targets 166 7.2.4 Polit ical Influence on Disclosure Qual ity 169 7.2.5 Pol i ti cal I nfluence on Corporate Governance 1 75 7.3 DISCUSSION AND CONCLUSION 176 7.4 CHAPTER SUMMARY 178 EIGHT SUMMARY AND CONCLUSION 8.0 INTRODUCTION 179 lX APPENDIX A APPENDIX B APPENDIX C APPENDIX D REFERENCES 8.1 SUMMARY OF THE IMPLEMENTATION OF THE 180 STUDY 8.2 SUMMARY OF THE F INDINGS 181 8.3 L IMITATIONS OF THE STUDY 183 8.4 CONCLUSION 184 8.5 SUGGESTIONS FOR FUTURE RESEARCH 188 A SUMMARY OF PRIOR STUDIES ON FINANCIAL 190 REPORTING QUALITY LIST OF COMPANIES USED IN THE STUDY 208 INTERVIEW SCHEDULE 214 A SUMMARY OF MAJOR FINDINGS AND A 21 6 COMPARISON WITH THE FINDINGS OF PRIOR STUDIES 224 X LIST OF TABLES Page Table 2 .1 Corporate Governance Init iat ives and Reforms 1 9 Table 2 .2 Three-Phase Shift to DBR 23 Table 5 . 1 D isclosure I ndex 88 Table 5 .2 Corporate Governance Index 94 Table 6 .1 Definition and Measurement of Variables 105 Table 6 .2 Descriptive Statistics of Sample (Company-Years N= l 495) 106 Table 6 .3 Descriptive Statistics of Government Ownership and Company 1 07 Characteristics ( Identified As Continuous Variables) Table 6 .4 Descriptive Statist ics of Disclosure Qual ity, Earnings Quali ty 1 07 and Corporate Governance S trength Table 6 .5 Analysis of Mean Differences in Financial Reporting Quality, 1 1 0 Corporate Governance Strength and Company Characteristics between L isted and Non-listed Sample Companies; and between Polit ical ly Influenced and Non-pol i tically Influenced Sample Companies Table 6 . 6 Univariate Analysi s of Mean Differences in Financial I 1 1 Reporting Quality, Corporate Governance Strength and Company Characteristics between Polit ically Influenced and Other Companies Table 6 . 7 Correlation Matrix 1 1 3 Table 6 . 8 Results of the Relationship between Disc losure Qual i ty and 1 1 7 Pol i ti cal Influence and Control Variables Table 6.9 Results of the Relationship between Earnings Qual ity and 120 Polit ical Influence and Control Variables Table 6 . 1 0 Results of the Relationship between Corporate Governance 1 22 Strength and Pol i tical Influence Attributes and Control Variables XI Table 6 .11 Results of the Relationship Between Corporate Governance 125 Strength and Disclosure Quality and the Mediating Effect of Corporate Governance S trength on the Relationship between Disclosure Quality and Pol i tical Influence Table 6 .12 Results of the Relationship Between Corporate Governance 126 Strength and Earnings Qual i ty and the Mediating Effect of Corporate Governance S trength on the Relationship between Earnings Quality and Pol i t ical Influence Table 6 . 1 3 Mahalanobis and Cook's Distances 136 Table 6 .14 Multicol l inearity Tests 138 Table 6 .15 Correlation Coefficient between Absolute Value of Regression 1 40 Residuals and Key Independent Variables Table 6 .16 A Comparison of Results of Regressions between Measures of 1 42 Disclosure Qual ity Table 6 .17 A Comparison of Results of Regressions between Measures of 144 Earnings Quality Table 6 .18 Results of Regressions Using Each Political Influence Variable 1 46 Alternatively Table 6 .19 Results of Autoregressive Regressions 148 Table 6.20 Moderating Effect of Corporate Governance on the 150 Relat ionship between Political Influence and Financial Reporting Qual i ty Table 6 . 2 1 Results of Regressions Using Different Types of Government 1 52 Ownership Structure Table 6 .22 Relationship between Corporate Governance Strength and 155 Financial Reporting Qual i ty Table 7.1 Background Information on the Interviewees 161 Table 7.2 Reasons Why Earnings Should Be Predicted 167 XII LIST OF FIGURES Page Figure 3 . 1 Proxies for Financial Reporting Qual ity 40 F igure 3 .2 The Examples of Determinants of F inancial Reporting Quality 5 1 (FRQ) Examined by Prior Study Figure 4 . 1 The Study Framework 68 Figure 4 .2 Expected Links between Political Influence, Corporate 69 Governance Strength and Financial Reporting Quality Figure 5 . 1 The Current Study's Strategy of Inquiry 79 Figure 5 .2 The Steps of the Interview Data Analysis 1 00 Figure 6 . 1 Histogram of Standardised Residuals of Regression 1 1 28 Figure 6 .2 Normal Probabi l ity Plot (P-P) of Standardised Residuals of 1 29 Regression 1 Figure 6 .3 Scatter Plot of Standardised Residuals of Regression 1 1 29 Figure 6 .4 H istogram of Standardised Residuals of Regression 2 1 30 Figure 6 . 5 Normal Probabil ity Plot (P-P) of Standardised Residuals of 1 30 Regression 2 Figure 6 .6 Scatter Plot of Standardised Residuals of Regression 2 1 3 1 Figure 6 .7 Histogram of Standardised Residuals of Regression 3 1 3 1 Figure 6 .8 Normal Probabi l ity Plot (P-P) of Standardised Residuals of 1 32 Regression 3 Figure 6 .9 Scatter Plot of Standardised Residuals of Regression 3 1 32 F igure 6 . 1 0 H istogram of Standardised Residuals of Regression 4 1 33 F igure 6 . 1 1 Normal Probabi l ity Plot (P-P) of Standardised Residuals of 1 33 Regression 4 F igure 6 . 1 2 Scatter Plot of Standardised Residuals of Regression 4 1 34 Figure 6 . 1 3 H istogram of Standardised Residuals of Regression 5 1 34 Figure 6 . 1 4 Normal Probabi l ity Plot (P-P) of Standardised Residuals of 1 35 Regression 5 F igure 6 . 1 5 Scatter Plot of Standardised Residuals of Regression 5 1 3 5 XIII ADR AIMR CAPM cc CCM CFRA CIFAR CLSA CPA EOI FAF FASB FRA FRQ GAAP IAS IASB IASC IFRS IPO ISI ISS ITC KLSE MASB MCA MCCG MIA MICG LIST OF ABBREVIATIONS American Depository Receipt Association for I nvestment Management and Research Capital Asset Pricing Model Commercial Code Companies Commission of Malaysia Center for F inancial Research and Analysis Center for International F inancial Analysis and Research Credit Lyonnais Securities Asia Certified Public Accountant Export Oriented Industrial isation The Financial Analysts Federation Financial Accounting Standards Board Financial Reporting Act Financial Reporting Qual ity General ly Accepted Accounting Principles International Accounting Standards I nternational Accounting Standards Board Internat ional Accounting Standard Committee International Financial Reporting Standards Initial Public Offering Import Substitution Industrialisation International Shareholder Services International Trade Commission Kuala Lumpur Stock Exchange Malaysian Accounting S tandards Board Malaysian Chinese Association Malaysian Code of Corporate Governance Malaysian Institute of Accountants Malaysian Institute of Corporate Governance XIV MICPA MIM MYR NACRA NDP NEP NZD NZSE OECD ROB se SCA 1993 SEC SEDC SEL SFAC SI CDA SOE SOCPA SPSS Malaysian I nstitute of Certified Public Accountants Malaysian I nstitute of Management Malaysian Ringgit National Annual Corporate Reporting Award National Development Pol icy New Economic Policy New Zealand Dollar New Zealand Stock Exchange Organization of Economic Cooperation and Development Registrar of Business Security Commission Security Commission Act 1 993 Security and Exchange Commission State Economic Corporation Development Securities and Exchange Law Statement of F inancial Reporting Concepts Securities I ndustry Central Depository Act State-owned Enterprises Saudi Organization of Certified Public Accountants Statistical Package for the Social Sciences XV CHAPTER ONE INTRODUCTION 1 .0 INTRODUCTION, MOTIVATION FOR AND SIGNIFICANCE OF THE RESEARCH The importance of publicly avail able financial reports has long been recognised, as they enable stakeholders to make more informed economic deci sions by uti l is ing informat ion about the financial conditions and performance of an organisation (Watts & Z immerman, 1 986) . F inancial reporting has also been viewed as a vital part of the infrastructure i nvolved in gain ing access to global capital such as foreign direct investments, especial ly in emerging market economies 1 (Chowdhury & Mavrotas, 2006). Companies i n such economies face greater obstacles obtaining access to global capital and higher qual ity financial reporting has been c laimed to help reduce such barriers (Frost, Gordon, & Pownall, 2008) . Therefore, high quality financial reporting is useful not only for stakeholders when making economic decisions but also to developing countries who are attempting to attract global capital inflows. Whi le the importance of high qual i ty financial report ing has been recognised, it is worrying when recent corporate misdeeds suggest that financial report ing qual ity needs further scrutiny (Canada, Kuhn, & Sutton, 2008 ; Penman, 2003) . Some studies have connected low-quality financial reporting with the influence of pol itical factors ( Bushman, Chen, Engel, & Smith, 2004; Leuz & Oberholzer-Gee, 2006). In addition to pol it ical influence, corporate governance has also been known to have an effect on fi nancial reporting quality. Wright ( 1 996) and Han (2005) found that corporate governance mechanisms i nfluence financial reporting quality. Byard, Li and Wein trop (2006) and Claessens and Fan (2002) suggested that low financial Emerging econom ies are "low- income, rapid-growth countries using economic l i beral ization as the ir primary engine of growth" ( Hoskisson, Eden, Lau, & Wright, 2000, p. 249) . In common usage, the term refers to formerly social ist countries in Central/Eastern Europe and East Asia (most notably China), the newly i ndependent states of the former Soviet Un ion, as we l l as the more advanced developing countries in South Asia (most notably India), Southeast Asia, M iddle East, Lat in America (most notably Brazi l) , and Africa (Peng, 2003; World Bank, 2002). reporting quality is associated with weak corporate governance and this in turn has been associated with political influence (ADB, 1 998; Aggarwal, 1 999; Fan, Wong, & Zhang, 2007). While prior studies recognised political influence and corporate governance as contribut ing factors to low financial reporting quality, to date there has been no research that examines the three variables- political influence, corporate governance and financial reporting qual i ty - i n a single study. Therefore, a study that examines financial reporting quality and the factors that may influence the quality, such as pol itical influence and corporate governance, is necessary and important, especial ly in emerging economies like that of Malaysia. Currently, although non-western companies in emerging and developing economies are becoming increasingly important in the world market, l ittle is known about their financial reporting quality. These economies are typified by very different cultures and regulations compared to western institutions. Market activities in these countries are often relationship-based2 as opposed to rule-governed as in developed economies (Peng, 2003) . Emerging economies rely less on formal rules and more on informal constraints (North, 1 990). Businesses work to bui ld informal networks or rel ationships with stake-holders (for example the government and pol iticians) that help secure trust, commitment and loyalty i n the absence of an effective regulatory framework (Foo, 2007), and thus protect the interests of the business. In addition, there is often concentrated ownership in firms in such economies, particularly manifesting itself via government-ownership, but also seen in other forms. This unique feature may have resulted in corporate success in the past (for example, in East Asian economies), but effective corporate governance mechanisms sti l l need to be implemented to ensure the protection of interests of both majority and minority shareholders (Rachagan, 2007; Reed, 2002) . A recent McKinsey & Company study (2002) advocated more transparency when it came to portraying the distinct and complex ownership structures that exist in emerging markets, such as those of government-owned businesses. W ithout such transparency, these umque structures could continue to act as a barrier to corporate governance reform. Ala vi ( 1 996) j ust ifies the c lose relation between polit ics and firms on pol icy grounds whi le Rajan and Z ingales (2003) argue that relat ionsh ip-based business is a resu l t of a relative financial u nder-development rather than some cultura l propensity for corruption. 2 Claessens, Djankov and Lang (2000) and La Porta and Lopez-de-Salanes ( 1 999) reported that Malaysian companies are highly concentrated and government participation in equity ownership is significant as government pol icy attempts to rationalise the distribution of economic resources among different races (Menon, 2009). In fact, some Malaysian companies were initial ly set up to achieve social rather than purely economic objectives, and as a result such companies may be regarded as more pol itically sensitive (Mohd Ghazali , 2007). Malaysian firms tend to be smaller and younger than those in the west, whi le also being strongly influenced by government incentives, support and subsidies (Jusoh, 2008). For these reasons, the Malaysian market requires specialised corporate governance schemes and offers the chance for unique research. Apart from the above, Malaysi a has also been through significant financial sector and corporate governance reform. Since the 1 970s, there has been the launch of various financial restructuring programs that aim to achieve a better financial and corporate governance system (Ang & McKibbin, 2007). Unfortunately, there is l ittle empirical evidence providing policy makers with the necessary information as to whether these reforms have had a positive or negative impact on financial systems, or on economic growth. This study provides insights and additional guidance for regulators and policy makers of Malaysia in particular and of other developing countries or emerging capital markets in general, in order to improve the design of corporate governance features and financial reporting frameworks. Another reason why Malaysia has been chosen is because it is one of the emerging capital markets in Asia that complies with the IFRS (International Financial Reporting Standards, which are c laimed to be of high quality) but which has been reported to exhibit low financial reporting qual ity (Ball , Robin, & Wu, 2003) .3 The researchers c laim accounting standards are not the sole contributing factor but suggest that pol itical determinants may be among the contributing factors to this low Bal l's et al. (2003) study involved four Asian Countries - Malaysia, S ingapore, Hong Kong and Thai land. At the time of Bal l et a l . ' s (2003) study, the I FRS was known as the Internat ional Accounting Standards (!AS). 3 quality. Among companies, government-owned companies have been c laimed to be highly exposed to political influence (Boardman & V ining, 1 989; Megginson, Nash, & Randenborgh, 1 994; Shleifer & V i shny, 1 998) and have weak corporate governance (ADB, 1 998) . Moreover, Malaysia has a relatively good database of historical economic information by the standards of developing countries, and the availabil ity of a set of sufficiently long time series data allows for a meaningful time series investigation. This provides an added incentive for the research. Generally, Malaysia offers an interesting and important case study of relationship­ based capitalism that is being forced to evolve as Malaysia attempts to l iberalise its capital market for further economic development and growth. Given this special environment, Malaysia provides a setting in which the study can robustly examine the relationship between pol itical influence, corporate governance and financial reporting quali ty . Overall , this study expands on the exi st ing body of knowledge on financial reporting quality in two ways. F irst, it examines pol itical influence and financial reporting quality from two perspectives: earnings quality and disclosure quality. Therefore, it fol lows the recommendation of Ball et al . (2003) to take into account pol itical factors as a detem1inant of financial reporting quality. At the same time, the study extends upon Ball et al . ' s (2003) study by examining financial reporting qual ity in terms of disclosure quality as well as earnings quality. In addition, the study examines pol itical influence from three perspectives - government ownership, a special share (a golden share) held by government and politician/s on board of directors. This is an extension of prior studies on political influence (Belkaoui, 2004; Faccio, 2006; Faccio, Masulis, & McConnel l , 2006), which defined pol itical connectedness as existing i f there is one or more politicians on a company's board of directors. Second, to further understand the contributing factors of financial reporting quality, the study examines the mediating effect of corporate governance on the political influence - financial reporting qual ity relationship and employs a qual itative approach, via interviews, to support and supplement the findings of the quantitative data analysis . No research (to date) has examined corporate governance as a mediating variable nor employed a qual itative approach to confirm and explain findings from a quantitative analysis in this way. 4 1 . 1 RESEARCH PURPOSE, OBJECTIVES AND QUESTIONS The study uses l isted and non- l isted companies in Malaysia in order to get a c lear picture o f financial reporting qual ity and corporate governance strength in each of the firms, and to quantitatively and quali tatively investigate the effects of political influence on corporate governance and financial reporting quality. To achieve this, the study has the fol lowing specific objectives: 1 . To analyse Malaysian companies in terms of their disclosure and earnings quality and corporate governance strength. 2 . To examine the direct effect of political influence on financial reporting q ual ity. 3 . To examine the direct effect o f political influence on corporate governance strength. 4 . To examine the effect of corporate governance strength on financial reporting qual i ty, after control l ing for pol itical influence. 5 . To examine the mediating effect o f corporate governance o n the relationship between political influence and financial reporting qual ity. 6 . To discover the perceptions of top management personnel regarding political i nfluence in Malaysian companies. Having outl ined the objectives, the research questions addressed m this study inc lude : 1 . What is the extent of financial reporting quality ( in terms of disclosure and earnings quality), and corporate governance strength of Malaysian companies? 2 . What is the relationship between political influence and financial reporting qual ity? 3. What is the relationship between political influence and corporate governance strength? 4 . What is the relationship between corporate governance strength and financial reporting quality, after control l ing for pol itical influence? 5 5 . Does corporate governance strength mediate the relationship between political i nfluence and financial reporting quality? Because of the complexity of the relationships, qualitative data was col lected to help explain and understand the results of the quantitative analysis answering the above five questions. To achieve this, interviews were conducted to discover the perceptions of top management personnel of political influence in Malaysian companies, especial ly government-owned companies. 1 .2 MAJOR FINDINGS I n general, the results of this study are consistent with the findings of prior studies that recognise pol itical influences (Bushman, Chen et al . , 2004; Bushman, Piotroski, & Smith, 2004; Leuz & Oberholzer-Gee, 2006), and corporate governance (Wright, 1 996; Han, 2005) as contributing factors to low financial reporting qual ity. S ince there is no standard measure of reporting quality (Daske & Gebhardt, 2006), the conclusion derived from the current study is l imited to financial reporting quality as measured by disclosure quality ( indicated by extent of disclosure) and earnings qual ity (measured by accruals quality) . Specifical ly, the findings of the study reveal that pol itical influence, only in terms of the presence of politician/s on the board, is significantly and negatively associated with both financial reporting quali ty (disclosure and earnings) and corporate governance strength. Pol itical influence measured by government ownership, on the other hand, has a positive relationship with both financial reporting quality (disclosure and earnings) and corporate governance strength. The latter contradicts the findings of past studies (Aggarwal , 1 999; Naser & Nuseibeh, 2003 ; Zhuang, 1 999b) which found that the h igher the percentage of government ownership in a company the lower the disclosure qual i ty, in that the protection and support the companies received from government al lowed them to get easy access to financial resources, especial ly from government-owned banks, and thus reduced their need to rely on securities markets which often demand higher transparency of information or higher disclosure quality. The disparity is possibly due to the fact that, i n Malaysia, 6 government-control led companies play a key role in national economic growth4 and especially in attracting foreign direct i nvestment and thus it is critical for these companies to ensure high quali ty financial reporting. As a result, government­ controlled companies i n Malaysia are wil l ing to share the companies' financial information (Chu & Cheah, 2006). These possible causes of a disparity in the results can also be appl ied to the positive effect of government ownership on corporate governance strength, because in attracting global capital Malaysian companies need not only to have h igher financial reporting quali ty, but also to have quali ty corporate governance. This study also provides evidence that after control l ing for political influence; corporate governance strength is an important predictor of financial reporting quality, especiall y in terms of disclosure quality. In addition, the findings suggest that corporate governance strength mediates the rel ationship between political influence and financial reporting qual ity, in that pol it ical influence wil l affect corporate governance strength and together affect financia l reporting quality. This impl ies that more attention needs to be given to efforts to strengthen the corporate governance structure of companies, especial l y in relation to pol itical influence in companies, at least in Malaysia. Although initiatives by the Malaysian government, such as the introduction of the Malaysian Corporate Governance Code in 20005 and the ful l implementation of the disc losure-based regime in 200 1 , have apparently helped improve the corporate governance strength and disclosure qual ity of Malaysian firms, more such measures are needed. Furthermore, the findings obtained from the qual itative investigation into the perceptions of top management and ex-top management of the sample companies on political influence and the effect of pol i tical influence on managerial decisions such as decisions on corporate governance structure, accounting and reporting, indicate that political influence does occur in Malaysian companies and it affects managerial decisions. The findings also provide some explanation of the relationship between pol itical influence, corporate Mohd Ghaza l i (2007) mentioned that, government companies control led more than 30 percent in terms of market capital isation in Malaysia a s at December 2000. The Malaysian Code on Corporate Governance was revised in 2007. 7 governance strength and financial reporting quality. Overall , the findings obtained from the qual itative investigation support and supplement the quantitative findings. 1 .3 THESIS ORGANISATION The remainder of the thesis is organised as fol lows. The fol lowing chapter (Chapter Two) describes the institutional settings and since Malaysia is used as a case study here, the chapter begins by explaining the Malaysian business environment. Spec ifical ly, this chapter talks about the history of the Malaysian pol i tical economy after Malaysia achieved its independence in 1 957, its introduction of a public pol icy dimension to address the socio-economic imbalance between ethnic groups in the country and the subsequent effects of this on the business environment. This chapter also discusses the nature of companies in Malaysia where the government and certain famil ies are the biggest shareholders and play an active role in management. Initiatives undertaken to improve corporate governance, especially after the economic crises in 1 997 are reviewed and the Malaysian reporting environment is also discussed. Chapter Three provides a review of prior studies on agency theory, which forms the theoreti cal framework of the study. This chapter also discusses why government, particularly the Malaysian government, wants control over companies. The concept of pol itical influence defined in prior studies is also clarified in this chapter and the concept of financial reporting quality is also presented. Studies of financial reporting qual ity from 1 968 to 2008 are grouped into two main categories : those that use disclosure quality and those that use earnings qual ity as a proxy of financial reporting quality. This chapter also discusses the concepts of corporate governance and what makes strong and weak governance. Finally, this chapter presents a review of prior studies on the association of pol itical influence with financial reporting quality and with corporate governance strength, and the relationship between corporate governance strength and financial reporting qual ity. Chapter Four develops the research hypotheses. For this purpose, agency theory and evidence from prior studies provide a basis on which to examine the relationship 8 between financial reporting, corporate governance and financial reporting quality. Four hypotheses are developed, predicting the relationships between pol itical influence, corporate governance and financial reporting qual ity. Chapter F ive describes the research methods employed in the study. The chapter includes a discussion on the structure of the inquiry process including the way the samples are selected, and how data is coll ected and analysed. Chapters S ix and Seven report and discuss findings for the study. Quantitative findings and discussion are reported in Chapter Six and qualitative findings and discussion in Chapter Seven. Generally, the findings show that politics do influence corporate governance strength and financ ial reporting qual ity. However the findings suggest that the nature of the relationship between pol it ical influence and corporate governance strength and financial reporting qual ity i s dependant on how political influence is defined. Chapter Eight concludes the study by summarising the findings and discussing the contributions of the study to the l iterature, the l imitations of the study and suggestions for future research. 9 CHAPTER TWO INSTITUTIONAL BACKGROUND 2.0 INTRODUCTION This chapter discusses the institutional background surrounding business in Malaysia, the involvement of pol itics in business, and the corporate governance and reporting environments. Section 2 . 1 outlines pol itical and business environments in Malaysia, focusing on the influence of pol itics on business. Section 2 .2 provides a discussion of the corporate governance structure of Malaysian firms as wel l as the initiatives undertaken to improve corporate governance and Section 2 .3 describes the Malaysian reporting environment, focusing on statutory requirements and other measures undertaken to ensure high qual ity reporting and the problems associated with them. Finally, Section 2 .4 provides a summary of the chapter. 2. 1 POLITICS AND BUSINESS IN MALAYSIA When analysing the business situation m Malaysia, i t is logical to begin by considering Malaysia's post- 1 957 social, economic and political history that led to the development of the intimate relationships between government and business seen today. In 1 957 , when Malaya, later to become Malaysia, achieved independence from Britain, it inherited a form of government based on the Westminster model which, with some local adaptation, remains very much in place today (Goh, 2008) . Equally significant i s the inheritance of an economy based on the traditional British colonial mercanti le interest centred on rubber and tin exports. At that time, the nation boasted the most efficient plantation economy in the world; so efficient, in fact, that Malayan foreign exchange earnings helped Britain enormously to repay much of its war debt to the United States. Economic prosperity, by Asian standards, was not new to Malaysia (Aziz, 1 999). 1 0 The Industrial isation Strategy, as Malaysia's government policy was known, has since focused on the d iversification and industrial isation of the country's economy (Alavi , 1 996; Siddiquee, 2006) . Thi s strategy was implemented via Import Substitution Industrial isation (ISI) in the 1 960s and 1 970s but Export Oriented Industria l isation (EOI) became the dominant method in the 1 980s and 1 990s. Both forms of industrial isation continue to be pronounced in Malaysian government pol icy. This i s evidenced by the fact that companies found to be compatible with the government industrialisation pol icy are more l ikely to be chosen to receive ISIIEOI motivated patronage from the government ( Fraser, Zhang, & Derashid, 2006) . Social considerations have also played an important role in government pol icy. Fol lowing the riots of 1 969, the Malaysian government set out to address the socio­ economic imbalance between the two dominant ethnic groups in the country - the Malays and Chinese (Butcher, 200 1 ; Jomo & Hui, 2003) . The riots proved to be damaging for nation-building (Chakravarty & Roslan, 2005) , and economic factors were b lamed. The government was widely critic ised for its inept handl ing of the growth and division of economic gains that had widened the economic gap between ethnic groups. The uneven distribution of wealth in Malaysia was mostly a legacy of British colonial pol icy (Ritchie, 2005; Crouch, 200 I). According to Hague (2003 ), ethnic groups had been divided into specific employment areas to faci l itate their administration. Malays were encouraged and moulded to fit the "padi" field; Indians, the rubber estates; and Chinese, the business arena. Because Malay society was feudal, with all the inequities that such a system brings, the British believed the Malay were particularly i l l suited for modern economic activity . Traditional agriculture, where the majority of Malay peasants worked, was considered irrelevant to the promotion of colonial rule and left largely unaffected. The British chose to foster a modern urban economy consisting of trade and commerce and considered the immigrant population6 to be better suited to those activities (Wi l l i ams, 2007, p .252) . 6 British colonial i ntervention i n the Malay states i n the 1 860s expanded the number of Ch inese and Ind ian imm igrants for economic purposes (Stockwe l l , 1 982) . 1 1 To restructure the socio-economic imbalance, the policy instruments used by the Malaysi an government were the New Economic Pol icy (NEP) from 1 970 to 1 990 and the National Development Policy (NDP) from 1 99 1 to 2000. While there were differences i n priorities and a strategy between the two, the NDP was sti l l what Torii ( 1 997, p .2 1 0) cal led "ethnicity-oriented policy". As a result of this pol icy, government involvement in the corporate sector increased, effectively intertwining business and politics in Malaysia (Tarn & Tan, 2007). The pol icy to support companies with certain group ownership resulted in another group of companies being "picked" by the government to receive NEP/NDP motivated patronage. Moreover, the introduction of the NEP/NDP resulted in the polit icisation of civil service management and functions. The elite Bumiputera7 of the bureaucracy increasingly took on senior business management roles and functions in state owned enterprises (SOEs) (Chatterjee & Nankervis, 2007). As a result, "both Chinese and foreign companies began to actively solicit business ties with the pol itically influential , but co-operative Malays" (Bowie, 1 99 1 , cited in Jomo & Gomez, 2000, p.290). However, whi le the government used the large numbers of SOEs as proof of increased diversification and growth, the poor coordination and accountabil ity of the sector started to become apparent. This has been evidenced by regular cases of "rent seeking" (Jomo & Gomez, 2000, p. 75) and improper governance, consequently leading to a call for reform implementation (Aziz, 1 999). As Aziz ( 1 999, p . l 9) stated, To make matters worse, each of the state governments competed to set up its own state economic development corporation with l iteral ly hundreds of subsidiaries that were accountable to no one but themselves. Although some attempts were made to monitor and coordinate their activities, they were feeble at best, and unethical business practices continued unhindered. Bumiputera means in Malay "sons of soi l". The Malays are the main Bumiputera in Peninsu lar Malaysia. In Sabah, the main Bumiputera are Kadazan, Bajau and Murut, whi le in Sarawak, they are I ban, Malay, B idayuh and Melanau. Both Sabah and Sarawak are part of Malaysia. 1 2 When the fourth Malaysian prime minister, Tun Dr Mahathir Mohamed came to power in 1 98 1 , the government interventionist pol icies focused more on increased industrial isation and advancement of the manufacturing sector. The prime minister believed that the development and modernisation of Malaysia was c losely associated with the development and modernisation of the civil service. The slogan "leadership by example" underpinned the administrative approach of his vision (Ahmad, 2004, p .68) . This period saw the strengthening of a tripartite relationship between the civi l service, the political sphere and business, and proved the theory that administrative reform and political leadership priorities can be said to be "inter-supportive and complementary" (Ahmad, 2004, p .68) . As a result of the affirmative pol icy, the Malaysian publ ic sector grew from only ten SOEs in 1 957 to over 1 1 00 by 1 990 (Salazar, 2004). Increasing regional competition and the need to improve local productivity resulted in a steady privatisation of the SOEs and development of a privatised and market-based business culture. However, the early privatisation process received some critic ism for concentrating wealth in the hands of a small group and exacerbating many of the inefficiencies that the pol icy aimed to resolve (Salazar, 2004) . Thi s was due to excessive government involvement such as in ensuring corporate and social responsibi l ity. With the government involved in business, politi cal considerations often won out over commercial ones. To worsen the situation, pol it icians often seemed to end up in jobs as advisers or board members while the companies to which they were attached were poorly managed (Daily Times, 2005). The close l ink between business and politics in Malaysia is wel l documented (see for example, Faccio, Lang, & Young, 200 1 ; Fraser et al . , 2006; Gomez, 2002) . In Malaysia, pol itical ly connected companies are not necessari ly owned by the state but are identified as "favoured" companies by the rul ing government (Gul, 2006, p .937), and the Malaysian government plays the role of political patron. It exerts a significant influence over the corporate sector through l isting restrictions, direct equity ownership of l i sted companies, control of the banking sector, and through government-sponsored "institutional investors"8 (Gomez & Jomo, 2000, p .36) . In Al l "inst itutional investors" in Ma laysia are supported by various levels of government. In part icu lar, the two largest i nstitutional investors, Amanah Saham National and Amanah Saham 1 3 addition, Malaysia' s resource wealth generated has been captured by the business cronies of those in power, who in turn have contributed to growth by re-investing in the protected domestic economy, mainly in import-substitute industries, commerce, services, property, privatised uti l i ties and infrastructure (Jomo, Felker, & Rasiah, 1 999) . As for privatised state-run enterprises, the government has awarded privat isation contracts under concessionary terms and offered special privi leges such as soft credit, state-backed guarantees for loans, and in some cases secure monopoly status. This has led to the establ ishment of conglomerates that include totally unrelated businesses ( Salazar, 2004 ) . Bowie ( 1 99 1 ) reports that in many cases, despite giving up ownership stakes of 50 percent or more, the state has continued to have control over privatised companies, often by the sale of equity to quasi-state entities such as Petronas or the Central Bank. In other instances, the government maintained control through the relatively widespread use of special rights or golden shares (Adams & Wi l l i am, 1 992) . The formation of government corporations has also created a competitive threat to some Malaysian Chinese business groups. The threats have led to a complete overhaul of their operations, an increased involvement of the dominant Chinese polit ical party (the Malaysian Chinese Association or MCA) and an establ i shment of the Multi Purpose Holding Berhad, the MCA-owned business entity, with the express purpose of getting involved in various sectors (Bhaskaran & Sukumaran, 2007). Besides the direct involvement of government and pol it icians in business, informal ties between companies and polit icians may represent another type of polit ical patronage in a "relationship-based" capital i st system such as that of Malaysia (Fraser et al . , 2006, p. 1 293) . It could logically be suggested that the informal ties may result in polit ical connections that include personal dimensions, along with economic and social dimensions, and that the three overlapping components reinforce one another. In summary, the evolution and development of "close" relationships between government and business have become the hal lmark of the Malaysian economy. It is Bu rn iputera, are under the control of the Department of Finance in Malaysia (Gomez & Jomo, 2000, p .36) . 1 4 widely acknowledged that the government has played a significant role in the Malaysian economy (Amsden, 1 989; Deyo, 1 987; Ragayah, 2008; White, 1 988 ; White, 2004 ) . The government created a holding company whose main purpose i s to i denti fy, i nvest in and manage proj ects in heavy industries such as basic metals, automobi les, petrochemicals, machinery and equipment (Jomo & Wah, 1 999). Investment incentives were also introduced in an attempt to increase foreign direct investment and to stimulate private enterprise. Moreover, in Malaysia, as in many East Asian countries, the government sometimes plays a quasi-directive role to encourage firms to pursue a strategy that is seen to be of national interest (Mamman, 2004) . From the outset, i t is important to recognise that the Malaysian political economy is distinguishable by a number of ethnic, pol itical and economic relationships that make it very d ifferent from the general Anglo-American experience. As in the rest of East Asia, economic policy-making in Malaysia has had a critically important and overtly pol itical d imension (Norhashim & Aziz, 2005). Malaysia's politics are also based on patron-cl ient relations between the government and business. Although their strong solidarity contributes to economic development, it may result in a negative aspect of capital ism emerging, the so-cal led "crony capitali sm" (Lee, 2004, p .23) . The review and analysis of the socio-economic and political environment m Malaysia suggest that colonial heritage, the economic pol icies of the British colonial government, and the economic position of different ethnic groups before and after independence and the national policies in the post independence era, have al l influenced the growth and development of political and business relationships in Malaysia. The next section discusses the corporate governance position of Malaysian compames. 2.2 CORPORATE GOVERNANCE IN MALAYSIA According to Gourevitch and Shinn (2005), the story of corporate governance in Malaysia began almost one hundred years ago, when a company cal led Kuala Kangsar Plantations became the first publ ic ly l i sted company in Malaysia. In the 1 5 early days, most publicly l i sted companies tended to be trading, p lantation or tin companies which had their origin in the United Kingdom, or were subsidiaries of United Kingdom companies. After Malaysia got its independence in 1 95 7, the number of l i sted companies in Malaysia also blossomed, and many ventured into different sectors, for example construction, property, infrastructure, technology, trading and services, consumer products, industrial products and plantations. By the end of 1 997, the number of l isted companies in Malaysia was 708 (Rahman, 1 998), 795 in 2000 (Rahrnan, 2002), and 874 by the end of 2003 (KLSE, 2003) . When reviewing these important years, 1 998 cannot be ignored. I t was the time when relat ively small companies were permitted to be l isted for the first time, enabl ing them to raise capital from the publ ic .9 Very quickly, an owner-entrepreneur who had been the ego-led manager of his own private firm now found himself the director of a publicly l isted company that needed to fol low a huge range of regulatory requirements, the significance of which he neither understood nor appreciated (Gourevitch & Shinn, 2005). Many of these companies had been establ ished using the financial and human capital of one particular family (McConaughy, 2000) . As a result, even after these companies had been publicly l i sted, shareholders maintained int imate relationships with their businesses. 1 0 Redding ( 1 996) shown that the entrepreneurs' wealth and esteem were often l inked with the companies' performance. With their large initial contribution, the entrepreneurs found it important to concentrate shareholding in order to maintain a dominant voice in the companies' pol icy and decision-making. In addition, these entrepreneurs wished to maintain control of their firms so that they could pass the business down to future offspring (Anderson & Reeb, 2003; Schulze, Lubatkin, Dino, & Buchholtz, 200 1 ) . 9 KLSE rules: ( I ) the company is incorporated in Malaysia, (2) the paid-up ordinary share capital is not less than MYR 40 m i l l ion (NZD 1 9 m i l l ion), (3 ) at l east 25 percent, but not more than 50 percent, of the paid-up capital is i n the hands of a min imum of 500 publ ic shareholders hold ing not less than 1 000 shares each, (4) the company has five consecutive years of after-tax profit of at least MYR I m i l l ion (NZD 0 .5 m i l l ion) and an aggregate after-tax profit of not less than MYR 1 2 m i l l ion (NZD 6m i l l ion) over the same five years, and ( 5 ) the company compl ies with the corporate d isc losure requi rements and other rules and by-laws of the K LSE. 10 The majority of businesses in Ma laysia are owned and operated by Chinese. Ch inese business general ly have some common characteristics inc l uding centralised deci sion-making with heavy rel iance on one dominant chief executive, fam i ly ownership and control , and most, i f not a l l , top management positions being fi l led by fam i ly members (Hor i i , 1 99 1 ) . 1 6 The rapid growth of Malaysia's economy has not di luted the concentrated structure i n Malaysian companies (Tarn & Tan, 2007). L im ( 1 98 1 ) found the ownership of shareholding and wealth among the hundred largest companies in the 1 960s to be highly condensed. An update by Zhuang, Edwards and Capulong (200 1 ), showed that the largest shareholder sti l l possessed an average 30 .3 percent of outstanding shares among al l l isted companies in Malaysia in 1 998, with the top five shareholders owning 58 .8 percent. About 40.4 percent of the 238 sample companies in Malaysia are c losely held by a single large shareholder (Claessens et al . , 2000). The nominee company is the largest shareholder group among the top five shareholders in Malaysia. Capulong, Edwards, Webb and Zhuang (2000) postulated that the majority of shareholdings by the nominees were owned by fami l ies. In 2002, the nominee firms held 46.5 percent of the total shares of an average non-financial publ ic l imited company whi le the rest were shared by non-financial firms (22.5 percent), the government (20.5 percent), finance companies (5 .9 percent), ind ividuals ( 3 . 4 percent), and foreign investors ( 1 .2 percent) (Bank Negara Malaysia, 2003 ) . Concentrated ownership in most industrial i sed nations often sees the general separation of management and control , but this is not the case in Malaysia, where most companies are dominated by l arge shareholders who exerci se control rights, resulting in significant risk to minority shareholders (Claessens et al . , 2000). There is also sceptic ism about the abi lity of boards, especially the non-executive directors, to monitor management, as they are often perceived as a "rubber stamp" only and are selected for reasons other than monitoring (Haniffa & Cooke, 2002) . Moreover, governmental activism in the corporate sector may diminish incentives for institutional investors to act ively monitor returns on their investments, leading to greater information asymmetry and free rider problems (Suto, 2003). Foreign companies are unlikely to be active in this area because their abi l ity to compete is l imited due to the nature of highly personal and close-knit business networking and information sharing in Malaysia, as in many Asian countries (Redding, 1 996; Wong, 1 996). These characteristics of weak corporate governance could be among factors that lead to economic downturn, for example the economic downturn that happened in Southeast Asian countries, inc luding Malaysia, in 1 997. 1 7 There has been much debate since the onset of that crisis about the factors and the structural weaknesses i n the afflicted economies that helped to trigger the downturn (see for example, Joh, 2003 ; M itton, 2002; Ow-Yong & Guan, 2000; Rahman, 1 998; Rajan & Zingales, 2003) . Although it may not have been the prime factor, there is some truth to the c laim that poor governance was partly to blame ( Harvey & Raper, 1 999; Johnson, Brone, Breach & Friedman, 2000; Lemmon & Lins, 2003 ; Kim, 1 998 ; Sal im, 2007). Malaysia is no exception: unlike the crisis of the 1 980s where inadequate public sector governance could be held accountable, the primary contributing factor to 1 997's economic problems in Malaysia was poor corporate governance in the private sector (Piei & Tan, 1 999) . Political i nfluence was found to be an additional contributing factor to the financial crisis. As Johnson and Mitton (2003) point out, political interference by the government, such as through crony all i ances, a relatively easy access to credit or other faci l ities enjoyed by the particular companies resulted in unproductive and unviable investment and ventures. I n the wake of the financial cns1s, the Malaysian government began a renewed program to enhance minority shareholder protection, promoted as • top-down reforms' . The top-down reform project began with the establ ishment of the H igh Level F inance Committee on corporate governance by the Ministry of F inance in March 1 998, which unleashed a series of regulatory changes through the Securities Commission (SC), the Kuala Lumpur Stock Exchange (KLSE), and the Registrar of Companies. These changes led to the creation of a Malaysian Code on Corporate Governance, the Malaysian Inst itute of Corporate Governance, and the Minority Shareholder Watchdog Committee - each of which attracted strong participation by the representatives of the Employees Provident Fund. The motives for these changes were to reassure investors, both domestic and international, so as to hold and attract capital. Domestic groups had the usual response: block holders did not l ike being challenged, yet domestic investors wanted protections enforced (Gourevitch & Shinn, 2005) . Table 2 . 1 below shows the corporate governance initiatives and reforms made by Malaysian authorities since 1 965 and after the 1 997 financial crisis. 1 8 Table 2 . 1 Corporate Governance I nitiatives and Reforms Year Initiatives and Reforms 1 965 The true and fair certification by d i rectors of financial statements was i ntroduced. 1 993 The audit committee requ irement was i ntroduced. 1 997 An independent accounting standard sett ing board was introduced. 1 998 The formation of the H igh Level F inance Committee to conduct a detai led study on corporate governance and to make recommendations for improvements. 1 998 Amendments were made to the Security I ndustry Central depository Act (S ICDA) w it h a v iew to enhanc ing transparency in share ownership am idst other improvements. 1 998 The Malaysian I nst itute of Corporate Governance was estab l i shed . 1 998 The regu lations for d irectors and CEOs to disc lose in terest i n the pub l i c ly l i sted compan ies ( PLC) were introduced . 1 999 Quarterly report ing was introduced. 1 999 A revamp of takeovers and mergers code was done. 2000 The Malaysian Code on Corporate Governance was introduced. 2000 Amendments were made to the Securities Commiss ion Act 1 993 by making the Securi ties Comm ission the sole regulator for fund rais ing activ it ies and the corporate bond market. 200 1 The Audit Comm ittee must have a member who is financ ia l ly trained . 200 1 The Malaysian Capital Market master plan was launched to further stream l ine and regu late the capital market and to chart the course for the capital market for the next ten years. 200 1 The F inancial Sector master plan was launched to chart the fut ure d irection of the financial system over the next ten years. I t out l ined the strategies to ach ieve a d iversified, effective, effic ient and res i l ient fi nancia l system . 200 1 The mandatory d isclosure of corporate governance code compl iance was introduced . 200 1 The establ ishment of a m inority shareholders watchdog group. 200 1 The mandatory accreditation programme for directors was i ntroduced. 2002 The i nternal audit gu ide l ines for PLCs were introduced. 2003 Guidance notes on share spl i ts, gu idance for companies to meet compl iance and i nternal control requ irements were introduced . 2004 Amendments to the security l aws and takeover codes for better investors' protection were made. 2005 A review in respect of account ing for minority interests in compan ies' financial statements and guide l ines on compl iance functions for fund managers to further strengthen investors' protection were introduced. 2006 Revised gu idel ines on securities borrowing and l end ing were made and the enhanced guide l ines for p lacement of securities for greater shareholders ' and investors' protection were i ssued. A set ofg_uide l ines to strengthen corporate bond market was also introduced. 2007 A Publ ic Compan ies Accounting Oversight Board ( PCAOB) was formed . Amendments to audit comm ittee gu idel ines were made. The Malaysian Code on Corporate Governance was revi sed. Amendments i n re lation to corporate governance to Compan ies Act 1 965 were made. Source: Mahmood, (2003 ); Securities Commission of Malaysia (ww-vv . sc .com.mv/index.asp; accessed on 02.0 1 .09); Malaysian I n st itute of Corporate Governance (www.micg.net/home.htm; accessed on 02.0 1 .09) 1 9 Among the initiatives taken after the economic downturn, the i ntroduction of the Malaysian Code on Corporate Governance in 2000 is seen as the most important. It was largely derived from the recommendations of the Cadbury Report ( 1 992) and the Hampel Report ( 1 998) in the United K ingdom (FCCG, 2000). The revised l i sting requirements (LRs) of B ursa Malaysia (formerly known as Kuala Lumpur Stock Exchange - KLSE) in 200 1 provide a greater obligation for publicly l i sted companies to enhance Malaysia' s corporate governance regime. Speci fically, these amended LRs outline the requirements for financial report ing disclosure on corporate governance matters and continuing l i sting obligations. The Malaysian Code on Corporate Governance also recommends that the board of directors appoints remuneration and nomination committees other than the audit committee, which has been mandatory since 1 993 . The establ ishment of other committees such as a risk management committee and corporate governance committees are also recommended but are less frequently set up by l i sted companies. The code strongly recommends the separation of responsibil ities between the board chair and the chief executive officer even though the LRs of Bursa Malaysia (200 1 ) do not require the segregation of these positions. The code also states that the board of directors should maintain a sound system of internal control . This led to the issue of a Guide on Statement of Internal Control in May 2000. This guide explained the key areas that directors must pay attention to before they present a Statement of Internal Control in their company's annual reports. A l isted company i s required to address in their annual reports the principle and best practices of the Malaysian Code on Corporate Governance relating to internal controls such as ident ifying principal risks and ensuring implementation of appropriate systems to manage risks. In addition, directors appointed to the board of directors of a publicly l i sted company are required under the LRs to attend a directors' training program known as the mandatory accreditation programme. The programme covers topics such as the Companies Act 1 965, the LRs, risk management and internal control and relevant securities l aws. As for the composition of boards of d irectors, recent studies suggest that 90 percent of l isted companies have at least two non-executive directors, and the Malaysian Code on Corporate Governance has set a minimum of 30 percent 20 i ndependent non-executive directors on boards ( PricewaterhouseCoopers, 2002). The obl igations of directors have begun to be moni tored by the Government Minority S hareholders Watchdog Committee, created on the recommendation of the H igh Level F inance Committee on Corporate Governance. Self-regulatory in it iatives also continue to be developed by various industry and professional bodies aiming at promoting knowledge and awareness of corporate governance best practice in Malaysia (Yatim, Kent, & Clarkson, 2006). Moreover, Malaysia general ly accepted these accounting principles, with a few minor deviat ions, that were adapted to match the International Financial Reporting Standards ( IFRS) . With the influence of the strong professional traditions of the Commonwealth, the accounting profession was wel l-organised through the Malaysian Institute of Accountants and the Malaysian Association of Certified Public Accountants. The Malaysian Accounting Standards Board also became relatively independent of the Ministry of F inance, with greater freedom i n setting standards. In terms of auditing, the Company Act 1 967 allowed third party auditing, a requirement backed-up by new rules issued by the KLSE. Malaysia's legal system also plays an important role in corporate governance . The system imposes strong standards of fiduciary duty to minority shareholders, and the court has begun to entertain derivative suits for breaches of this duty, although class­ action suits are not possible. The Watchdog Committee, the SC, and the KLSE have enforced a one share, one vote rule and have ensured that minority shareholders have at l east a nominal voice in key corporate decisions. Malaysia's Codes of Takeovers and Mergers were revised in 1 999 to resemble the C ity Code in most respects. With regards to providing protection to minority shareholders, Malaysian i nformation inst itutions are said to have become more robust (Gourevitch & Shinn, 2005) . Efforts to protect investors and shareholders were continued in 2004 where amendments were made to the securities laws and takeover code. The accounting for minority interests in companies' financial statements was then reviewed in 2005 . The efforts to ensure higher shareholders' and investors' protection were then continued in 2006. To date, the obvious effort to strengthen and enhance the corporate governance framework can be seen with a revision of the Malaysian Code on Corporate 2 1 Governance and amendments to Companies Act 1 965 in 2007. The Malaysian Code on Corporate Governance was revised to represent the continued col laborative efforts between government and the industry (the Malaysian Code on Corporate Governance, revised 2007). This code was specifically revised to strengthen boards of directors and audit committees and accordingly to ensure both effectively perform their roles and responsibil ities. In this revi sion, the el igibil ity criteria for appointment of directors, the role of nominating committees, the eligibi l ity criteria for appointment as an audit committee member, the committee composition, the frequency of meetings and the need for continuous training were spelt out. While the Malaysian Code on Corporate Governance has been revised to strengthen corporate governance in Malaysian companies, various statutory requirements have been issued and various efforts have been implemented by statutory bodies to ensure higher reporting qual ity within the Malaysian reporting environment. These are discussed i n the fol lowing section. 2.3 MALA YSIAN REPORTING ENVIRONMENT All l isted compames m Malaysia are obl igated to publ ish annual reports in accordance with the N inth Schedule of the Companies Act 1 965 and must fol low the accounting standards of the Malaysian Accounting Standard Board (MASB). The MASB is authorised by the Financial Reporting Act 1 997 (FRA) to set reporting and accounting standards. The FRA's purpose was to streaml ine financial reporting of Malaysian companies in accordance with International Financial Reporting Standards (IFRS) and to allow for effective enforcement of financial reporting. The Supreme Court and the Companies Commission of Malaysia (formerly known as the Registrar of Companies) monitor such enforcement in order to promote financ ial reporting qual ity. Further, to ensure high quality financial reporting, Bursa Malaysia has set LRs which require the preparation of complete accounting records and financial statements that fol low accounting standards. Professional accounting bodies are also concerned with maintaining high standards in financial reporting. Three such bodies include the Malaysian Institute of Accountants (MIA), the Malaysian Institute of Public Accountants (MICPA) and the 22 Malaysian I nstitute of Management (MIM). In 1 990, these three bodies, along with Bursa Malaysia, introduced the National Annual Corporate Reporting Award (NACRA) which gives esteem and recognition to organisations deemed to have achieved excel lence i n annual corporate reporting. The award was designed to encourage the highest standards i n the presentation and reporting of financial and other information needed by shareholders, investors and other interest groups. N ine criteria are used to assess annual reports under certain headings which include timely publ ication of annual reports, compliance with accounting standards and unqualified reports from auditors. Annual reports are classified as having a good quality of reporting when they meet these NACRA criteria. Fol lowing the move from the merit-based regime, the disclosure-based regime (DBR) was introduced to further ensure high qual ity financial reporting. It was introduced by the Securities Commission in 1 996 and ful ly implemented in 200 1 . Table 2 . 2 shows the three-phased shift to DBR over that time. Table 2.2 : Three-Phased Shift to DBR Phase Time Frame Focus I 1 996-1 999 Flexible/hybrid merit-based regime which emphasises disc losure, due di l igence and corporate governance. I l Jan 2000 Partial DBR which further emphasises disclosure. due dil igence and corporate governance, and the promotion of accountabi l ity and self-regulation . . I l l 200 I onwards Full DBR which emphasizes high standards of disclosure, due di l igence and corporate governance as well as the promotion of self- regulation and responsible conduct. Source: Capital Market Master P lan (KLSE, 200 1 ) . A s seen i n the table, the DBR has three founding principles: disclosure, due di l igence, and corporate governance. Disclosure means divulgence of all material information in order to aid investors' investment decision-making. With regards to due di l igence, it is important for companies to undertake a due di l igence process in disc losing information, to make sure that al l information is ful ly and accurately 23 disclosed in a timely manner. Finally, corporate governance is used to direct and manage a company' s business and affairs in order to promote business prosperity and corporate accountabi lity (PricewaterhouseCoopers, 2002). In terms of Malaysian l i sted companies, disclosure can be divided into two areas: primary market disclosure and continuous disclosure. Primary market disclosure is related to the initial publ ic offering ( IPO). The ultimate aim of primary market disclosure i s to provide potential investors with tools that enable the self-evaluation of the risks of investing in the I PO, based on the risk profile of any offering company. The Malaysian Companies Act 1 965 and the SC Act 1 993 outline these disclosure obligations in ful l . Continuous disclosure and reporting obl igations, on the other hand, are dictated by the Bursa Malaysia's LRs. In accordance with the DBR, Malaysian publ icly l i sted companies are required ( 1 ) to publish financial statements on a quarterly basis within two months of each financial quarter (these include an income statement, a balance sheet, a cash flow statement and explanatory notes); (2) to furnish annual audited accounts, auditors' and directors' reports within four months from the end of the financial year; (3 ) to state the extent to which they have complied with the Malaysian Code on Corporate Governance and; ( 4) to make immediate public disclosure of all material information (of a financial and non-financial nature) concerning its affairs (Nathan, Lin, & Fong, 2000). Parts two and ten of the Bursa Malaysia's LRs set out the obligation to immediately reveal any information which is necessary to avoid a false market. Such disclosures include changes in dividend pol icy, substantial shareholders, directors, company secretary or auditors; acquisition of shares beyond a certain threshold; valuation of assets and any proposed issue of new securities. In spite of all the improvements in financial reporting, disclosure sti l l remams a problem in Malaysia (Nathan et a l . , 2000) . Rahman ( 1 998) argues that these initiatives to increase qual ity reporting have not achieved their objectives because of the lack of appropriate enforcement efforts. Asian Development Bank (ADB, 1 998), mentioned that in most of the countries affected by the financial crisis of 1 997, including Malaysia, the regulatory framework for transparency appears to have been adequate on paper only. Their SC regulations, l i sting rules of stock exchanges and 24 company laws have ample provisions requiring disclosure of information to protect i nvestors . The real problem is compliance and enforcement and how to strengthen regulations to faci litate these processes. On this i ssue, the Malaysian F inance Committee Report on Corporate Governance states that regulators must be allowed to enforce laws without interference or fear or favour; the enforcement of law must be consistent, to ensure a level playing field for al l participants; and the regulator cannot countenance a market that is perceived to be unfair and must be allowed to enforce laws and regulations to protect the integrity of the system (FCCG, 2000). But as the experiences of many countries have shown, regulators cannot exercise their functions independently when the regulated are either owned by the state or the business has close connections with state or political powers. Ball et al . (2003) described a case study of four East Asian countries, including Malaysia, that have a similarly low endogenous demand for high-qual ity financial reporting and disclosure, and that have implanted accounting rules developed in overseas common-law economies without making widespread complementary changes i n infrastructure. According to the author, this experiment achieved no appreciable effect on the quality of financial reporting in these countries. One conclusion is that mandating the IAS/IFRS, without altering the i ncentives facing financial statement preparers, i s at best a superficial exercise. In summary, Malaysian authorities have put a lot of effort and energy into improving the reporting environment in the country as mentioned by the chairman of the Malaysian Institute of Corporate Governance (MICG), Megat Najmuddin ( in Hardy, 2005, p . l 6) . We have one of the h ighest set of accounting standards in the world, totally transparent, and we have some of the toughest disclosure rules i n the world but we have to do more to ensure that companies and directors conform to the values as envisaged by our national program initiated by Pak Lah [Prime Minister, Abdul lah Badawi] , for corporate responsibi l ity. 25 2.4 CHAPTER SUMMARY In this chapter, the institutional setting of this study, that is the relationship between business and politics, corporate governance and the Malaysian reporting environment, has been discussed. The inheritance of the colonial state by national ist e lites in the era of post-war decolonisation raises some important impl ications for the sociology of postcolonial societies, as shown by the case of Malaysia. It is well documented that one of the British legacies in Malaysia is the distinct ethnic divisions in the country, where ethnic groups had been divided into specific employment areas to faci l itate Brit ish administration. These divisions have not only affected the formation of the state and its policy agenda but have drawn the state into the role of mediating and managing inter-ethnic tensions ari sing from competition amongst major ethnic groups for economic resources and pol itical power. What is known as "affirmative action" in other countries (referring to corrective measures taken to reduce discrimination and ensure proportional representation of the underprivi leged ethnic groups) has taken the form of "preferential polic ies" or "special rights" in Malaysia. In implementing the policies (for example the ISIIEOI, NEP, NDP) business and pol itics have not been separated. As an emerging economy, seeking investments or funds from outside the country is necessary to the Malaysian economy. For this purpose, the western idea of corporate transparency is seen as important for application by Malaysian companies. Further, fol lowing the global economic cri sis, better corporate governance standards have been emphasised al l over the world, i ncluding Malaysia. If Malaysia wishes to be part of the global market, i t must further enhance corporate governance and bring its standards to the h ighest l evel possible . However, the existence of pol itical influence in the Malaysian firms is seen as an i ssue. The Malaysian economic environment has been criticised heavily due to its lack of monitoring and control by authorities when implementing pol icies which are supposed to address the lack of income equality between ethnic groups in Malaysia (Gomez & Jomo, 1 999) . The problems were exacerbated during the economic recession in 1 997, with many researchers documenting the existence of cronyism in many companies. This phenomenon and the lack of strong corporate governance and financial reporting quality in such companies have been given as the cause of the 26 economic downturn. In the wake of 1 997, the Malaysian government has taken steps to strengthen corporate governance and reporting quality by implementing and enforcing new rules and regulations. Evidence from previous research suggests that further changes are sti l l needed. Research that addresses the business and political environment of Malaysia and looks deeply into the relationship between political influence, corporate governance strength and financial reporting quality can help clarify areas for such changes. To this end, the next chapter provides a review of l iterature that forms a basis and framework to examine the l ink between political influence, corporate governance strength and financial reporting quality. 2 7 3.0 INTRODUCTION CHAPTER THREE LITERATURE REVIEW This review of l iterature is carried out to provide an understanding of agency theory that forms the framework to relate pol itical influence, corporate governance and financial reporting quality. In addition, the review of l i terature provides an understanding of the concepts of the three variables. Prior studies on polit ical influence, corporate governance and financial reporting quality are also reviewed and the review is also discussed in thi s chapter. Fol lowing the introductory section, Section 3 . 1 discusses agency theory. Section 3 . 2 discusses the merits and demerits of government influence and the importance of government influence in the Malaysian context. The concept of financial reporting qual ity is introduced in Section 3 .3 and it is e laborated on in the four subsections that fol low. The concept of corporate governance is discussed in Section 3 .4 and followed by a discussion on the review of prior studies on pol itical influence, corporate governance and financial reporting quality in Section 3 . 5 . This chapter concludes with a summary, provided in Section 3 .6 . 3. 1 AGENCY THEORY This study examines the l ink between pol itical influence, corporate governance and financial reporting qual ity. Although there is a l iterature which relates pol itical costs to earnings quality (for example, Cahan, Chavis & Elmendorf, 1 997; Cahan, 1 992; 1 996; Wong, 1 988), there is no specific theory that directly l inks pol itical influence to corporate governance or financial reporting quality. This study uses agency theory to relate the three variables. Agency theory explains the origin of conflict and ways to minimise the conflicts that can occur between parties in a contract (Jensen & Meckling, 1 976) . In a company, the parties involved are owners (the principals) and managers (the agents) . As stated 28 by Jensen and Meckl ing ( 1 976, p .308) , a company i s a "set of formal and informal contracts under which one or more principals engage another person as their agent to perform some service on their behalf, the performance of which requires the delegation of some decision making authority to the agent." In thi s regard, agency theory recognises the existence of a contract or relationship between managers and owners. I n addition to i ndividual shareholders, the owners may include financial i nstitutions and government shareholders (Hill & Jones, 1 992). Based on the theory, confl icts between managers and owners occur when they have dissimi lar and contrary interests such that the acts of the managers do not meet the interests of the owners. Jensen and Meckling ( 1 976) point out that agents (managers in a company) are assumed to make decisions that maximise their own interests and that do not satisfy the interests of principals (the owners of the company). This conflict i nvolves cost to the principals and this cost is known as agency or confl ict cost (Watts & Zimmerman, 1 990). For companies where the government holds an ownership (government-owned companies), more severe agency problems may occur (Shleifer & Vishny, 1 994) . In such companies, the principal-agent relationship is broken down into two other agency relationships as the government acts simultaneously as principal and agent. In relation to the managers of a government-owned company, the government I S a principal, thus it must assign goals (Rodriguez, Espejo, & Cabrera, 2007). The government is also the agent in its relationship with the publ ic, the ultimate owners of the resources invested in by the government-owned company (Ernst, 2004). Based on Downs's ( 1 95 7) model of government, in the decision-making process, government considers not only the i nterests of the publ ic as voters, but al so the plans or agendas of the opposition parties that compete for votes. Therefore, government wants to control or monitor managers and managerial decisions so that the decisions are in l ine with its pol itical interests. In the current study, the government i s deemed to have controls on or monitor managers and managerial actions through share ownership in the companies, holding golden shares, and/or by locating politicians or appointed officials as its representatives on the board of directors. The government may use its political power to interfere with companies' operational decisions (Chen, 2004). For example, the government, either directly or through its 29 representatives on the board, can put pressures on managers to stabi l ise employment or provide other benefits to supporters (for pol itical interests) and induce them to drift beyond profit-maximising goals (Brumby, Hyndman & Shepherd, 1 997; Kornai, 200 1 ; Roe, 2003) . Government influence can also be seen in the areas of investment p lanning, pricing of goods, work force levels, and board and management appointments (Wong, 2004). According to Wong (2004), government actions can i nfluence taxes and, as a result, determine cost and capital structures. Governments also decide on the need to regulate (or own) natural monopolies or other monopol ies, intervene in the case of externalit ies (such as regulating pol lution), and help provide publ ic goods ( such as providing national defence and education, or in areas where there is a public good aspect to providing inforn1ation) . The arguments for government influence become more complicated when they extend to distributional concerns. For example, the government can enact a "welfare state" by using state intervention i n the market economy to modify the actions of the market (Briggs, 1 96 1 ' p.222) . Bortolotti and Faccio (2006) examine control or intervention of government in newly privatised companies and find that this is common in Organisation of Economic Cooperation and Development (OECD) countries. Bortolotti and Faccio (2006, p.2) refer to this situation as "reluctant privatisation", in which the governments do not surrender complete control after privati sation and either remain the largest shareholders of the company, o r use special powers (specifical ly, golden shares). Golden shares are seen as a means to keep the companies pol i tical ly tied and thereby for the government to retain control. In addition to pol itical influence in government-control led compames, political influence can occur in any companies other than government-controlled companies. The managers of these companies see the importance of l inking companies to the government, which is consistent with the resource dependency theory pioneered by Pfeffer and Salancik ( 1 978) . Resource dependency theory explains the importance of the l ink between companies and external contingencies that create uncertainty and interdependence (Hi llman, 2005). According to Hi l lman (2005), for a business a critical source of uncertainty and interdependence is government, and a way to form a l ink with government is through the appointment of pol iticians on the board of 30 directors. This l ink is said to be able to reduce external uncertainties sourced from the government policies, regulations and enforcements (Hillman, Zardkoohi & Bierman, 1 999). Such l i nks could protect companies from external fluctuations, lower transaction costs and improve firms' survival (Pfeffer, 1 972; S ingh, House & Tucker, 1 986 i n H i l lman, 2005; Thompson, 1 967) . Companies that have the l ink would also enjoy significant benefits in terms of high leverage, low taxation and high market value (Faccio, Masul is & McConnel , 2006; Fisman, 200 1 ) . However, the i nvolvement of politicians in a company can create double agency problems i nvolving self- interested behaviour by both managers and pol itic ians (Wong, 2004) . As Buchanan and Tul lock ( 1 968) argue, individuals involved in the political process are self- interested actors who want to maximise their own self interests which can be to the detriment of the interest of the majority shareholders as the owners. For example, politicians may supply information on publ ic policy or regulations or offer a l inkage between managers and government agencies (such as preferential access to credit) in return for financial incentives such as campaign financial contributions and social welfare expenditures that could gain constituency supports or votes during election (Hi l lman & Hitt, 1 999) . There can also be negotiations or bargaining processes between pol iticians and managers in order to maximise their own self-interest. Shleifer and Vishny ( 1 994) provide a model of bargaining between pol iticians and managers. The model suggests that when a company is control led by managers, politicians involved in the company (such as those who are board members) use subsi dies as bribes to influence companies' managers to pursue their pol itical objectives. On the other hand, when politic ians have control rights in a company, managers use bribes to convince pol iticians not to urge companies to fol low their political objectives that go beyond the managers' interests. In either way, the involvement of politicians in a company can affect managerial decisions and as a result may affect the outcomes of the company' s economic decisions. The current study looks at corporate governance strength and financial reporting quality as the outcomes. Overall, the interference from government and pol iticians in companies may give the impression that managerial autonomy in the companies has not been fulfil led. This, 3 1 according to Chen (2004), creates a l ack of incentives for managers to monitor the companies' success and as a result the management may pursue its own interests at the expense of companies' i nterests (Andrews & Dowling, 1 998) . The conflict of interest between the principal and agent doubles in these companies. Managers are the agents of both the government and other stakeholders as the principals. Pol iticians as the government' s representatives are the agents of the government. The interests of the managers may differ from those of the government and other stakeholders. Also there may be conflict of interests between the government, the politicians and the managers. The companies suffer not only from agency costs, but also pol itical costs - specifically, the costs associated with control of companies by government or politicians who have pol itical goal s that differ from economic efficiency (Shleifer & Vishny, 1 994). The companies may also suffer additional pol itical costs if they are perceived to be operating in a manner that can be exploited by the government ( Ikin, 2005) and by pol iticians. The "exploitation" by the government is assumed in the current study to take place via government control or influence through share ownership, by holding golden shares and by locating pol itic ians on the board. In addition to pol itical interference causing severe agency problems, the accounting systems of the companies may also be affected. This is because accounting systems are closely l inked to the agency problem (Tagesson, 2007). Government or pol iticians may prefer an accounting system which al lows them to report selective subsets of information and for annual reports to be presented in their best i nterests (Zimmerman, 1 977). Managers may provide qual ity financi al reporting in order to increase confidence among current and potential investors and to reduce agency conflicts (Chow & Wong-Boren, 1 987) . Agency problems can also generate a tendency for management to produce substandard financial information (Chung, F i rth & Kim, 2005; Richardson, 2006; Warfield, Wild & Wild, 1 995) in order to cover actions that have not been in the best interests of the shareholders or debt holders (Jensen & Meckling, 1 976). With regards to corporate governance and within the framework of agency theory, corporate governance provisions appear as a result of the agency conflict between the different parties of a company. Because of the differences between the interests and 32 i ncentives of managers, shareholders and other resource providers, corporate governance mechanisms are put i n place to reduce agency conflicts (Beasley, 1 996; Fama & Jensen, 1 983a, 1 983b) in that it can be used as a mechanism to monitor management's behaviour (Botica-Redmayne, 2004). In summary, agency theory provides a framework for l ink ing political influence, corporate governance strength and the outcomes of management behaviour ( including financial reporting quality). The current study focuses on the effect of pol itical influence in Malaysian companies and looks at how decis ion-making outcomes in terms of corporate governance strength and financial reporting qual ity are associated with the influence of politics. In thi s study, pol itical influence i s assumed t o occur through government ownership, golden shares and pol iticians on the board of directors. The next section discusses the merits and demerits of government influence. 3.2 MERITS AND DEMERITS OF GOVERNMENT INFLUENCE The merits and demerits of government influence have been comprehensively analysed and commented on by researchers in the areas of business and political economics (for example, Esfahani & Ardakani , 2002; Brewer, 1 993; Brumby, Hynman, & Shepherd, 1 997; Gunasekarage, Hess, & Hu, 2007; Henderson & Phi l lips, 2007; Kornai, 200 1 ; Mamman, 2004; Sappington & Stiglitz, 1 987 ; Wong, 2004; Zhuang, 1 999b ). Sappington and Stiglitz ( 1 987) argue that under the assumption of a benevolent government, market fai lure may be addressed by government control . According to the researchers, information, contracting and bargaining costs l imit the government's abil ity to regulate by ex-ante design and when government cannot exactly determine its objectives due to lack of experience, it may want to retain direct control to avoid costly contract renegotiation procedures with private parties. The inabi l ity of a sovereign government to commit to market-friendly tax and regulatory policies, which discourages private investment, may also result in direct government involvement in production as a substitute (Esfahani & Ardakani , 2002). 33 The researchers further suggest that the direct control of government over companies can be the solution for regulators to control significant decisions by private owners. In Asia, government influence in companies was one of the factors that contributed to the I 997 financial crisis (Mamman, 2004), including in Malaysia. Government influence, such as the subsidising of particular industries, sectors, and firms by direct lending, implicit and expl icit guarantees and various forms of protection, may lead to misal location of resources or distortion of incentives and result in moral hazard problems (Zhuang, I 999b). These moral hazards, such as excessive risk-taking, inefficient allocation of capital and the weakening of the domestic financ ial system were the keys to the wider economic crisis that ensued. Given the moral hazard and agency problems that are caused by pol itical or government influence in a company and which are expected to consequently affect the management and management economic decisions, a question arises as to why government wants control or i nfluence over companies? Within the Malaysian context, thi s i ssue is discussed in the fol lowing section. 3.2 . 1 The Importance to the Malaysian Government of Control over or Influence on Companies Chapter Two has provided a background to pol itics and business in Malaysia. In order to address the question of why the Malaysian government wants control over companies, this background information can be referred to. The reason why the Malaysian government wants control over companies is because of the balanced socio-economic policy. Within the policy, the government carried out the New Economic Pol icy (NEP) for the period of 1 97 1 to 1 990, the National Development Policy (NDP) for the period of 1 99 1 to 2002, and the National Vision Policy (NVP) for the period 200 I to 20 I 0, in order to restructure the socio-economic imbalance among ethnic groups, particularly the Bumiputera ( inc luding the majority ethnic - Malays and other Bumiputera such as Kadazan, Bajau, Bidayuh and Melanau) , Chinese and I ndians. The imbalanced socio-economic status among the ethnic groups has been the result of the economic and pol itical interests of the British colonialism (Abdul lah, 1 997; Chin, 2000). At the time of colonial i sm, the British open-door immigration pol icy which brought a great number of immigrant labourers from 34 China and India drastically and substantially reduced the percentage of the Malay population within mainstream economic growth and social development (Furnival l , 1 956) . This is because, according to Furnivall ( 1 956), the British divide and rule pol icy resulted in the different ethnic groups l iving in different geographical areas, engaging in different economic activities with different rate of economic progress. The Chinese and Indians were i nvolved with the major economic sectors whi le the Malays and other indigenous populations were left in rural areas and l ived in a very traditional and economically unproductive way. This pol icy, since then, has benefited certain groups, especially the Chinese and Indians, and has neglected the others, espec ial ly the Malays and other i ndigenous people. The Malays have been "left out" in terms of economic and social development compared to the other major ethnic groups. In order to correct the economic imbalances and to reduce the identification of race with economic functions, the NEP was implemented with the main targets being to ensure the Malays and other indigenous people come to manage and own at least 30 percent of the total commercial and industrial activities; to ensure the employment pattern at all levels and in al l sectors reflects the racial composition of the population; and to establ ish new industrial activities in selected new growth areas. To achieve these targets the government has played a significant dominant role, in that the government has partic ipated more directly in the establ ishment and operation of productive enterprises by having ownership in them (Abdullah, 1 997) and therefore having controls over their management and operations. In addition, and especial ly to accelerate the creation of the Malay and other indigenous "commercial and industrial community", the government has upgraded and created specialised agencies such the National Trading Corporation, the State Economic Development Corporations and the National Equity Corporation. These agencies are owned and control led by the government. Furthermore, the government, through privatisation policy, also has control s over its privatised companies' operations in order to ensure that the Malay and other indigenous people continued to participate in business by involving them in the workforce even after privatisation (Rasiah & Shari, 200 1 ). The NDP was then i ntroduced based on the objectives ofNEP, aimed at attaining balanced development 35 and emphasised the strategy of growth with equity (Malaysia, 1 99 1 ) . The key feature of the NDP has been the reliance on the private sector to proactively act as the economic engine growth with the supportive and complementary role played by the public sector. At present, the NVP continues the efforts of the NEP and NDP to attain a united, progressive and prosperous Malaysian society (Ragayah, 2008). Al l these policies have seen significant government intervention into and control over Malaysian companies especial ly the government-owned. The Malaysian government has also intervened and control led significantly through its industrial policy. Within the policy, a holding company is created with the main purpose to involve in the operations of heavy industries (Jomo & Wah, 1 999) . In addition to boosting national economic growth, the introduction of the government­ sponsored heavy industries is to promote the indigenous people ' s businesses by fil l ing professional positions in the government-sponsored companies with individuals with the indigenous status (Rasiah & Shari, 200 1 ). I n addition, government wanting control over companies is to ensure national and public interests (Abdul lah, 1 997). The government exercises control over companies which are of national or public interest such as those within the energy and infrastructure sectors. These companies are required to pursue a particular government strategy to ensure that national and public interest are being protected and to ensure continuous pol itical support from the constituents. As an emerging economy, Malaysia is dependent on foreign direct investments (FDI) in stimulating corporate sectors (Doraisami, 2007; Mamman, 2004) Therefore, in order to attract more FDI, the government has to ensure that Malaysian companies are well-governed and perform wel l . For this purpose, in addition to providing investment infrastructures and incentives to the corporate sector, the government gains its control rights on the companies' managerial and economic decisions through substantial share ownership and holding golden shares in the particular companies. With these rights, the management and operation of the companies can be monitored. This is necessary because private Malaysian companies, which are mainly fami ly-owned (Mal l in, 2007), tend to be badly governed with expropriation of minority shareholders and self-deal ing by control l ing shareholders, among others. According to Mall in (2007), the governance of these companies, which have evolved 36 from the traditional family-owned enterprises, i s relatively poor as their directors may not be responsive to minority shareholders' rights and for that reason, the governance and transparency of these companies need to be improved to restore i nvestors' confidence. In summary, the l iterature on why the Malaysian government wants control over firms provides further understanding into the context of the study. The expected relat ionships between the three main variables (political influence, corporate governance strength and financial reporting quality) are discussed in the fol lowing chapter - Chapter Four: Hypotheses Development. The fol lowing sections provide a review of l iterature on financial reporting quality, corporate governance and the relationship between political influence, corporate governance and financial reporting qual ity. 3.3 F INANCIAL REPORTING QUALITY Financial accounting information and disclosure are very important tools for investors (Healy & Palepu, 200 1 ; Lambert, Leuz, & Verrecchia, 2007) as financial accounting information and disclosure supply a key quantitative representation of individual corporations (Bushman & Smith, 2003). A high level of disclosure qual ity can reduce the cost of capital of a company (Ashbaugh, Col lins, & LaFond 2006; Krishnamurti , Sevic, & Sevic, 2005b). Moreover, as a result of the increased global i sation of financial and product markets, i nterest of both market participants and regulators i n financial reporting quality is developing worldwide (Kothari, 200 1 ) . While much attention is given to the quality of financial reporting and indeed the phrase "financial reporting qual i ty" is widely used, the concept of financial reporting qual ity is e lusive and has been interpreted in a variety of ways (Ball et a l . , 2003). There has been no agreement on the definition of or the framework for financial reporting quality among researchers and accounting professionals (Jonas & Blanchet, 2000). As stated by McDaniel, Martin, and Maines, (2002, p . 1 44) "the SEC, auditing profession and national exchanges ( in the US) have not specified an explicit 3 7 defin ition of or a framework for financial reporting quality". As a result, there are various interpretations of or proxies for financial reporting quality. Most pnor studies use either disc losure quality (for example, Wright, 1 996) or earnings quality (Bushman, Piotroski et al . , 2004) as a proxy for financial report ing qual ity (refer Appendix A for a summary of the studies) . Very few studies use multiple proxies for financial report ing qual ity (see for example Barton & Waymire, 2004; Han, 2005; Rajgopal & Venkatachalam, 2008). This has motivated the current study to provide an understanding of the concept of financial reporting quality through multiple proxies. The current study assumes incorporation of both disclosure quality and earnmgs quality as being important because it has been shown that companies with high quality disclosure substitute enhanced disclosure for low quality of earnings. that is, earnings are managed and delayed earnings recognition of value-relevant events is overcome by providing high quality disclosure (Shaw, 2003) . In other words, even if a company' s disclosure qual ity is high, this does not necessarily mean its earnings qual ity is also high. Therefore, taking only disclosure qual ity as a proxy for financial reporting qual ity misleads users of financial reports. Only taking earnings quality as a proxy for financial reporting quality i s seen as inadequate as earnings information in investment decision-making is often i nsufficient (Schadewitz & Kanto, 2002) . It is claimed to be insufficient because it is based primari ly on historical figures (Coll ins, Maydew, & Weiss, 1 977), and therefore l imits a prediction of a company' s future prospects. On the other hand, according to Schadewitz and Kanto (2002), disclosure allows management to communicate detai led information about not only historical information but also the future prospects of a company' s business activities. General ly, a review of prior studies in the area of financial reporting quality can group them into two main categories; those that use disclosure qual ity and those that use earnings qual ity as a proxy for financial reporting quality. Other than these major categories, there are studies that refer to financial reporting qual ity in relation to certain characteristics or attributes. The fol lowing sub-sections discuss these two 38 maJor proxies of financial reporting quality and also look at other attributes of financial reporting qual ity. The review of disclosure and earnings quality studies reported in the fol lowing sections focuses on understanding the concepts and measurements instead of the findings of those studies. However, Appendix A provides the detai ls of the studi es, including their findings. Figure 3 . 1 shows the proxies for financial reporting quali ty establ ished from the l iterature review and the discussions of the proxies in the fol lowing sections. 39 • • • • • • • Figure 3. 1 : Proxies for Financial Reporting Quality l "'� • Extent of d isclosure • Disclosure quantity • Level of d i sclosure • l nfonnat iveness • Timel iness. details, c larity • Comprehensiveness • Potent ial usefu lness • Amount of d isclosure • I nformation contents " I Develop I ndex l ( Items: 1 0-296\ * I Financial experts Investors Literatures Loan officers Authors Financial analysts Security analyst • Professional RlltinPsll nclex • Cl FAR AIMR S&P FAF • • • • • • • • • • • l : + I Defin ition I I FRQ - Sec. 3.3 I I 1 � Sec. 3.3.2 I Earnings persistence. precis ion Earn ing sustainabi l ity Earn ing response coefficient Predictab i l ity of cash flows Discretionary accruals. abnormal accruals Feedback value. neutral ity, t imeli ness, representat ional fai thfulness Earnings smoothing. t imely loss recogn it ion Reflection of earni ngs on current economic act iv it ies l nformativeness of accounting earnings Conservatism Earnings composed primari ly of operati ng cash flows Information content F :arnin12 usefulness FRQ : Financial Reporting Quality DQ : Disclosure Qual ity EQ : F:arnings Qual ity • • • • • • • • • • • • • 1 Other Attributes Sec.3.3.3 Jones model ( 1 99 1 )/Modi fied Jones model ( 1 993 ) Dechow and Dichev model ( 2002), Penman and Zhang model ( 2002 ), Leuz, Nand a & Wvsocki model ( 2003 ) F ASB's conceptual framework Report by CFRA Change in investors' assessments, Survey method, ratios Behav iour of security prices Earnings response coefficient and future earni ngs growth Magnitude of abnormal accruals. the t imel iness and relevance of earn ings Deviation of net income from operat ing cash flows Earnings return relation Volat i l i ty of accruals and volati l ity of earnings Conservat ion index (C Scores) & earn ings qual ity indicator (Q Scores) Investment strategy based on the rank of the unexpected earnings and stock returns on the contemporaneous level and change in earnings • • I Defin itio�--J Measurement • Relevance. rel iab i l ity. comparab i l ity • • Employed analysis judgement SEC's assessment criteria • Transparency. fu l l d isc losure. comparabi l i ty • Relevance. rel iabi l ity. clarity and management to assess qual ity • • Used audit committee members. Auditors and management to access qual i ty 40 3.3.1 Disclosure Quality and Its Measurement Various i nterpretations of disclosure quality have been put forward by prior studies. It has been referred to as adequacy of disclosure (Buzby, 1 974); comprehensiveness of information disclosure - the fact that no important aspect has been left undisclosed ( Imhoff, 1 992; Wallace and Naser, 1 995); the extent of disclosure (Bushee, 2004; Cooke, 1 989, 1 992), as wel l as the degree of compliance with standards requirements (Naser and Nuseibeh, 2003) . Unl ike the studies that carried out annual report content analysis, M itton (2002) considers companies to have indicators of high qual ity disclosure if the companies have a listed American Depository Receipt (ADR) and if their auditor is one of the Big Four 1 1 international companies. In determining disclosure quality, pnor studies have used either their own self­ developed disclosure index (for example Buzby, 1 974; Cooke, 1 989, 1 992; Naser & Nuseibeh, 2003 ; Robbins & Austin, 1 986; Singhvi & Desai , 1 97 1 ; Wallace & Naser, 1 995) ; indices of professional bodies (such as Chartered F inancial Analysts I nstitute - CF A 1 2 ; F inancia l Analysts Federation - F AF; the Center for Financial Analysis and Research - CIF AR; or Standard and Poors - S&P) or the professional bodies' disc losure rat ings . The disclosure index procedure involves an evaluation of the i nformation items disclosed in a report (such as an annual report), based on a pre­ defined l i st of the possible index items. The disclosure index used i s either weighted or un-weighted. A weighted index takes into account the importance of information i tems whereas an un-weighted i ndex assumes al l items are of equal importance. The studies that developed weighted disclosure indices include those of Singhvi and Desai ( 1 97 1 ) , Buzby ( 1 974), F irth ( 1 979), Hooks, Coy and Davey (2002) and Naser and Nuseibeh (2003). S inghvi and Desai ( 1 97 1 ) developed an index of thirty-four items to assess the adequacy of disc losure of l i sted and non-l isted companies' annual reports. Buzby ( 1 974) developed a weighted index of thirty-nine items to measure the extent of disclosure of financial and non-financial items in annual reports of smal l and medium size companies. The index was based on the importance of each 1 1 At the t ime of Mitton's (2002) study, i t was the Big Six . 1 2 Formerly known as the Association of Investment Management and Research (AIMR). 4 1 of the items for disclosure in annual reports as perceived by financial analysts. S imi lar to Buzby's ( 1 974) study that measured the extent of disclosure, Firth ( 1 979) also developed a disclosure index made up of forty-eight voluntary items. The index developed in this study was a weighted index where the voluntary items were weighted based on their importance to financial analysts working for stockbrokers and investment institutions. By also developing and applying a weighted index, Hooks, Coy and Davey (2002) measured the extent and quality of disclosure based on seventy-six information items, where the weighting of disclosure importance was based on l iterature and a panel of expert opinions. In contrast to the above weighted indices to measure disclosure quality, there are studies that have used an un-weighted i ndex . These include Cooke ( 1 989), who used a dichotomous procedure in developing and applying a disclosure index in order to measure the disclosure qual ity of annual reports of Swedish companies. The procedure identified whether an item was present in the companies' annual reports or not. A score of 1 was allocated to each item disclosed and 0 for non-disclosure. The ratio of actual scores awarded to the total expected (maximum possible) scores indicated the qual ity of disclosure. In Cooke' s ( 1 989) study, the un-weighted index was made up of 229 items. Also using the un-weighted index procedure, Wallace and Naser ( 1 995) constructed a disclosure index of thirty items to assess the comprehensiveness of disclosure. While the above studies developed and appl ied either a weighted or un-weighted index in order to assess disclosure qual ity, there are studies that have used both weighted and un-weighted indices (for example, Barrett, 1 976; Robbins & Austin, 1 986; Naser & Nuseibeh, 2003 ; Chow & Wong-Boren, 1 987) . Barrett ( 1 976) constructed a disclosure index using seventeen categories of information. The qual ity of disclosure was i ndicated by the extent of financial disclosure that was determined from the application of the index and the degree of comprehensiveness of the companies' financial statements as determined by quality criteria identified by the researcher. In Robbins and Austin ( 1 986), the index was made up of twenty-seven items and used to measure the extent and importance of disclosure of sample companies' annual reports. Naser and Nuseibeh (2003), in assessing the quality of information disclosed by a sample of non-financial Saudi companies l i sted on the 42 Saudi Stock Exchange, constructed a disclosure index which was weighted by the mean and median responses of several user groups of annual reports in Saudi Arabia. I n the study, the un-weighted procedure was also appl ied. Naser and Nuseibeh considered the extent, the importance of disclosure and the degree of compl iance to the statutory requirements as a measure for disclosure quality. S imi larly, by using an index and compared scores when weighting was added and not added, Chow and Wong-Boren ( 1 987) examined the extent of voluntary financial d isclosure. The index consisted of eighty-nine items that were weighted for various degrees of importance by loan officers. Their comparison between weighted and un­ weighted scores revealed almost identical results and the finding has been used in a lot of subsequent research to defend the use of un-weighted indices (for example, Marston and Shrives, 1 99 1 ; Wallace and Naser, 1 995; Naser and Nuseibeh, 2003) . These studies found that the use of weighted and un-weighted indices gave no material difference in results. From the late 1 990s, researchers in the disclosure qual ity used disclosure ratings issued by professional bodies as a measure of disclosure quality. For example, Lang and Lundholm ( 1 996), Sengupta ( 1 998) and Shaw (2003 ) used companies' disclosure ratings as outl ined in the report of the F AF. In addition to the F AF ratings or scores, disclosure qual ity ratings issued by the CF AI AIMR were also used (for example, Bens & Monahan, 2004; Brown & H i l legeist, 2007; Bushee & Noe, 2000; Healy, Hutton, & Palepu, 1 999; Lee, Petroni, Shen, & Hirst, 2006) . The AIMR ratings were based on the financial analysts' perceptions of the importance and qual i ty of disclosure items selected. The disclosure qual ity scores issued by CIF AR have also been used in prior studies, for examples Bushman and Smith (2003); DeFond, Hung and Trezevant (2007) and Hope (2003 ) . The CIFAR index largely covers the same items as S&P's Transparency and Disclosure i ndex and focuses on the quantity or extent of disc losure (Bushee, 2004 ) . Whi le the above reviewed studies used the ratings/scores issued by the professional bodies as the construct of disclosure qual ity, there are studies that appl ied the index 43 used by professional bodies - such as the S&P's index - to the annual reports of their sample companies (for example, Dargenidou, McLeay, & Raonic, 2006; Patel, Balic, & Bwakira, 2002). This index was used by Patel et al. (2002) to assess the level of d isc losure of ninety-eight possible information items which were divided into three sub-categories: ownership structure and investor relations; financial transparency and i nformation disclosure; and board and management structure and process. In summary, the review of disclosure quality studies finds that there is no common understanding of the concept of disclosure qual ity. In terms of its measurement, prior studies have recognised the use of disclosure indices to measure disclosure quality. The index can be either weighted or un-weighted. In addition, there is no agreement on the number of items used in the index developed. Appendix A provides a summary of prior studies related to disclosure qual ity and disclosure indices ( including the above reviewed studies). The results of each study are also reported in the summary. The disclosure quality assessed in the current study is that of annual reports. Annual reports are not the only source of corporate reporting; however, focusing on this source only will not reduce the qual ity of information, as it is general ly bel ieved that the annual report is one of the most important sources of corporate reporting (Botosan, 1 997) . The definition of disclosure quality that is employed in the current study is in l ine with Cooke ( 1 989, 1 992), who considers the extent of disclosure as a construct of quality. Extensiveness ensures a sufficient amount of disclosure is provided to the users of financial reports to make economic decisions. It i s an adequate measure of the quality of disclosure (Botosan & Plumlee, 2002). As this current study is concerned with the extent of disclosure as a proxy for the quality of disc losure, the use of a disclosure index is seen as appropriate. Chapter Five provides details of the development of the disclosure index. 3.3.2 Earnings Quality and Its Measurement Earnings qual ity has al so been defined and measured differently in previous studies. Earnings qual ity has been referred to as earnings informativeness ( Beaver, 1 968; Fan 44 & Wong, 2002; Vafeas, 2000), and the usefulness of earnings operational ised by the behaviour of security prices (Ball & Brown, 1 968). Schipper and Vincent (2003) came out with an extensive review of earnings quality constructs and measures which were classified into four sources - the time-series properties of earnings; the relationships between income, cash and accruals; selected qualitative characteristics m the F ASB's Conceptual Framework; and implementation decisions (Schipper & Vincent, 2003, p.99). Earnings constructs have been mostly derived from the first two sources. The time-series-based and accrual-based constructs have been then modified and/or combined in subsequent studies for the purpose of measuring earnings quality. For the time-series classification, three constructs have been identified (Schipper et al . , 2003, p.99) - "persistence" where earnings are viewed as "more permanent and less transitory"; "predictive abi l ity" which is referred to as "the abi lity of past earn ings to predict future earnings" (Lipe, 1 990 in Schipper et al . , 2003, p. 99); and "variabi lity" which is identi fied from whether the earnings are natural ly smoothed earnings or result from income smoothing activities. Studies that used earnmgs quality constructs derived from the t ime-series classification, as reviewed by Schipper et al. (2003) include Kormendi and Lipe ( 1 987), Coll ins and Kothari ( 1 989), and Leuz Nanda and Wysocki (2003) . In more recent studies, DeFond et al. (2007) also measured earnings qual ity using the t ime­ series c lassification - a variation of the earnings management metric used by Leuz et al . (2003) . The second earnings construct c lassified by Schipper et a l . (2003, p.99) was mostly related to accruals which include "changes in total accruals", "direct estimation of discretionary accruals" and the "relations of accruals-to-cash". According to the researchers, changes in total accruals i ndicate manipulations by managers, in that the greater the changes, the lower the quality of earnings. The d irect estimation of discretionary accruals was initially i ntroduced by Jones ( 1 99 1 ) using accounting fundamentals - revenues adjusted for receivables or plant, property, and equipment. In this approach, total accruals are regressed on the accounting fundamentals and the residuals from the regression are the discretionary accruals which indicate earnings 45 management that reflects lower earnings quality. Jones' s ( 1 99 1 ) model was also used in the studies of Bedard, Chtourou and Courteau (2004), Cahan ( 1 996) and Myers, Myers and Omer (2003) . According to Schipper et al . (2003), Jones's ( 1 99 1 ) model was improved by Dechow and Dichev (2002) by capturing aspects of the relations of accruals-to-cash. Thi s approach i nvolves a regression of changes in working capital accruals on prior, current, and next period cash flows. The estimated residuals from the regression describe an estimation error in unintended and manipulative accruals and indicate an opposite measure of earnings qual ity . The extent to which working capital accruals map onto operating cash flow real isations reflects accruals qual ity (Francis, LaFond, Olsson, & Schipper, 2005). Dechow and Dichev' s (2002) model has been employed i n a number of research studies, for example Francis, Huang, Raj gopal and Zang (2008a); Francis, Nanda and Olsson (2008b ), Francis, LaFond et al. (2005) and Chen, Shevl in and Tong (2007). Francis, LaFond et al . (2005) and Francis et al . (2008a; 2008b) integrate Jones' s ( 1 99 1 ) model and Dechow and Dichev's (2002) models in measuring earnings quality. Dechow and Dichev ' s (2002) model is able to identify a direct l ink between cash flows and current accruals. Whi le the above studies employed time-series properties-based and/or accrual based earnings qual ity constructs, Basu ( 1 997) operational ised earnings quality as timely recognition of economic losses. This operationalisation of earnings quality was then used in other studies (see for example, Ball et al . , 2003 ; Ball & Shivakumar, 2005). Ball et al . ' s (2003 ) highlighted the fact that financial reporting qual ity was ultimately determined by the underlying economic and political factors influencing managers' and auditors' incentives, and not by accounting standards per se. However, Bal l et al . (2003) did not empirically examine the relationship between pol itical factors and financial reporting quality . This provides an opportunity for the current study to investigate the relationship. I f Ball et al . (2003) and Bal l and Shivakumar (2005) focused on timely recognition of economic losses, Ashbaugh et al. (2006) used timel iness and value relevance (transparency) of accounting earnings as one of the proxies of earnings qual ity. According to Ashbaugh et al . (2006), more transparent and current earnings reflect a 46 company's current economic activity information and contribute to higher earnings quality. In Ashbaugh et al. (2006), the construct of timel iness and value relevance of earnings was combined with two other constructs - discretionary accruals and the i ndependence of the audit committee. The magnitude of the three constructs was used as the proxy of earnings quality. S imi lar to Ashbaugh et al . (2006) in combining more than one construct in determining earnings qual ity, Franc is et al . (2008a; 2008b) took into account accruals-based and time-series-based earnings qual ity as classified by Schipper et al . (2003). In Francis et al . ' s (2008a) study, the proxy of a company' s earnings qual ity was the common factor identified by factor analysis performed on the constructs of accruals quality, absolute value of discretionary accruals and earnings variabil ity. Appendix A provides a summary of prior studies related to earmngs qual ity i nc luding the determination of earnings qual ity, the purpose and the results of each study. S ince there is no standard definition and measurement of earnings quality, the current study employs the modified model of Dechow and Dichev (2002) as the main model, and the original model of Dechow and Dichev (2002), as an alternative model , in the determination of earnings quality, simi lar to those used in Francis, Lafond et al . (2005) and Francis et al . (2008a; 2008b). Other previous studies that have used the Dechow and Dichev (2002) model include Francis, LaFond, Olsson and Schipper (2004); Aboody, Hughes and L iu (2005) and Ashbaugh et al . (2006). The original model of Dechow and Dichev (2002) shows a direct l ink between cash flows and current accrual and assumes that estimation errors in current accruals decrease the qual ity of accrual s and earnings (Schipper & Vincent, 2003). However, according to McNichols (2002), the model does not distinguish between intentional and unintentional estimation errors 1 3 in accruals. The original model is modified and improved upon by taking into consideration accruals association with cash flows from operation in the current, prior and future periods as wel l as the change in revenues and property, p lant and equipment (PPE) (Francis, et al . , 2008a; 2008b; McNichols, 2002). The modified model takes into consideration the unintentional 1 3 Intentional errors arise from incentives to manage earnings as proxied by Jones's ( 1 99 1 ) model and un intentional errors are related to management lapses and environmental uncertaint ies (Franc is, LaFond et al . , 2005). 47 errors and the two additional variables; the change in revenues and PPE provide a more complete characterisation of the relation between accruals and cash flows. The modified model is more appropriate to the current study, as this study involves uncertainties such as polit ical risks that may affect accruals and cash flows. The detai ls of the modified model are presented in Chapter Five. 3.3.3 Financial Reporting Quality in Relation to Certain Characteristics or Attributes In addition to disclosure or earn ings quality, financial reporting qual ity has also been related to certain characteristics. Jonas and Blanchet (2000), in their commentary, suggest that the quali ty of a company's financial reporting ultimately depends on the qual ity of each part of the financial reporting process, which highlights the financial information's quali tative characteristics (for example relevance, reliabil ity and clarity) . From a simi lar perspective, Daniel, Beasley, Menelaides and Palmrose (2002), refer to financial reporting qual ity as having selected characteristics of reporting qual i ty as espoused in the Statement of Financial Accounting Concepts (SF AC) No. 2. These include feedback and predictive value for the relevance characteristic, and verifiabil ity, comprehensiveness, representational faithfulness, and neutral ity for the rel iab i l ity characteristic. While the above studies refer to certain qual i tative characteristics, Pownal l and Schipper ( 1 999) use multiple proxies in determining financial reporting quality. The study refers to financial reporting as being of high qual ity if it possesses three attributes : transparency, ful l disclosure and comparabi lity. Transparency is referred to as the reveal ing of information about events, transactions, judgments and estimates which al lows users to see the results and impl ications of the decisions, j udgments and estimates of preparers. Full disclosure is related to the provision of all information necessary for decision-making, whi le comparabil ity means that simi lar transactions and events are accounted for in the same manner, both cross-sectional ly among companies as wel l as over time. 48 By also including transparency, Barton and Waymire (2004) combine the attribute of transparency of the i ncome statement and balance sheet with two other attributes - the existence and quality of the external audit and the extent to which conservatism influences the firm's financial reporting - when determining the qual ity of financial reporting. S imilarly, Rajgopal and Venkatachalam (2008) use multiple proxies in determining financial reporting qual ity - earnings quality and analysts' forecast dispersion. Multiple proxies of financial reporting quality are also found in Han 's (2005) study in which the researcher uses earnings quality and disclosure quality as measures of financial reporting qual ity. Similar to Han (2005), the current study uses both disclosure qual ity and earnings quality as proxies for financial reporting quality. Han (2005) employs the S&P's transparency and disclosure rating (which include the overal l company rating and rating of financial information) as a measure for disclosure quality and the absolute value of discretionary accruals and standard deviation of residuals as proxies for earnings quality. However, the current study develops and applies an index in measuring disclosure qual ity and employs the modified Dechow and Dichev's (2002) model in determining earnings quality . 3.3.4 Prior Studies on Determinants of Financial Reporting Quality Prior studies have examined the determinants of financial reporting qual ity (either in terms of disclosure or earnings qual ity) . These determinants include a company' s fundamental characteristics such as size, l i sting status, age, governance structure; their financial characteristics, namely financial leverage, operating leverage, growth, return variabi l ity and profitabi l ity; their policies, such as dividend and investment policies and degree of internationali sation; and external factors such as statutory regulations and enforcement, accounting regimes, the type of industry ( regulated or non-regulated) that the company is involved in and any pol itical influence on the company' s dealings. For example, prior studies have identified company characteristics that determine the quality of disc losure ( for example, Buzby, 1 974; Cooke, 1 989; S inghvi & Desai, 1 97 1 ) . Ownership structure has been identified in prior studies as another determinant of financial reporting quality, in terms of earnings ( for example, Fan & Wong, 2002). In addition, corporate governance structure has also been found in prior studies to determine financial reporting qual ity ( for example, Bedard et al., 2004; Vafeas, 2000). Prior studies have also identified 49 t hat political factors help determine the quality of financial report ing (for example, Bushman & Piotroski , 2006; Bushman, Piotoski et al . , 2004; Leuz & Oberholzer­ Gee, 2006) . Figure 3 .2 i l lustrates examples of determinants of financial reporting quality examined by prior studies. Most of the determinants shown in F igure 3 .2 are i ncluded in the current study either as test or control variables. The study looks at both disc losure and earnings qual ity as proxies of financial reporting qual ity and uses multiple proxies of political influence - govemment ownership, pol iticians on board of directors and golden shares. The current study extends the l iterature on the determinants of financial reporting quality by examining the relationship between different proxies of pol itical influence and corporate governance strength and/or financial reporting quality . 50 Figure 3.2 Examples of Determinants of Financial Reporting Quality (FRQ) Examined by Prior Studies. Industries ( regulated vs. non regu lated) Law and enforcement Accounting techn iq ue/methods/esti mates /recognition practices Firm's fundamental characteristics (size, l isting status, age) Firm's financia l characteristics (financial/operating leverage, growth, profitabi l ity, return variabi l ity) Company's pol icy (disclosure pol icy, d ividend pol icy, investment pol icy) Accounting standards/accounting regimes Governance structure/mechanisms Pol itical influence Determina nts Financial Reporting Quality 5 1 The fol lowing subsections provide a review of l iterature related to corporate governance i n order to gain insights i nto the concept of corporate governance and what makes strong or weak corporate governance. This is relevant because the current study includes corporate governance strength as a test variable. 3.4 CORPORATE GOVERNANCE There i s no common definition of corporate governance used i n the l iterature. Donaldson ( 1 990) defined corporate governance as the structure whereby managers at the organisational apex are control led through the board of directors, its associated structures, executive incentives and other schemes of monitoring and bondi ng. From a broader perspective corporate governance is defined as a system by which companies are directed and contro lled (Cadbury, 1 992) . It consists of two components : corporate, which refers to corporations and governance, which refers to the act, fact or manner of governing (Lanno, 1 999) . Stressing stakeholders' rights, Demb and Neubauer ( 1 992) stated that corporate governance is the process by which corporations are made responsive to the rights of stakeholders. Monks ( 1 994) defined corporate governance as the relationships between the various participants who determine the direction and performance of corporations. It helps address the issues facing the board of directors, such as i nteraction with top management and the relationships with the owners and others i nterested in the affairs of the company, including creditors, debts financiers, anal ysts, auditors and corporate regulators (Tricker, 1 994). Corporate governance is used as a mechanism to protect stakeholders' interests, by which stakeholders of a corporation exercise control over corporate insiders and management (Johri & Wenbet, 1 998) and especial l y minority shareholders. Corporate governance is the means by which minority shareholders are protected from expropriation by managers or controll ing shareholders (Mitton, 2002) . Scott ( 1 999) referred to corporate governance i n its most comprehensive sense as every force that supports a deci sion-making process of a company. Thi s encompasses 52 not only the control rights of stakeholders, but also the contractual covenants and solvency powers of debt holders, the commitments entered into with employees, customers and suppliers, the regulations issued by government agencies, and the statutes enacted by parliamentary bodies. Additional ly, corporate governance is said to influence how business corporations allocate resources and returns (O'Sull ivan, 2000). In Malaysia, the Finance Committee on Corporate Governance (FCCG, 2000) defined corporate governance as the process and structure used to direct and manage the business and affairs of a company towards enhancing business prosperity and corporate accountabi l ity. The ultimate objective is to real ise long term shareholder value, whi le at the same time taking into account the interests of other stakeholders. The current study takes a broad definition of corporate governance - the system and processes within and by which a corporation is owned, managed and control led. The importance of corporate governance has been widely recognised in prior studies. It is noted as being an important factor in firm value (La Porta & Lopez-de-Salanes, 1 999; La Porta, Lopez-de-Salanes, Shleifer, & Yishny, 2000) and an important control mechanism (Dechow, S loan, & Sweeney, 1 995) . In relation to government­ owned companies, many of which have commonly been regarded as natural monopol ies, comparison with simi lar companies to assess relative performance become difficult and this makes it easier for managers to pursue their own interests (Ernst, 2004). Therefore, with these l imited market mechanisms to control for managers' performance of government-owned companies, corporate governance becomes a very important control mechanism. As a control mechanism, four basic categories of individual corporate governance mechanisms outl ined by Jensen ( 1 993) include ( 1 ) legal and regulatory mechanisms, (2) internal control mechanisms, (3) external control mechanisms and ( 4) product market competition. The current study focuses on internal control mechanisms of corporate governance as unlike the others; these mechanisms are within the control of a company. "The i nternal governance structure of a firm consists of the functions and processes establ i shed to oversee and influence the actions of the firm's management" (Davidson, Goodwin, & Kent, 2004, p .244) . Thus, internal corporate 53 governance mechanisms must be strong enough to ensure better outcomes such as good performance, h igher firm value and higher financial report ing quality. 3 .4. 1 What Makes Strong or Weak Corporate Governance? A system of strong corporate governance al lows a board of d irectors to drive their companies forward without restraint while exercising thi s freedom within a framework of accountabi lity (Cadbury, 1 992) . It is aimed at treating the shareholders equal ly and preserving their rights (Darman, 2004). In other words, strong corporate governance means l ittle expropriation of corporate resources by managers or controll ing shareholders. Strong corporate governance goes beyond rules and regulations (Wieland, 2005) and is about ethics and values, which drive companies in the conduct of their business where directors, management, employees, accountants and auditors have to each p lay a role. S imi larly, M itchel l (2003) associated strong corporate governance with good manners: treating others the way one l ikes to be treated and taking responsibil ity for ones conduct and the consequences of ones behaviour. S imilarly, M itchell (2003 , p . l 4) considered weak corporate governance as "corporate rudeness", having a damaging impact on stakeholders, management, directors and other related parties. She claimed that the victims of weak corporate governance i nclude shareholders, directors and management. Shareholders, who (through their e lected directors) choose the executives leading the company whose shares they own, stand to lose on their equity investments. Directors, who are financially and personally responsible for the business conduct of the executives, lose when poor j udgements and the consequences of them surface . F inally, management itself ultimately pays for its rude behaviour through stock options that become worthless, lost employment for themselves, criminal prosecution or civil law suits, and private civil actions for damages. Indicators of weak corporate governance (as stated by Moody's I nvestors Service in Duffy, 2004) include: ( I ) an insider-dominated board of directors; (2) the presence of a "celebrity" CEO; (3) questionable board composition, including members with inadequate business experience or those who appear to be members due to political 54 or other influence; ( 4) risky pay schemes for top executives that could encourage short-term actions harmful to companies' creditors; ( 5 ) the absence of an i ndependent committee to nominate directors; (6) accounting restatements or indications the company is unusually aggressive in its accounting assumptions, i ndicating a lack of proper controls or effective director oversight; ( 7) evidence that the company' s audit committee is not firmly in charge of the relationship with the external auditor; (8) high director absenteeism or lack of attendance at key meetings, particularly those of the audit committee; (9) lack of reasonable director turnover, which may indicate the absence of fresh perspective on the board; ( I 0) an excessive number of takeover defences indicating an entrenched management and desire to protect the status quo; ( 1 1 ) no respect for shareholders' view by rejecting shareholder proxy requests; and ( 1 2) an incoherent ethics pol icy or one without a clear implementation plan. To summarise, strong corporate governance motivates managerial behaviour towards improving the business and directly controls the behaviour of managers to ensure that the rights of stakeholders are protected. Based on the indicators outl ined by Moody' s I nvestors Service cited in Duffy (2004) above, it can be summarised that strong or weak corporate governance is dependant on the internal mechanisms of corporate governance. The current study develops a corporate governance index to measure overal l corporate governance strength and relates it to pol itical influence, firm disclosure and earnings qual i ty, instead of using a particular corporate governance mechanism or a combination of several mechanisms as in the above studies. Prior studies that relate pol itical influence and corporate governance, disclosure quality or earnings qual ity, and corporate governance and disc losure qual ity or earnings qual ity are relevant to the current study. The next section provides a review of those studies. 55 3.5 PRIOR STUDIES ON POLITICAL INFLUENCE, CORPORATE GOVERNANCE AND FINANCIAL REPORTING QUALITY Prior studies have shown that pol itics can have an influence on corporate governance especial ly i n terms of board composition and/or the management appointment (for example Agrawal & Knoeber, 200 1 ; Chen, 2004; Fan et al . , 2007). Agrawal and Knoeber (200 1 ) found companies that have business rel ations with government tend to i nc lude outside directors with backgrounds in politics or have government representatives on their board. I f a company's board of d irectors consists of members who have polit ical influence, the company's CEO will also be someone with political connections (Fan et al . , 2007). Chen (2004) found that politics do influence the composition of management teams and board of directors. In the Malaysian context, Abdul Wahab, How and Verhoeven (2007) investigated the impact of the Malaysian Code on Corporate Governance. The results of the study showed that the corporate governance reform in Malaysia has been successful, with a significant improvement in governance practices. They also found that political connection has a significantly negative effect on corporate governance, which i s mitigated by institutional ownership. However, Abdul Wahab et al . ' s (2007) study classified pol i tically connected companies as those that had been associated with certain polit icians (as identified by other researchers) and companies that are under Khazanah Berhad (the government' s i nvestment company). The current study extends the operational definition of pol itical influence of Abdul Wahab et al ' s. (2007) study by including government ownership, not only by Khazanah Berhad but also other companies either l i sted or non-l isted with government ownership, the presence of politicians on the board of directors and the existence of a golden share as the proxies for political influence. Prior studies have found that political influence can arise through connection with individuals who have power in the government (Belkaoui, 2004; Faccio, 2006; F isman, 200 1 ; Johnson & Mitton, 2003; Leuz & Oberholzer-Gee, 2006), through state ownership of enterprises (Bushman, Piotroski et al . , 2004; Nee, Opper & Wong, 2007); the presence of politic ian/pol it icians on the board of directors (Faccio, 2006) and through golden (special) shares held by government (Hanousek, Kocenda, & 56 Svejnar, 2007; Jones, Megginson, Nash, & Netter, 1 999). Pol itical ties or connections between a company and politicians are difficult to identify because ( in reference to Malaysia), the t ies or connections are mostly informal and are not disclosed i n company annual reports. Although Gomez and Jomo ( 1 997) released a l i st of companies with pol itical ties or connections in Malaysia, the l ist is outdated because the pol iticians referred to are no longer in positions of pol itical power i n the government. In relation to financial reporting quality, Leuz and Oberholzer-Gee (2006) and Bushman, P iotroski et al . (2004) empirically found that political influence is negatively related to disc losure. Leuz and Oberholzer-Gee (2006) examined the relationship between political connections and corporate transparency, finding that polit ical connection is negatively related to proxies for disclosure. Bushman et al . (2004a) also found that financial transparency is negatively related to political factors. In Bushman, Piotroski et al . ' s (2004) study financial transparency was referred to as the amount and timeliness of financial disclosure and one of the pol itical factors included in the study was direct political i nvolvement in terms of the extent of state or government ownership. In terms of earnings qual ity, pol itical influence is found as contributing to earnings opacity (Belkaoui, 2004), which indicates low qual ity of earnings. In addition, prior studies have documented several outcomes of the association between corporate governance mechanisms and both disclosure and earnings qual ity. Wright ( 1 996) found significant correlations between the composition of a company' s board of directors, financial reporting quality measured by the AIMR's rating and the existence of an SEC Accounting and Auditing Enforcement release against the company or its auditors. Prior studies have tended to focus on specific corporate governance mechanisms and the extent of specific information disclosure that indicates the disclosure quality. Leftwich, Watts and Z immerman ( 1 98 1 ) compared the proportion of independent directors to interim reporting disclosure and found a significant positive relationship. Chen and Jaggi (2000) used the same corporate governance mechanism but related it to the extent of voluntary and mandatory disclosure . They found a significant positive relationship, in that the h igher the proportion of independent directors, the higher the extent of disclosure. 5 7 While the above studies focused on the proportion of i ndependent directors, Mi l l stein ( 1 992) focused on the existence of dominant personali ties on the board and related it to the extent of share option disclosure and found a s ignificant negative association between the variables. In addition, it is argued that a company may have higher disclosure qual ity if its auditor is one of the big firm auditors (Mitton, 2002), as these audit firms have been associated in previous research with h igher quality auditing (DeAngelo, 1 98 1 ; Reed, Trombley, & Dhal iwal, 2000). The type of auditor used has also been c lassified as a corporate governance mechanism. The structure of the audit committee as a corporate governance mechanism has also been related to disclosure quality. For example, Carcel lo and Neal (2003) found that audit committee independence is positively related to the extent of disclosure of financial statement notes and Management Discussion and Analysis (MD&A) in annual reports. There are also studies that have used more than one corporate governance mechanism and related them to disclosure quality . Forker ( 1 992) looked at the relationship between the proportion of independent directors, the existence of dominant personal ities and the existence of an audit committee with the extent of share option disclosure. Except for the existence of dominant personal ities, the other two attributes show a significant and positive relationship with share option disclosure. Ho and Wong (200 1 b) related four corporate governance mechanisms to the extent of voluntary disclosure. The mechanisms are the proportion of independent directors to the total number of directors on the board, the existence of an audit committee, the existence of dominant personal ities and the percentage of fami ly members on the board. They found a significant and positive relationship for the existence of an audit committee as wel l as a significant and negative relationship for the existence of dominant personalities. However, the relationship between the other two attributes and the extent of voluntary disclosure is not significant. In the Malaysian context, Haniffa and Cooke (2002) related two corporate governance mechanisms (a chairman who i s a non-executive director and domination of fami ly members on boards) and culture (race and education) to the extent of 58 voluntary disclosure. They found a significant association between the corporate governance mechanisms and the extent of disclosure. A significant association was also found between one cultural factor (proportion of Malay directors on the board) and the extent of disclosure. Gul and Leung (2004) examined the l ink between CEO duali ty and the proportion of expert outside directors on the board (as corporate governance mechanisms) and the l evel of voluntary disclosure. Their results showed that CEO duality is associated with lower levels of voluntary disclosure. However, they also found the association is moderated by the expertise of non-executive directors, in that the negative association between CEO dual ity and the level of disc losure is weaker for firms with a higher proportion of expert outside directors on the board. Whi le the above review focused on studies that examine the relationship between corporate governance and disc losure quality, a review of studies that relate corporate governance and earnings quali ty is also carried out. Chtourou, Bedard and Courteau (2004) investigated whether a company' s corporate governance has an effect on earnings quality proxied by the extent of earnings management. Specifically, this study examined the relationship between audit committees and the board of directors' characteristics and the extent of corporate earnings management. The study concluded that effective boards and audit committees constrain earnings management activities and thus increase its earnings qual ity. Looking at a broader aspect of audit committee, Saleh, Iskandar and Rahmat (2007) used Malaysian data to i nvestigate the relationship between audit committee characteristics and earnings management (another indicator of earnings quality). The characteristics used in Saleh et al . ' s (2007) study included the independence of members, frequency of meeting and knowledge of the members. Their study found that each of these variables reduces earnings management practices, which indicates higher earnings quality. 59 Dechow, S loan and Sweeney ( 1 996) i nvestigated the impact of board of directors on financial statement fraud. The greater the fraud, the greater the negative impact on earnings qual ity. They found that companies manipulating their earnings through al leged violations of generally accepted accounting principles were more l ikely to have board of directors dominated by management. Similarly, Sharma (2004) found that as the percentage of independent director increases, the l ikel ihood of fraud decreases. Both studies suggest that less independent board members are l ikely to be associated with poor qual ity of earnings as the result of accounting fraud. Other studies have analysed the association between characteristics of board members and earnings qual ity ( indicated by earnings management). These studies include Peasnel l , Pope and Young (2005), which revealed that the l ikel ihood of managers making income-increasing abnormal accruals is negatively related to the proportion of outside board members. In the Malaysian context, Abdul Rahman and Mohamed Al i (2006) investigated board characteristics - board independence, board member tenure, CEO dual ity and board size - and related them to earnings management. They found that earnings qual i ty as indicated by earnings management is positively related to board size but found no significant evidence between board independence, audit committee independence, and earnings management. How the system of independent directors influenced the earnmgs conservatism, another proxy of earnings quality was analysed in a recent study by Chen, Zeng and Tan (2008). They looked at four dimensions : percentage of independent directors within the board of directors, professional capacities, stimulations and work conditions. Their results showed that the more powerful the independent directors, the better the accounting conservatism (thus the better the earnings quality). The above reviewed studies in relation to corporate governance have shown the relationship between an individual corporate governance mechanism or a combination of several corporate governance mechanisms and the quality of specific disclosure (mostly in terms of voluntary disc losure) in annual reports. Only a few studies (for example, Cheung, J iang, L impaphayom, & Lu, 2008; Shen & Chih, 60 2007) have used an aggregate level of corporate governance strength measured by using a corporate governance index. Cheung et al . (2008) developed and appl ied a corporate governance i ndex to measure the overall quality of corporate governance and disclosure practices of the ten largest Chinese l isted firms. Shen and Chih (2007) used a corporate governance index to determine good (strong) or poor (weak) corporate governance. They examined the rel ationship between the strength of corporate governance and the extent of earnings management and concluded that companies with good corporate governance ( indicated by a higher score on the corporate governance index) constrain earnings management and thus increase the earnings qual ity. Supporting this conclusion, Lara, Osma and Penalva (2007) also found that companies with stronger corporate governance exhibit a higher degree of earn ings quality ( indicated by a higher degree of accounting conservatism). 1 4 The current study fol lows these studies by using a corporate governance index in determining the strength of corporate governance . The current study controlled various company characteristics (size, age, leverage, l isting status and i ndustry) in examining the relationship between the key variables. S ize has been documented in past studies to have a significant positive associat ion with corporate governance quality (Nam & Nam, 2005). Size has also been found to be positively associated with the existence of an audit committee, with board independence and with the use of internal audit (Goodwin & Kent, 2006b). Larger companies face a greater information demand from financial analysts (Lang & Lundholm, 1 993 ) and a positive association between size and disclosure has been found in past studies such as those carried out by Hossain, Tan and A dams ( 1 994 ), F irth ( 1 979) and Cahan, Rahman and Perera (2005) . Higher earnings quality has also been found in larger firms (Sanchez & Garcia, 2007). The reason for including age as a control variable is that older companies might have more valuable pol i tical influence or connections (Leuz & Oberholzer-Gee, 2006) . In relation to leverage as a control variable, companies with high leverage wil l have increased reporting quality as the higher the leverage level, the higher the demand for qual ity reporting (Craswell & Taylor, 1 992). Leverage has been found to be positively associated with financial reporting quality (Ab Manan & Mohd I skandar, 2003 ) and with corporate 1 4 Beekes, Pope and Young (2004) relate earnings conservat ism to accounting qual i ty. 6 1 governance (Harford, L i , & Zhao, 2008) . Listing status has been associated with d isclosure level (Ahmed & Courtis, 1 999). Speci fical ly focused on cross l i st ing status, Charitou, Louca and Panayides (2007) found that cross listing was positively associated with corporate governance. Furthermore, type of i ndustry has been shown to have effect on disclosure level (Cooke, 1 989). The review of prior studies indicates that there has been no study (to date) that relates pol itical influence, corporate governance and financial reporting quality in a single study. This provides an opportunity to carry out the current study by addressing the fol lowing questions: 1 . What is the extent of financial reporting quality ( in terms of disclosure and earnings quality), and corporate governance strength of Malaysian companies? 2. What is the relationship between pol itical influence and financial reporting quality? 3 . What is the relationship between political influence and corporate governance strength? 4 . What is the relationship between corporate governance strength and financial reporting quality, after control l ing for political influence? 5 . Does corporate governance strength mediate the relationship between pol it ical influence and financial reporting quality? Overall , the reviewed studies have provided a theoretical framework within which to relate pol itical influence, corporate governance strength and disclosure qual ity or earnings quality . The expectations of the relationships are stated in research hypotheses that are developed and discussed in the next chapter. 62 3.6 CHAPTER SUMMARY This chapter has reviewed prior studies that have provided an understanding of the concepts of pol itical influence, disclosure quality, earnings qual ity, and strong and weak corporate governance. The occurrence of political influence in a company has been recognised in prior studies through ( 1 ) pol itical ties or connections between the company and pol iticians or individuals with political power in the government; (2) the presence of pol itician/politicians on the board of directors; (3 ) government share ownership of the company and (4) golden ( special) shares held by government. The current study employs the last three as proxies for pol itical influence. As prior studies refer to financial reporting quality mainly as disclosure and earnings quality, the current research takes up these two as the proxies for financial reporting quality. In relation to corporate governance, since internal corporate governance mechanisms play an important role in ensuring compl iance with mandated reporting requirements and maintaining the credibi l ity of a firm's financial statements (Dechow et al . , 1 995), the overal l strength of internal mechanisms of corporate governance is the concern of the current study and its relation to pol itical influence and financial reporting qual ity is analysed. The next chapter provides a discussion on the expectation of the relationships that involve the three test variables - political influence, corporate governance strength and financi al reporting quality and how the hypotheses of the relationships between the variables are developed. 63 4.0 INTRODUCTION CHAPTER FOUR HYPOTHESES DEVELOPMENT The prev10us chapter provided a theoretical framework within which to develop research hypotheses. This chapter describes the development of the research hypotheses predicting the relationships between pol itical infl uence, corporate governance and financial reporting quality. Fol lowing the introduction section, thi s chapter has three main sections: Section 4 . 1 describes the framework of the study based on the theoretical framework discussed in the previous chapter. Section 4.2 covers the development of hypotheses and is divided i nto four sub-sections related to four research hypotheses. Section 4.3 provides a summary of the chapter. 4.1 THE STUDY FRAMEWORK This study argues that pol it ical influence can occur through government ownership, government holding of a golden share and the presence of politic ian/s on board of directors. In this regard, the study examines pol i tical influence in Malaysian companies. These companies include those where the government has share and/or golden share ownership and polit ician/s on the board, non government-owned companies but with pol it icians appointed on the board, and other private companies. It i s argued in the study that the government has influence on and/ or control over a company through the ownership of shares or a golden share in i t and through pol it icians appointed by the government as its representatives on the company board. Pol itical i nfluence can also occur in a non government-owned company with the presence of politicians on the board of directors. 64 Within the framework of agency theory discussed in the prevwus chapter, it is argued in the current study that in the government-owned companies, agency conflict can occur between ( 1 ) the government (the principal and also the agent of the people) and the managers (the agents); (2) the government (the principal) and the politic ian as the government' s representative on the board (the agent) 1 5 ; (3) pol it ician (the principal) and the managers (the agents); and (4) the managers (the agents) and other shareholders (the principals). Government can have a direct influence on or control over its owned companies by imposing its pol i c ies, rules and regulations in order to achieve national and pol itical agendas. The actions of the manager that have been influenced by the government may confl ict with the manager' s economic interest. In addition, the government can monitor or have control over managers' actions and dec i sions by appointing pol itic ians as its representatives on the board. A politician is a true agent for the government when he/she is acting in the government' s interest. On the other hand, a pol itic ian as the government's representative can also use his/her political power to influence the managers in his/her personal interests. These personal interests may contradict the government's pol icies and/or the managers' economic obj ectives. The study argues that the influence of politicians on the board can also occur in a company which is not owned or controlled by the government but which has appointed a politic ian to its board to create l inkage with the government. The l inkage, as discussed in the previous chapter, can secure benefits from the government. In some situations, politicians may use bribes in terms of subsidies to infl uence managers to act in their personal interests (Shleifer and Vishny, 1 994). The interests may contradict with those of the managers to maximise other shareholders' interests. Therefore, i t is expected that there is a l ink between pol itical influence and the outcomes of the managers' actions and decisions. In this study, pol itical influence is proxied by government ownership, the existence of a golden share, and the presence of polit ician/s on the board, and the outcomes in terms of both corporate governance 1 5 Pol it ic ian control is viewed as a form of agency problem because pol it ic ians enjoy the control rights but are not the residual c la imants, and thus can be viewed as agents of the cit izens too (Ba i & Wang, 1 998). 65 strength and financial report ing quality (both disclosure quality and earnings qual ity) are examined. The findings of prior studies, as discussed in the previOus chapter, i ndicate that political i nfluence negatively affects financial reporting quality and corporate governance. However, almost every study reviewed l imits pol itical influence to a particular measure, most of them using pol itical connection and government or state ownership. The current study considers three measures of pol itical influence simultaneously - government ownership, pol itical connection through the presence of pol itician/s on the board, and the existence of a special (golden) share held by the government. In relation to financial reporting quality, the current study tests both the main proxies for financial reporting qual ity - disclosure quality and earnings qual ity. In respect of corporate governance, most of the pnor studies examme certain corporate governance mechanisms, and indicate that certain corporate governance mechanisms (such as an effective board and I or audit committee) have done an effective j ob of monitoring which then resulted in enhanced financial reporting. Only a few research studies incorporate various corporate governance mechanisms to represent the strength of corporate governance as a whole. The current study extends prior studies by incorporating various mechanisms in an index, in order to determine corporate governance strength and then relates this to financial reporting qual ity . Further, the current study extends prior studies by examining the mediating effect of corporate governance on the relationship between political influence and financial reporting qual ity. The results of most of the prior studies are based on l isted companies in developed countries, especially in the United States, which might not represent unique characteristics of companies in developing countries and emerging markets. Whether political influence provides the same effect on corporate governance and financial reporting quality in the setting of developing countries and emerging markets has not been thoroughly examined. Figure 4 . 1 summanses the framework of the study. The relationship between political influence, corporate governance strength and financial reporting qual ity is examined to achieve the fol lowing four relevant research obj ectives : 66 1 . To examine the direct effect of political influence on financial reporting quality. 2 . To examine the direct effect of political influence on corporate governance strength. 3 . To examine the effect o f corporate governance strength on financial reporting quality after contro l l ing for pol itical influence. 4 . To examine the mediating effect of corporate governance on the relationship between pol itical influence and financi al reporting quality. As shown in Figure 4. 1 , pol itical influence is proxied by three attributes -the percentage of government ownership, the existence of a golden share held by the govenunent ( indicator variable) and the presence of pol itician/s on the board ( indicator variable). Corporate governance strength is measured by a total score from company annual report as per corporate governance index. Two attributes are used for financial reporting qual ity - earnings qual ity (accrual quality derived from the regression of the modified Dechow & Dichev (2002) model) and disclosure qual ity (measured by a total disc losure score from company financial report as per a disclosure i ndex). The expected l inks between the three variables (political influence, corporate governance strength and financial reporting quali ty) as model led in Figure 4.2 become the framework used to develop the hypotheses of this study. 67 Figure 4. 1 The Study Framework Percentage of government ownership Golden share to �' ' ' ' ' ' ' government �- - - - - - - - - - - - - ( indicator variable) , , Politician on BOD 1 , ' ( indicator variable) �/ Key: BOD : Board of directors Pol itical influence CG : Corporate governance H2 H l , H4 l CG strength H3 Financial ....... reporting quality • = Earn ings qual ity : accrual 1f quality; / modified / Dechow & / Dichev (2002) ' ' Disc losure \ I quality index � 68 Figure 4.2 Expected Links between Political Influence, Corporate Governance Strength and Financial Reporting Quality Hl, H4 Pol it ica l Corporate governance Financ ial I nfl uence strength reporting qual ity H2 H3 Hypothesis one tests a direct relationship between pol itical influence and financial reporting qual ity. Hypothesi s two tests a direct relationship between political influence and corporate governance strength. After control l ing for political influence, hypothesis three tests the relationship between corporate governance strength and financial reporting qual ity. F inal ly, hypothesis four tests the mediating effect of corporate governance strength on the relationship between political influence and financial reporting quality. The development of the hypotheses is discussed in the fol lowing section. 4.2 HYPOTHESES DEVELOPMENT 4.2 . 1 Political Influence and Financial Reporting Quality Within the framework of agency theory, severe agency problems may occur when there is government influence in a company and/or pol itic ians as board members. I n addition to the usual agency problems, political pressures can induce managers to move away from profit-maximising goals (Roe, 2003). The accounting systems of a firm can also be seriously affected when there exist such pol it ical influences. Government or politicians can influence managers to report selective information and to present the arumal reports in their best interests (Zimmerman, 1 977). Agency problems may also lead to the issuance of substandard financial information (Chung et al . , 2005 ; Richardson, 2006) or may result in the amount of accounting information that is disclosed being reduced (Rodriguez et al . , 2007) . In this regard, 69 Belkaoui (2004, p.6) points out that "principal-agent conflict suggests that the firm's i nsiders are more i ncl ined to mask firm performance to minimize outsiders' and/or l egal intervention and/or to present a financial picture that can be deemed as financial ly attractive by outsiders" - the activities which Belkaoui (2004) refers to as earnings opacity, which indicates a low quality of earnings. In another study, agency problems may negatively affect the credibi l ity of earnings due to manipulation by controll ing owners (Fan & Wong, 2002) . The low credibil i ty of earnings can imply a low earnings qual ity and the control l ing owners in the current study include the government through a concentrated ownership. The concentrated ownership structure and dominance of control-oriented shareholders have a negative impact on transparency and disclosure (Zhuang, 1 999a). If ownership is concentrated in government, the demand for disclosure is less . This is consistent with Kothari (200 1 ), who states that the demand for high­ qual ity financial i nformation is reduced because the stakeholders and management resolve much of the information asymmetry when corporations have concentrated ownership (Kothari, 200 1 ). Lack of demand for disclosure, coupled with weak enforcement, suggests that the qual ity of financial disclosure wi l l be poor. In addition, according to Kothari (200 1 ) , financial statement numbers in such corporations are l ikely to be influenced by the payout preferences of the agents for labour, capital and government, which can be met in part by earnings management. This suggests that corporations with concentrated government ownership have a tendency to produce low-qual ity financial reporting. Empirical studies have found that political infl uence i s negatively related to financial reporting quality (Aggarwal, 1 999; Belkaoui 2004; Bushman & P iotroski 2006; Bushman, Piotroski et al . 2004; Kothari 200 1 ; Leuz & Oberholzer-Gee 2006). Bushman, Piotroski et al . (2004) found low financial disclosure in companies with pol itical influence. Kothari (200 1 ) suggested an increase in earnings smoothing and earnings management in companies which are exposed to pol itical influence and Belkaoui (2004) related political influence to earnings opacity, which indicates low earnings qual ity. 70 Therefore, i t i s expected that political influence would negatively affect financial reporting quality and the relationship i s hypothesised as fol lows (stated in the alternative form against a null of no effect) : H l : Pol itical influence is associated with lower financial reporting quality 4.2.2 Political Influence and Corporate Governance Strength Within the framework of agency theory, corporate governance provisions appear as a result of the agency conflict between the different parties of a company. Because of the d ifferences between the i nterests and i ncentives of managers, shareholders and other resource providers, corporate governance mechanisms are put i n place to reduce agency problems. Agency theory suggests that agency problems can be reduced by separating management and the control aspects of decision-making (Beasley, 1 996; Fama & Jensen, 1 983a, 1 983b) . In this regard, the board of directors, in terms of its size and composition, is recognised as being the most important internal protection against i ssues arising from agency conflict (Fama & Jensen, 1 983a, 1 983b; Singh & Davidson, 2003) . Spec ifically, corporate governance i s designed to monitor management' s behaviour (Botica-Redmayne, 2004) as wel l as to monitor and determine a company' s overal l information d isclosure policy (Lopes & Rodrigues, 2007). The role of governance mechanisms i n determining di sclosure policy may be either complementary or substitutive (Ho & Wong, 200 1 a) . It is complementary when the adoption of governance mechanisms strengthens the i nternal control of a company and prevents managers from withholding information for their own benefit. This leads to an improvement in disclosure comprehensiveness and in the quality of financial information. I t is substitutive when governance mechanisms reduce information asymmetry and opportuni stic behaviours in a company, resulting in a decrease in the need for more monitoring and disclosure. If corporate governance structure is weak, management' s behav iour cannot be properly monitored and may result in unfavourable outcomes. Previous studies have provided evidence that poor governance is associated with the consequences of 7 1 management ' s misbehaviour, such as earnings manipulation (for example, Dechow et a l . , 1 996), financial statement fraud (for example, Beasley, 1 996) and low quality of financial reporting (Wright, 1 996). Thi s implies that the strength of corporate governance may affect the outcomes of management behaviour such as the quality of financial information and reporting. The stronger the corporate governance mechanism, the more effective its monitoring function in reducing unfavourable outcomes is . H igher government ownership tends to be closely related to more political control (Xu, Zhu, & L in, 2005) . Having government or pol itical control over a company indicates political influence on a company's major economic decis ions and in appointing a board of directors and management. As d iscussed in the l iterature rev iew, prior studies have confirmed this relationship (Agrawal & Knoeber, 200 1 ; Fan et al . , 2007). Fan et al . (2007) found that pol itically connected companies are l ikely to appoint more bureaucrats to the management team and board of directors and fewer directors with professional backgrounds or prior business experience. This may influence the strength of the company' s governance. Political power or control is exercised over a firm not only through the appointment of the board of d irectors and management, but also through control l ing its board in selecting auditors (Wang, Wong, & Xia, 2008) . In addition, government influence or interference has been found to weaken the governance of a company (ADB, 1 998; Nee et al., 2007). If a government has control over a company, the government may influence the company' s governance systems to achieve political obj ectives rather than optimal economic performance . Overall , with political influence, the strength of corporate governance may be reduced. Within this framework, the fol lowing relationship IS hypothesised (stated in the alternative form against a null of no effect) : H2: Political influence is associated with weaker corporate governance 72 4.2.3 Corporate Governance and Financial Reporting Quality One purpose of corporate governance is to mitigate agency costs by improving the quality of financial reporting. Prior studies have documented l inks between internal governance mechanisms and financial reporting qual ity, measured in terms either of the quality of disclosure or of the qual ity of earnings. Associations have been found between disclosure quality and board characteristics : the proportion of independent board members (Chen & Jaggi, 2000; Leftwich et a l . , 1 98 1 ), the existence of an audit committee (Ho & Wong, 200 1 a), the existence of dominant personalities on the board (Forker, 1 992), and the expertise and independence of the audit committee (Bedard et al . , 2004). Other studies also show l inks between disclosure quality and governance mechanisms (Claessens & Fan, 2002; Haniffa & Cooke, 2002; Wright, 1 996). Earnings management has been found to be associated with board competency, board size, audit committee independence, frequency of audit committee meetings and the existence of financial experts on the audit committee (Chtourou et al . , 2004). I ndependent boards of directors and audit committees have been found to control earnings aggressiveness (Beasley, 1 996; Klein, 2002 ; Peasnel l et al . , 2005). Effective boards are also positively related to earnings accuracy (Aj inkya, Bhoj raj , & Sengupta, 2005 ; Karamanou & Vafeas, 2005), earnings informativeness (Vafeas, 2000) and earnings credibil i ty (Fan & Wong, 2002; Francis, LaFond et al . , 2005) . Shen and Chih (2007) used an index to measure the strength of corporate governance and concluded that companies with good corporate governance constrain earnings management and thus increase earnings quality. Lara et al . (2007) found that companies with stronger corporate governance report more conservative earnings. In general , pnor studies have found that the characteristics of weak corporate governance structure such as the existent of dominant personal ities, a lower proportion of independent directors, the non-existence of audit committees, and the non-independence of audit committees are associated with low financial reporting qual ity. The evidence suggests that weak corporate governance reduces financial 73 reporting quality even when the effects of political influence are absent. Accordingly, the current study hypothesises the same relationship when pol itical influence is present but controlled for (stated in the alternative form against a null of no effect) : H3: After control l ing for political influence, weak corporate governance ts associated with low financial reporting qual ity. 4.2.4 Mediating Role of Corporate Governance on Political Influence - Financial Reporting Quality Relationship The presence of a dominant shareholder, such as the government, in a company has been argued to have a negative influence on the qual ity of corporate communicat ion, by using the company ' s financial reporting system to benefit the dominant shareholder (Melis, 2004). When the owner of a company is part of management, they may have a personal interest in the information disclosed and incentives to manage the disclosures (Ball , 200 1 ) . This creates a moral hazard and information asymmetry between the owner and outside investors; and when the owner' s holding in a company increases and governance mechanisms of the company are weak then monitoring wi l l be more difficult to perform (Morck, Shleifer, & Vishny, 1 988) . Prior studies do not relate the two variables - political influence and corporate governance - with financial reporting qual ity. However, it has been shown in past studies that pol itical influence leads to weak corporate governance (for example, Bushman, P iotroski et al . , 2004; Leuz & Oberholzer-Gee, 2006) and weak corporate governance contributes to low financial reporting qual ity (Wright, 1 996; Shen & Chih, 2007; Lara et al . , 2007). Within the agency theory framework, the existence of pol itical influence causes severe agency confl icts and problems and the problems would negatively affect the outcomes of the managers' decisions. Corporate governance, which supposedly acts as a control mechanism, could not perform as expected because the political influence could lead to the weak governance structure that best accommodates the interests of the government or politicians. Specifical ly , political influence, either in terms of direct influence from government or influence from pol iticians as board 74 members, has been found to weaken the governance of a company (Nee et al . , 2007; Wang et al . , 2008). I t is therefore expected that when there is political influence on corporate governance, the corporate governance strength wi l l be weaker and the q uality of financial reporting as a whole will be reduced. Therefore, it is expected that political i nfluence will negatively affect corporate governance strength and wil l together affect financial reporting quality. Therefore corporate governance strength mediates the political influence-financial reporting quality relationship. This expectation helps develop the fol lowing hypothesis (stated in the alternative form against a null of no effect): H4: Corporate governance mediates the relationship between political influence and financial reporting quality. 4.3 CHAPTER SUMMARY This chapter has discussed the framework of the study based on agency theory, and the concepts and measurement of pol itical influence, corporate governance strength and financial reporting quality provided in the previous chapter. Agency theory provides a framework l ink ing pol itical influence, corporate governance and financial reporting quality to develop the hypotheses. It is first hypothesised that political influence is associated with lower financial reporting quality, and it i s then hypothesised that pol itical influence i s associated with weaker corporate governance. Further, it is hypothesised that after control l ing for political influence, weak corporate governance is associated with low financial reporting qual i ty. Final ly, it is hypothesised that corporate governance mediates the relationship between politi cal influence and financial reporting quality . The next chapter describes the analysis employed in testing the hypotheses, including the dependent, independent and control variables. 75 5.0 INTRODUCTION CHAPTER FIVE RESEARCH DESIGN This chapter outl ines the research methods employed in the current study. Fol lowing the i ntroduction section, Section 5 . 1 presents a discussion on the mixed-method design used in thi s study. Section 5 .2 discusses the sample and data collection. The measurement and measures of variables involved are discussed in Section 5 . 3 . Section 5 .4 discusses the data analysis which covers both quantitative and qual i tative analyses. F inally, Section 5 .5 provides a summary of the chapter. 5. 1 M IXED-METHOD DESIGN In an effort to shed l ight on the relationship between political influence, corporate governance and financial reporting quality, a mixed-method design was deemed appropriate for meeting the aim and objectives of the current study. A mixed-method design is defined as "the collection or analysis of both quantitative and qualitative data in a single study in which the data are collected concurrently or sequential ly, are given a priority, and involve the integration of the data at one or more stages in the process of research" (Creswell , P iano Clark, Gutmann & Hanson, 2003 , p .2 1 2) . Within this design, quantitative and qual itative methods are combined and the results from one method can be used to elaborate on results from the other method (complementarily) and to help develop or i nform the other method (development) ( Hanson, P iano Clark, Petska, & Creswell , 2005) . According to the researchers, the combination of the two methods can also recast results from one method to those from the other method ( initiation) and extend the inquiry range by using different methods for different inquiry components (expansion). In the current study, the rat ionale for using the mixed-method design i s "complementaril y", in that the results from qualitative method were used to elaborate on the results from quantitative method. 76 In a m ixed-method design, data i s collected either concurrently or sequential ly . According to Creswel l (2003) , i n a sequential procedure, both quantitative and qual itative data are collected in phases (sequential ly) . I n this procedure, e ither the quantitative or qual itative data may come first, depending on the purpose of the research . It is called "sequential explanatory design" when the quantitative data collection and analysis are carried out first, to be fol lowed by that of the qual itative data. I n this regard, the qualitative results are used to help explain and interpret the findings of the quantitative method. If the qualitative data comes first, fol lowed by the quantitative data, it is called "sequential exploratory design". For thi s design, the primary focus is to explore phenomena of research through a qual itative approach. Another version of the sequential procedure is "sequential transformative design". In this design, either method may be employed first and be given equal or different priority. I n contrast with the other two strategies using a sequential procedure, sequential transformative design needs a theoretical perspective to guide the part icular study. 1 6 Whereas the above sequential-based procedures collect types of data sequentially, concurrent procedures gather quantitative and qualitative data at the same time - concurrently - during the data col lection phase. This procedure can be divided into three types - the "concurrent triangulation strategy", the "concurrent nested strategy" and the "concur ent transformative strategy" (Creswell , 2003 , p .2 1 6) . In the concurrent triangulation strategy, both quantitative and qualitative methods are employed simultaneously in order to confirm, cross-verify or support findings within a s ingle study (Greene, Caracel l i , & Graham, 1 989; Morgan, 1 998) . The priority may be equal between the two methods or may be given to either quantitative or qualitative method. When this strategy is uti l ised, the results of the two methods are integrated during the interpretation phase. With the concurrent nested strategy, one part icular method (either quantitative or qual itative) is embedded within the predominant method. The data collected from both methods are mixed when the data is analysed. Finally, the concurrent transformative strategy applies a speci fic theoretical perspective to guide the particular study. In order to faci l itate the 1 6 See Creswel l (2003, pp.2 1 5-2 1 6) for a detai led discussion on the three sequential strategies. 77 particular theoretical approach, either triangulation or a nested strategy may be used. 1 7 The current study employed the sequential explanatory design o f inquiry, where quantitative data were collected and analysed to test formal hypotheses and then qual itative interviews were conducted to provide further insights i nto the findings. Speci fically, companies' financial data and other published corporate data gathered from companies' annual reports and databases (quantitative data) were col lected and analysed, and the political factors that are associated with corporate governance and financial reporting quality were identified. In addition, insights gained from the i nterviews of a sample of companies' top management (qualitative data) were used to further examine the impact of pol itical influence on the economic decision-making process in a company. In this regard, priority or relative emphasis given to the two types of data would be unequal, in that the quantitative data as major component of · the study was emphasised more than the qualitative data. By employing this design, the two forms of data were analysed separately and an integration of the quantitative and qual itative results occurred in the discussion (Hanson et al . , 2005 ) . This sequential explanatory design i s appropriate to the current study as i t al lows explanation and i nterpretation to relationships and study findings to be made (Creswel l , 2003 ) , especial ly when unexpected results arise from a quantitative method (Hanson et al . , 2005 ) . The results from the interviews may serve confirmation (Denzin, 1 970) and completeness (J ick, 1 983 ) purposes. In the current study, the interviews serve a completeness function: the results from the quantitative method were elaborated on and enhanced by the results from the analysis of interview data. The strategy of inquiry employed in the current study is shown in F igure 5 . 1 . 1 7 See Creswe l l (2003, pp.2 1 7-2 1 9) for a detai led d iscussion on the three vers ions of the concurrent procedure. 78 Figure 5 . 1 The Current Study's Strategy of Inquiry Quantitative data collection (Companies' publ ished document) Qualitative data collection ( interviews) Quantitative data analysis Qualitative data analysis Hypothesis testing � Further insights The data collection and analysi s of both quantitative and qualitative methods are discussed in the sections that fol low. 5.2 SAMPLE SELECTION AND DATA COLLECTION As the current study involved both quantitative and qual itative methods, both types of data were gathered. In so doing, the selection of samples and data sources were determined for each method of data collection. 5.2. 1 Quantitative Data Collection The population for this study comprises non-financial Malaysian companies active during the period 1 999 - 2003 (See Appendix B for the l ist of companies used in the study). This period was chosen as it was an economical ly stable period after the financi al crisis of 1 997. Malaysia had introduced a disclosure-based regime to encourage transparency and accountabi l ity, and this regime was ful ly implemented in 200 1 . The five-year period covers both the time before and after this implementation. This enables an indirect look at the contribution of such a regime towards improvement of financial reporting quality and corporate governance in Malaysia. 79 F inancial institutions were excluded because they were subj ect to a regulatory framework that did not apply to other companies. 1 8 The sampl ing frame for l isted companies was the Bursa Malaysia (formerly known as the Kuala Lumpur Stock Exchange - KLSE) 1 9 l ist, and for non-l isted companies was the l i st of companies registered with the Companies Commission of Malaysia (CCM) . A sample of l isted companies was selected by stratified random sampling, with firms being randomly selected from each of the nine major industry sectors classified by the Bursa Malaysia. The stratified random sampl ing was used to ensure that d ifferent industries i n the population were adequately represented in the sample (Frankfort-Nachmias & Nachmias, 1 996). Of the total 757 companies l i sted on the Bursa Malaysia (as in 1 999), the appropriate sample size should be of about 25 1 companies or the ratio of 1 :3 (Neuman, 1 997). In the current study, a sample size of 256 l isted companies was drawn. The sampling from the different industries was done by applying a uniform sampl ing ratio (sample size/population size), in that the sample size drawn from each i ndustry was proportionate to the population size (Frankfort-Nachmias & Nachmias, 1 996, p . 1 88) . Having decided the number of companies needed for each industry, companies were randomly selected from each industry. Companies having insufficient data, being under special administrators, or having changed their accounting year-end were excluded. A sample of non-l isted companies was selected from companies registered with the CCM . Forty-three non-listed companies which were clearly classified under one of the Bursa Malaysia classifications of industry sectors and which had data available for the five-year period were purposively selected for analysis?0 The combined 1 8 The industry is greatly regulated under the Banking and Financ ial Act, 1 989. Among others, the act a l low financial institutions (Fls) to make portfo l io investments in non-financial bus iness up to a max imum of20 percent of a Fl 's shareholders' funds and up to 1 0 percent of the issued share capital of a company in which the investment is made. The Fls are not al lowed to assume any management rol e or take up a board position. 19 The Kuala Lumpur stock Exchance (KLSE) became a de-mutua l i sed exchange and was renamed Bursa Malaysia in Apri l 2004. 20 This was done for cost reasons: a fee is charged for each company record retrieved, with no assurance that the selected company w i l l have useable data. However, it was assumed that the selected non-l isted companies would represent the active compan ies during the period of study and cover the n ine industry c lass i fications. 80 sample comprised 299 companies (256 l isted and 43 non-l isted) with 1 495 company­ years of observations. The sample of l isted companies represented approximately 34 percent of the total companies l i sted on the exchange in 1 999. The number of selected compames ( l i sted and non- l isted) from the mne maJor industry sectors are as fol low: construction (26), property (39), consumer products (3 1 ), i ndustrial products (73 ), plantation (32), technology (7), i nfrastructure (7), hotels (7) and trading and services (77) . The main source of data for the l isted companies was Thomson DataStream. Also used were companies' annual reports2 1 , KLSE annual handbooks and the KLSE­ RIAM Information System. Data col lected from one source were verified by reference to other sources whenever possible. For non-l i sted companies, the data were hand-collected from copies of companies' annual reports acquired from the CCM. 5.2.2 Qualitative Data Collection For the qual itative data col lection through interviews, the selected interviewees were Chief Executive Officers (CEO), Managing Directors (MD), General Managers (GM) and Chairmen (or ex-CEO and ex-MD) of companies that were deemed to have pol itical influence (conceptualised in the study as companies with government ownership, politician/s on the board or a golden share held by the government). These individuals were chosen because they were considered to be the top management people and had been directly involved in the company' s decision­ making processes. They were the company' s substantive leader whose roles included the gathering and dissemination of information, decision-making and resource al location (Thomas & S imerly, 1 994), and cultivating organi sation culture to achieve business excel lence (Hardjono & Marrewijk, 200 1 ) . Ex-CEOs and ex-MDs were also included because their past experiences in governance and decision-making process was sti l l relevant. In addition, the ex-CEOs and ex-MDs were believed to have more freedom to express their views regarding political influence in the companies they 2 1 Compan ies' annual reports were accessed v i a http://www.k l se.eom.mv/website/bm/ or from the B ursa Malaysia L ibrary. 8 1 had previously headed. The interview subjects were from l isted and non-l isted companies from different industries. A convenience sampl ing method was used in the selection of the potential interviewees. They were chosen from those who were easy to access and agreed to partic ipate . Personal contacts were used in order to get their cooperation, which would otherwise have been difficult given the sensitive, political nature of the study subject. Thirty top management or ex-top management personnel were approached but six decl ined an i nterview. In total, the interviews involved twenty-four people from twenty-four companies. Face-to-face semi-structured interviews were employed in the current study in order to al low the interviewees to explain their thoughts and to highlight any areas of particular interest they had, as wel l as to enable certain responses to be explored in greater depth, for example, to bring out and resolve any apparent contradictions (Horton, Macve, & Struyven, 1 996). A semi-structured interview was preferred as it gave the researcher more control over the t iming, content and sequencing of questions. In addition, having the researcher as interviewer al lowed the improvisation of suitable fol low-up questions and the interviewees a degree of freedom to explain their views. Structured and unstructured interview approaches were not considered in the study. This is because in structured interviews, interviewees are not free to provide additional information and to express their thoughts. Unstructured interviews are unsuitable and impracticable because they can be time consuming and would not suit the time constraints of interviewees with busy working l ives. Although an unstructured interview may provide more interesting and expanded information, unfocused i nformation would not be helpful at the data analysis stage. As Cavana, Delahaye and Sekaran (200 I ) point out, un­ structured interviews can provide more interesting information but are very time consuming and can lose the focus on the research objectives. In the current study, open-ended and probing questions were used in the interviews, in addition to questions related to the interviewees' demographic characteristics (namely age, education, position in the company, number of years in the position, number of years in the company and other positions held in the last five years) (see Appendix C for the interview schedule used in the study). This information is 82 important because background and experience may influence the evaluation of the activities they were involved in (Wiersema & Bantel, 1 992). Additionally, age and education factors may influence the decision-making process as Mel lahi and Guermat (2004) found that younger executives are more receptive to new ideas compared to older executives and O'Neil l , Saunders and McCarthy ( 1 989) found that a person' s values, knowledge and ski l l -base are shaped by their educational background. For the open-ended questions, an interview guide was prepared and was fol lowed during the interview sessions. At the initial stage of the interview process, the interviewees were asked to describe their background and experience and their personal or company' s policy on voluntary disclosures. They were then asked about the importance of earnings predictions in addition to their methods for achieving such predictions. Towards the end of each interview, the issue of pol itical influence was raised and topics such as the respondent ' s understanding of political influence concepts and their views on polit ical influence in their company were included. These issues were saved unti l l ast because they were potential ly sensitive. This is consistent with the suggestion of Sudman and Brad bum ( 1 983 ) that riskier questions be asked later in the interview. Throughout the interviews, leading questions and pre-set agendas were avoided as much as possible . Instead, the respondents were asked to freely discuss the importance of pol itical influence in economic decision-making in their respective companies. Within this, decisions related to voluntary disclosure and reported earnings were spontaneously explored. These were then followed by clarifying questions on, for example, the relative importance of different groups in decisions involving voluntary disclosure and reported earnings. Al ien and Blythe (2004) stated that c larifying questions play a key role in clarifying discussion and provide specific information that the interviewer needs in order to enhance their own understanding. The interviews were recorded on tape (with the permission of the partic ipants - the participants were first informed that their answers would be recorded and they were assured of confidentiality) and were summarised in note-form. The notes were used 83 to recal l comments that were unclear on the tape. The interviews varied in length from forty-five to sixty minutes. 5.2.2. 1 Ethical Issues As the i nterviews involved investigation i nto the attitudes and bel iefs of human subjects, ethical issues were considered in relation to privacy and other rights of the subjects (Neuman, 2000). Prior to the interview data col lection, approval from the Massey University Human Ethics Committee: Southern B (reference : HEC: Southern B Appl ication - 06/33 ) was obtained. The approval was granted based on the considerations of any potential risks to the human subjects, the existence of procedures to obtain informed consent and to ensure privacy and confidential ity. During the i nterviews, i nformed consent was obtained by giving a brief description of the purpose and procedure of the study along with an information sheet that detai led the approach of the study. They were also informed that their partic ipation was completely voluntary and were assured of the confidentiality of their responses as the results of the study would be used only in aggregated form. This was done to ensure that there would not be any risk to the interviewees in their work place or to their personal environment. 5.3 MEASUREMENT AND MEASURES OF VARIABLES As the nature of the current study is mainly hypothesis testing, careful measurement of the variables related to these hypotheses is important (Cavana et al . , 200 1 ). The key variables used were disclosure qual ity and earnings quality (as dependent variables and proxies for financial reporting quality), percentage of government ownership, the existence of a golden share and the presence of pol itician/s on the board of directors (as independent variables and proxies for pol it ical influence), and corporate governance strength (as the dependent variable in one hypothesis and mediating variable in another hypothesis) . The measures of these and control variables are discussed in the sections that fol low. 84 5.3 . 1 Disclosure Quality As discussed in Chapter Three, most previous research used two proxies for companies' disclosure qual ity - self-constructed scores (such as Botosan, 1 997; Cooke, 1 989; Naser & Nuseibeh, 2003), and externally generated scores such as the Association of Investment Management Research (AIMR) scores and Standard and Poors ' s (S&P) scores (for example, Lang & Lundholm, 1 996; Patel, Balic, & Bwakira, 2002; Wright, 1 996). Ab Manan and Mohd Iskandar (2003 ) assessed disclosure qual ity using the c lassification of companies made by the NACRA22 committee, so their study was restricted to companies which entered the NACRA competition and were chosen for its selection process. S ince a broader set of companies was needed in the current study, a disclosure index using items selected from a combination of the NACRA criteria and S&P's financial information disclosure items was constructed. Whereas prior studies (for example, Wei, Hui, Cheng, & Wei , 2007; Chen, Chen, & Cheng, 2008) used S&P analysts' ratings as proxies of disclosure qual ity, the current study uses the S&P l ist only to identify items to include i n the disclosure index . Scoring the items directly from financial reports allows objective measurement, avoiding the subj ectivity inherent in analysts' j udgments (Khanna et al . , 2004). Moreover, Healy and Palepu (200 1 ) noted that self-constructed measures increase confidence as the index captures what it is intended to evaluate. In the same vein, Bushee (2004, p. 524) noted that "the biggest payoff to future researchers wi l l l ikely come to those who construct their own disclosure indexes"23 . Out of the ninety-eight disclosure items that constitute the S&P ' s index, only financial information items were involved as the current study focused on financial reporting qual ity, and not on overall corporate reporting qual i ty. The S&P disclosure index was chosen instead of other i ndices, such as those of the Center for Financial Analysis and Research (C IF AR) or the Association of Investment Management Research (AIMR), because 22 The National Annual Corporate Report Awards (NACRA) is organised by the Bursa Malaysia Berhad. the Malaysian Inst i tute of Accountants. the Malaysian I nsti tute of Management and the Malaysian Institute of Cert ified Public Accountants to promote the h ighest standards in corporate reporting ( Pushpanathan. 2007). The awards are based on criteria including t imely publication of annual reports. compliance with accounting standards and having an unquali fied audit report. 23 See Bushee (2004) for a d iscussion of posi t ive and negat i ve aspects of the di fferent types of d isclosure indexes. 85 when comparing the S&P d isclosure items with the other two disclosure indices, it was found that the S&P was more comprehensive and transparent. As Pate! et al . (2002) argued, the S&P has introduced a methodology to assess the level of transparency and disclosure along the dimensions of timely and adequate disclosure of financial information, among others. A lthough the S&P l ist constitutes a global benchmark (Pate! et al . , 2002), it is based on best practice in United States companies and may also be biased towards large companies (Franci s et al . , 2008a). Thus, i t was deemed better for the current study to add the NACRA criteria, which take into account the Malaysian business environment. The use of NACRA criteria is considered appropriate as the criteria were determined by Malaysian professional bodies and are widely recognised in Malaysia. However, basing assessment on only local requirements, such as this, may bias the disc losure . Therefore, in the current study, the NACRA criteria were combined with the thirty-five items of financial information disclosure from the S&P index to form a l ist of items used to assess disclosure qual ity. By combining the NACRA criteria and S&P' s financial i nformation disclosure items, the assessment of the financial reporting qual ity of the Malaysian companies' financial reports has taken into account both the local recognition of good qual ity financial reporting in an international context, as wel l as the common practice of financial reporting. The index includes both mandatory and voluntary items, as some of the items in the NACRA portion of the index are mandatory items (e.g. provision of balance sheet, income statement, cash flow statement, statement of changes in equity, consol idated statements, significant accounting pol icies and auditor' s report) . Although the sampled companies are expected to disc lose al l mandatory items, the assumption is not necessari ly true. This is due to inadequate regulatory framework and weak enforcement mechanism, especial ly in a developing country, l ike Malaysia (Ku Ismai l & Abdullah, 1 998; Ahmed & McNichol ls, 1 994). An initial examination on the disclosure of two of the mandatory items from the NACRA portion ("a signed audit report" and "a signed statement by the directors stating their views on the financial statements") revealed that 64% ( in 1 999) and 4 7% (in 2003) of the total 256 l i sted companies in the sample did not present "a signed audit report", and 64% (in 1 999) and 48% (in 2003) did not present "a signed statement by the directors stating their views on the financial statements". This indicates that even a l i sted 86 company which is expected to disclose all mandatory items fai ls to do so because of the country' s weak enforcement mechanism. Therefore, the inclusion of mandatory items i n the i ndex in determining d isclosure quality i s relevant for the current study. An unweighted index was employed in the current study because prior studies employing both weighted and unweighted indices have reported identical results (Chow & Wong-Boren, 1 987; Naser & Nuseibeh, 2003 ; Wallace & Naser, 1 995) . This type of index employs a dichotomous procedure in that a score of I was given to each disclosed item and 0 otherwise. The study' s d isclosure index score is simply a count of items disclosed divided by the number of items appl icable to each particular company. This avoids penalising companies for non-disclosure of irrelevant items (Ferguson, Lam, & Lee, 2002; Wallace & Naser, 1 995) . The disclosure index developed and used in the current study is shown in Table 5 . 1 . Some of the index items appear to be very simi lar (e.g. item 1 2 from the NACRA portion and items 1 6 and 1 7 from the S&P portion). However, the items were retained and included i n both NACRA and S&P portions because it was thought that the NACRA criteria was very general while the S&P criteria could provide detai led description or discussion. This means that if an item appears in both portions, NACRA and S&P, it is more widely seen as essential and the item is scored more than once indicating greater weight is given to that particular item. 87 Table 5. 1 : Disclosure I ndex No ,,,,, �! NaCRA Fi�ancial R�,poftihg ���uty;friteria. w y � I Does the company provide a summary of results covering at least three years' performance? 2 Does the company provide a summary of share prices for at least three years? 3 Does the company provide a summary of earni ngs per share for at least three years? 4 Does the company provide a summary of dividends per share for at least three years? 5 Does the company provide a summary of shareho lder stat ist ics for at least three years? Review of operations: 6 I s there a d iscussion of the organisat ion 's principal activities and results for the year? 7 Does the company provide an indication of earn i ngs trends and prospects? F inancial statements shou ld comprise: 8 A balance sheet. 9 An i ncome statement. 1 0 A statement of changes i n equ i ty or a statement of recogn ised gains and losses. 1 1 A cash flow statement. 1 2 Sign ificant accounting po l icies. 1 3 Disclosure of comparative figures covering at l east the last financial year. 1 4 Cross-references between the statements and notes. 1 5 A s igned statement by the directors stating thei r views on the financial statements. 1 6 A signed audit report. Additional disc losures beyond the statutory requirements 1 7 Analysis of major expenses (e.g. raw materials, labour cost, R&D expend iture). 1 8 Deta i l s of short-term debt financing arrangements and fac i l i t ies. 1 9 Deta i l s of long term debt financing arrangements and fac i l it ies. 20 Disc losure of the estimated fair value or replacement market value of major assets. Total S&P's No Business focus I I s there a discussion of corporate strategy? 2 Does the company report detai ls the kind of business it is in? .., Does the company give an overview of trends in its industry? .) 4 Does the company report detai ls of the products or services produced/provided? 5 Does the company provide a segment analysis, broken down by business l i ne? 6 Does the company disc lose its market share for any or a l l of its business? 7 Does the company report basic earnings forecast of any k ind? I n detai l? (Two items) 8 Does the company disc lose output in physical terms? 88 Table 5 . 1 : Continue . . . N o Business focus 9 Does the company give an output forecast of any kind? 1 0 Does the company give characteristics of assets employed? 1 1 Does the company provide effic iency indicators (ROA, ROE, etc.)? 1 2 Does the company provide any industry-specific ratios? 1 3 Does the company d isclose its p lans for investment i n the comi ng years? 1 4 Does the company d isclose detai ls of its investment plans i n the coming years? Acco u n t ing policy review 1 5 Does the company provide financial information on a quarterly basis? 1 6 Does the company d iscuss its accounting pol icy? 1 7 Does the company d isclose the accounting standards it uses for its accounts? 1 8 Does the company provide accounts according to the local accounting standards? 1 9 Does the company provide each of the balance sheet, income statement, and cash-flow statement by internationa l ly recognised methods? (Three items) Acco u nting policy deta i l s 20 Does the company d isclose methods of asset valuation? 2 1 Does the company disc lose information on method of fixed assets deprec iation? 22 Does the company produce consol idated financ ial statements? Related party structure and transactions 23 Does the company provide a l ist of affil iates in which it holds a minority stake? 24 Does the company disclose the ownersh ip structure of affi l i ates? 25 I s there a I ist/register of related party transactions? 26 I s there a l i st/register of group transactions? I n fo rmation on aud itors 2 7 Does the company d isc lose the name of its auditing firm? 2 8 Does the company reproduce the auditors ' report? 2 9 Does the company d isc lose how much it pays in audit fees to the auditor? 3 0 Does the company disc lose any non-audit fees paid to auditor? TOTAL TOT A L N ACRA + S&P 89 I n order to ensure val id ity, the researcher and an i ndependent individual, fami liar with annual report disclosure and holding a relevant accounting background, were i nvolved i n the scoring process. The scores given for every item by both parties were compared. Where there were differences, the Accounting Standards and Statutory Requirements were referred to and discussions fol lowed unti l a consensus was achieved. 5.3.2 Earnings Quality In determining earnings qual ity as a jo int proxy of financial reporting quality with disclosure quality, the current study applied the modified version of Dechow and Dichev' s (2002) accrual s quali ty model proposed by McNichols (2002). This modified model i s a combination of the Dechow and Dichev's original model (2002) and Jones's ( 1 99 1 ) model (McNichols, 2002). The modified model captures the change in sales revenue and property, plant and equipment (PPE), the important elements that form expectations about current accruals, over and above the effects of operating cash flows (Francis et a!, 2005). The use of these accrual qual i ty models al lows for improved measure of earnings quality as it is able to overcome the weaknesses of the absolute discretionary accrual model (McNichols, 2002) and other attributes of earnings quality such as earnings persistence, value relevance, predictabi li ty of earnings and timeliness and conservatism (Francis, LaFond et ·a l . , 2005) . Additionally, the modified Dechow and Dichev model could significantly i ncrease the explanatory power of the original model of Dechow and Dichev (McNichols, 2002) . The modified Dechow and Dichev (2002) model is a s fol low: TCA ,,� CF0,,�_1 CF01,� CFO,.t+ l �':!REV,,� PPE,, � ----"- = /Jo , + /31 , + fJ2 , + /33 · + /34 , · + /Js · + & , .r Assets ,_, · · Assets1 ,� Assets1 .r 1 Assets ,,� · Assets i.r 1 Assets ,,� 90 Where; TCAj,t 6CAj,t 6CLj,t 6Cashj,t 6STDebtj.t AssetSj.t CFOi,t t-.REVj.t PPE j.t Firm j ' s total current accruals in year t = t-.CAj,t - t-.CLj,t - t-.Cashj,t + t-.STDebtj,t Firm j ' s change in current assets between year t- 1 and t. Firm j ' s change in current l iabi lities between year t- 1 and t . Firm j ' s change in cash between year t- 1 and t . Firm j ' s change in debt in current l iabi l ities between year t- 1 and t . Firm j 's average total assets in year t and t - 1 . Firm j ' s net operating cash flows in year t. Firm j 's change in revenues in year t- 1 and t. Firm j ' s gross value of plant, property and equipment (PPE). Following Francis et al . , (2008b), the accruals quality metric was determined based on firm-speci fic and t ime-series est imations of the modified Dechow and Dichev (2002) modeL In the current study (where 5 years data from t = 1 999 - 2003 was used), for each company U ) and time (t), the relation between current accruals and past, current and future cash flows using the most recent seven years data (because of the inc lusion of a lead and a lag cash flow term in the model) was estimated. The estimation provided five values of residuals for each firm. The accruals quality i s therefore the standard deviation of the resulting five firm-specific residuals .24 Thi s is an inverse measure of qual ity in that the larger the standard deviation of the residuals ( i .e . the larger the extent to which accruals do not map into cash flows, change in revenues and PPE), the lower the accruals qual ity which indicates lower earnings quality (Francis et al . , 2005; 2008a; 2008b). The final measure of earnings quality used in the current study i s discussed i n Chapter Six . 5.3.3 Political Influence Three proxies for pol itical influence were used. The first fol lowed the measurement of pol itical economy used by Bushman, Piotroski et al . (2004) . Since Bushman, Piotoski et al . (2004) used cross-country data, not all the measurements of political economy that they used are relevant to this study. The one used in the current study 24 The firm-specific approach uses the firm as its own benchmark (as opposed to an industry approach used in Francis et a l . , 2005). Accord ing to Francis et a l . , (2008b, pg. 66), the fi rm-specific approach requ ires a t ime series of observations about each firm, while an industry approach requires only a suffic ient size cross-section of firms in a given industry at a point in t ime, and the firm-spec ific approach may reduce noise i n the measure of accruals qual ity. 9 1 was the percentage of government ownership.25 To suit the Malaysian environment, the second measure of political influence was the control rights specified to government through a golden share.26 A golden share permits the government to exert control over the affairs of a company, which indicates political influence i n such a company (Adams & Wil liam, 1 992). I n the current study, the existence of golden share was a dummy variable that took a value of I if a government had control rights through a golden share and a value of 0 otherwise. The third measure of pol i tical influence was the presence of politician/s on the board of d irectors. This was also a dummy measure that took a value of I if one or more politicians were members of the board and a value of 0 otherwise. A politician was defined as any pol itician who held a position at state or federal level, or who had previously been in a political party committee at state or federal level . In order to identify whether the board members were politician/s, the fol lowing procedures were carried out: I . Review of i nformation about the background of each member, available m each company's annual report. 2 . Review of a l ist of cabinet members at federal o r state level . 3 . Review of a l ist of committee members of each pol itical party, avai lable on party websites. 4 . Confirmation of the l ist of polit icians identified in the above three procedures by a political expert from the Pol itical Science Department of the National University of Malaysia. 25 I n compl iance with the Compan ies Act 1 965, all l i sted companies d isc lose their s ubstantial shareholders inc l uding their th irty largest shareholders in their annual reports. Section 690 ( I ) st ipulates the mandatory d i sc losure of substant ia l shareholders who hold more than 5 percent of equ ity in any company, irrespective of their d irect or indirect control interest. This inc ludes their investment through nomi nees' institutions and other means. The government shareholding percentage is based on the th irty largest shareholders. The government sharehold ings are proxied by Khazanah Nasianal, Employess Provident Funds ( EPF), Tabung Haj i (TH), Lembaga Tabung Angkatan Tentera (LT AT), Permodalan Nasional Berhad ( PNB), State Economic Corporation Development (SEDC), M inistry of F inance I ncorporated, Felda, Felcra and other government agencies. 26 Can be accessed under "Syarikat-syarikat Menteri Kewangan Yang D iperbadankan" via: http://www. treasury. gov. mv/i nclex.php 92 5.3.4 Corporate Governance Strength Scores were calculated to represent the strength of corporate governance of each company. These were determined by applying a corporate governance index developed for the purposes of this study. The index was developed by taking into account (where appropriate) the index used by Brown and Caylor (2006). These researchers based their i ndex on the International Shareholders Services ( ISS) Corporate Governance Best Practice Users Guide and Glossary 2003 . I n addition, the Corporate Governance Codes of OECD countries (the United Kingdom, Australia and New Zealand) and Malaysian statutory requirements (the Companies Act 1 965 and Listing Requirements of Bursa Malaysia 200 1 ) were taken into account. With this combination, it was believed that the assessment of corporate governance strength would not be biased to the Malaysian environment but would also take i nto consideration best practice i nternational ly . Table 5 .2 shows the corporate governance i ndex developed and used in the study. In scoring each sample company's corporate governance strength, the disclosure of each item of the corporate governance index was given a score of 1 and a score of 0 was given to non-disclosed items. Each company's strength of corporate governance was represented by the total score of the company d ivided by the maximum possible score appl icable to the particular company as a result of the appl ication of the index. The same procedure appl ied in the scoring of disclosure quality, which involved an i ndependent scorer, was also applied in the scoring of corporate governance strength. 93 Table 5.2 : Corporate Governance I ndex NO CQNOJJ.A0\fE GQV};RN4�C,E A TTRQJUTES Board C h aracteristics/Structure: 1 Board s ize - at least s ix but not more than fifteen . 2 Proportion of independent non-execut ive d i rectors at least one th ird or two d irectors if the board s ize is less than s ix . 3 Non-executive directors on the board for not more than n ine years. 4 Board comprises m ix of sk i l l s and experience and other qual ities, inc lud ing core competencies wh ich non-execut ive d irectors shou ld bring to the board. 5 Separation of roles of CEO and Chairman. 6 Directors' appointment - annually e lected. 8 Directorsh ip : directors serve on boards of not more than twenty-five other companies, ten l i sted and fifteen un l isted. 9 Directorsh ip : CEO serves on the boards of no more than two l i sted compan ies. 1 0 N o former CEOs serve on board. 1 1 CEO is not l i sted as having a "related party transaction" in proxy statement. 1 2 The exi stence of remuneration comm ittee i n a l isted company. 1 3 Remuneration committee - composed whol ly or mainly of non-executive d irectors. 1 4 Remuneration commi ttee is chaired by an i ndependent director. 1 5 Remuneration pol icies d isc losed. 1 6 Directors' education - a l l d irectors have attended mandatory train ing. 1 7 The ex istence of a nominat ing committee in a I isted company. 1 8 Nominat ing committee - composed exc l us ive ly of non-executive directors; majority must be independent. 1 9 Nominating committee chaired by i ndependent directors. 20 Nominating committee annua l ly reviews board 's required m ix of ski l l s and experience and other q ua l i t ies, including core competencies wh ich non-exec ut ive directors should bring to the board. 2 1 Number of board of directors meeti ngs per year - at least four. 22 M in imum n umber of meeting directors to attend - at least 75 percent. A u d i t Com mittee 2 3 The existence of an audit committee i n a company. 24 Audit comm ittee size - at least three d irectors. 2 5 Proportion of independent members of the total members - majority. 26 The chairman must be an independent member who is not chairperson of the board. 94 Table 5.2 : Continue . . . A u d it Com m i ttee 27 Proportion of expert members from the total members - a t least one must be financia l ly trained or a qual ified accountant. 28 Number of meetings per year - four. 29 The main roles and responsibi l it ies are set out in written tenns of reference and reported in a separate section of the directors' report. I nterna l Audit Function 30 Presence of an internal audit function. Externa l Aud itor 3 1 Employment of a h igh qual ity auditor - B ig Four. 32 Consult ing fees paid to auditors are less than audit fees paid to auditors. 3 3 Company has formal pol icy on auditor rotation. D i rector Compe n sation 34 Directors receive al l or a portion of their fees in stock. 3 5 Company does not provide any loan t o executives for exerc ising options. 36 The remuneration for each of five h ighest-paid (non-d irectors) is disclosed. 37 The values of benefits other than remuneration received during the accounting period are disc losed in the annual report for each of the d irectors or former directors. Owners h i p 3 8 Al l d irectors with more than one year of service own stock . 3 9 Officers' and d i rectors' stock ownersh i p is at least I percent but not more than 30 percent of total shares outstanding. 40 Directors are subject to stock ownersh ip guide l ines. Progressive Practices 4 1 Board has outside advisor. 42 M in imum amount of time the audit committee has to meet with the external aud itors without executive board members present - at least once a year. Code of Business Conduct 43 Existence, adoption and d isc losure of a code of business conduct and eth ics. TOTA L CORPORATE GOVERNANCE SCORE 95 5.3.5 Control Variables The current study control led for variables that have been recognised in previOus l iterature to have an effect on disclosure quality, earnings qual ity, corporate governance or political i nfluence. The control variab les are as fol lows: 1 . S ize, measured by the natural log of the total assets of the company . 2 . Leverage, measure by the natural log of total l iabi li ties divided by total assets. 3 . L isting status, a dichotomous variable that was 1 i f the company was l i sted. 4 . Firm age, measured by the natural log of the number of years since incorporation. 5 . Eight dummy variables for the nine industry groupings described i n section 3 . 1 . Property was taken as the reference group. 6 . Four dummy variables for the years 2000-2003 , to capture calendar-time effects. The year 1 999 was taken as the reference year. As discussed in Chapter Three, s ize, leverage, age, l isting status and industry are al l expected to be associated with disclosure or earnings and/or corporate governance quality (see Section 3 .5 ) . Year dummies were included as control variables to control for changes in the regulatory environment over time. 5.4 DATA ANALYSIS As stated in Section 5 .2, the current study i nvolved both quantitative and qualitative data, and thus the analysis of data was also carried out both quantitatively and qual itatively. 5.4. 1 Quantitative Data Analysis For quantitative data analysis, descriptive, univariate and regression analyses were carried out. A descriptive analysis has been used to represent the characteristics of a phenomenon and univariate analysis has been used to establ i sh similarities and 96 d ifferences between the characteristics of the phenomenon or describing patterns or connections between such characteristics (Blaikie, 2003) . In the current study, descriptive analysis was used to ascertain and describe the characteristics of the variables of i nterest (such as disclosure quality and political influence attributes) by calculating measures of central tendency such as mean and median, and the d ispersion around the mean. The univariate analysis was performed to establ ish d ifferences in means of tested variables between different categories of the sample companies and to establ ish the strength of correlation between the variables. A multiple regression analysis was employed to test the hypotheses. The fol lowing five multiple regressions were estimated to i nvestigate the relative contribution of each political influence attribute in affecting the financial reporting qual ity of a company, after control l ing for factors that are l ikely to affect the association. The regression equations are as fol lows: DQ" = a0 + a 1 0 WNit + a 2 GOLDit + a 3 P OL,1 + f(control variables) + £11 ( 1 ) EQit = a0 + a p WN,1 + a 2 GOLD11 + a, POL,1 + j(control variables) + £,1 (2) CG,1 = a0 + a p WN,1 + a2GOLD,1 + a3 POL,1 + j(control variables) + £,1 (3) DQ,1 = a0 + aP WN,1 + a2GOLD" + a3POL,1 + a4CG11 + j(control variables) + £,1 (4) EQ,1 = a0 + apWN,1 + a2 GOLD,1 + a3 POL,1 + a4CG,1 + j(control variables) + £,1 (5) Where: DQ EQ OWN GOLD POL CG Control variables Disclosure quality. Earnings quality. Percentage of government ownership. Control rights through a golden share (dummy variable: if government has a golden share in a particular company or 0 otherwise). The presence of pol it ician/politicians on the board of directors (dummy variable: 1 if there a politician/s on the board or 0 otherwise). The strength of corporate governance. S ize, leverage, firm age, l isting status, industries and years. 97 The first two regression equations used disclosure qual ity and earnings quality as the dependent variable and the set of three political influence attributes (government ownership, politician/s on the board and a golden share) as independent variables. The third regression equation used corporate governance strength as the dependent variable and was used to examine the effect of political influence on corporate governance strength. The fourth and fi fth regression equations were simi lar to the first two, but added corporate governance strength as an independent variable. Equations (3) and ( 4) and equations (3 ) and (5) form sets of structural equations of which the pairs of equations ( 1 ) and (3) and equations (2) and (3) are the reduced forms . The coefficients in equations ( 1 ) and (2) wi l l differ from those in equations ( 4) and ( 5), which may be described as bias due to the omitted variable (corporate governance). However, the mediating effect of corporate governance can be measured by its effect in changing these coefficients. The use of the five regressiOn equations IS consistent with Baron and Kenny's ( 1 986) steps in establ ishing the mediating effect of a variable (e.g. corporate governance). The steps are as fol lows. 1 . To show that pol itical influence affects financial reporting quality - Equations ( 1 ) and (2). 2 . To show that political influence is correlated with corporate governance strength (the mediator) - Equation (3) . 3 . To show that corporate governance strength affects financial reporting qual ity even after controll ing for political influence - Equations (4) and (5 ) . The mediating effect of corporate governance is determined from this step by comparing the changes in coefficients of pol i tical influence variables ( i .e . by comparing equation ( 1 ) with ( 4) and equation (2) with (5)) . Al l regressiOns controlled for firm size, l isting status, firm age, leverage and differences in the regulatory environment across industries and over time. 98 5.4.2 Qualitative Data Analysis The main purpose of a qualitative data analysis is to make sense of the interview records. Qualitative data analysis needs to be tai lored to specific types of research strategies (Creswel l , 2003). Four types of strategy may be identified. In grounded­ theory research, the analysis of qualitative data i nvolves systematic steps (based on the studies of Strauss & Corbin, 1 990, 1 998) - open coding (information category generation), axial coding (setting of information position within a theoretical model) and selective coding (explication of a story from the information categories). Alternatively, for case studies and ethnographic research, the analysis involves a detai led description of the setting or individuals, fol lowed by analysis of the data for themes or i ssues. In phenomenological research, the analysis of significant statements, the generation of meaning units and the development of a core description are involved. F inally, in narrative research, the qualitative data analysis involves a reinstatement of the participants' stories (Creswell , 2003) . This study took an ethnographic approach. The interview data analysis involved a description of interviewees and the companies to which the interviewees were attached, fol lowed by an analysis of the interviewees' views for relevant themes. The steps i nvolved i n the interview data analysis are summarised in F igure 5 . 2 . 99 F igure 5.2 : The Steps of the Interview Data Analysis • • • • Transcription of interview data l Description of background of the interviewees Coding Process Generating in itial themes . Coding data according to the initial themes. Development of key themes based on research questions. Coding data according to the key themes. Interpretation of themes � Integration of the interpretation of the themes with quantitative data findings In the transcription process, the interview records were transcribed word-for-word27 . Each interview transcript was taken back to the particular i nterviewee for comments, correction and confirmation. The description process involved a detai led rendering of information about the background of the interviewees such as their age, education background, current 27 There were a few i nterv iewees who provided b i l ingual ( Engl ish and Malay languages) responses. Therefore, the in terview records in the Malay language (the amount was insignificant) were transcribed and trans lated into Engl ish. 1 00 position, number of years m the position and the company, and their past expenences. In the coding process, in itial themes or categories were first generated based conceptual framework from the earlier part of the thesis, the interview schedule, and on initial reading of interview transcripts. Data from interview transcripts were then c lassified and coded according to the i nitial themes or categories. Thi s was done to allow the researcher to become fami l iar with the data to gather a general idea of the i nterviewees' perceptions of pol itical influence in their companies. The initial themes or categories were related to the key issue investigated - the pol itical i nfluence i n a firm. The categories included "the formation of the firm by the government" (coded FORM), "business opportunities given by the government" (coded BO), "direct connection with government, for example direct access to the state Chief Minister" (coded DC), "the government' s final say on economic dec isions" (coded ED), "meeting of the government' s social obl igations" (coded SO), "presence of politicians on the board" (coded PBOD), and "general" (coded PIMO). Any statements that the researcher considered as indicating the existence of political influence in the company's management and operations were classified into one of the initial themes or categories and coded accordingly. Since the number of interviewees was smal l (twenty four) and the interview was not the maj or instrument in the study, the data from each transcript were manual ly coded. The functions within Microsoft Word and Excel were uti l i sed to manage datasets and assist in data analysis. The init ial themes or categories were reconsidered and the key themes related to the main research questions were developed. For example, the original code PIMO was split into "pol itical influence on earnings quality" (coded P IEQ), "pol itical influence on disclosure qual ity" (coded PIDQ) and "pol itical influence on corporate governance" (coded PICG) . The data was revisited and was re-coded accordingly. In the i nterpretation stage, data under each key theme was re-read carefully to extract meaningfu l summaries of i ssues, which are reported i n Chapter Seven. 1 0 1 I n the integration process, results from the i nterpretation of themes were compared with quantitative findings to identify new insights and extensions. These are also d iscussed i n Chapter Seven. 5.5 CHAPTER SUMMARY I n this chapter, the appl ication of the mixed-method design has been discussed. The quantitative method, which is considered the dominant part of the study, involved quantitative data col lection through the use of secondary data and quantitative data analysis, both descriptive and regression analyses. The qual itative method is considered supplementary to the quantitative method and involved qualitative data collection through a series of interviews and analysis through descriptive analysis and thematic i nterview data transcription analysis. This chapter has also di scussed how financial reporting quality, political influence proxies, corporate governance strength and control variables were measured. For financial reporting qual ity, two proxies were used - disclosure qual i ty and earnings quality. The measurement of disclosure quality i nvolved disclosure index development and appl ication of the index to score the qual ity of financial disclosure. For earn ings quality, the measures were derived from the modified Dechow and Dichev (2002) model. Pol itical influence proxies used in the current study consisted of the percentage of government ownership, the existence of a golden share and the presence of politician/s on the board of directors. Corporate governance strength was determined by developing and applying a corporate governance index. Overal l , the research design discussed in this chapter was used to structure the current study. The fol lowing chapters report and discuss the findings of the study. 1 02 CHAPTER SIX QUANTITATIVE FINDINGS AND DISCUSSION 6.0 INTRODUCTION The previOus chapter reported on the methods used to gather and analyse the quantitative data related to financial reporting quality (both disclosure and earnings quality), political influence and corporate governance strength, as wel l as sample firm characteristics. Thi s chapter reports the findings obtained from quantitative data analyses. Before report ing the findings, Section 6. 1 provides a l ist of the definition and measurement of variables used in the analyses. Section 6.2 provides a descriptive analysis of the characteristics and the distribution of disclosure quality, earnings qual ity and corporate governance strength of the sample companies. The findings from univariate and b ivariate analyses are presented in Section 6 . 3 . The findings obtained from multivariate analyses are provided in Section 6.4 and the robustness of results is discussed i n Section 6 .5 . In order to further describe the relationship between the tested variables, supplementary analyses were performed and the results of these are reported in Section 6 .6 . Section 6. 7 presents a discussion and conclusion of the findings . Section 6 .8 provides a summary of the chapter. 6. 1 DEFINITION AND MEASUREMENT OF VARIABLES Table 6 . 1 provides the definition and measurement of both continuous and dichotomous variables used in the data analyses. S ince tests of normality on some of the variables suggest non-symmetrical distribution, the variables (for example earnings quality, the percentage of government ownership, total assets, leverage and firm age) were transformed for the stat istical analyses used in the study. In order to make the data distribution closer to a normal d istribution, the square root of the percentage of government ownership (OWN), the natural log of total assets (SIZE), the natural log of leverage (LEV) and the natural log of firm age (AGE) were used as the final measures. 1 03 I n respect of earnings quality, the measurement is basically consistent with prior studies (e.g. Francis et al. , 2005; 2008a; 2008b), that is an inverse measure of accruals qual ity, in that the larger the standard deviation of the residuals of the regression using the modified Dechow and Dichev (2002) model, the lower the earnings quality . However, in the current study, the standard deviation of the residuals was transformed using natural log. This was done because the skewness of the untransformed values indicated non-normality in the data distribution. The transformation is necessary to make the data c loser to norn1al distribution, so that the effect of distribution in the variable can be reduced. The use of dependent variable (e .g. earnings qual ity) that does not display outliers or that has an acceptable number of outliers is necessary because if the dependent variable has extreme outliers then in general the residuals of the regression estimated wil l also have extreme outl iers . This will then make significant tests unrel iable. However, in the current study, the normality test for the residuals of the regression where earnings qual ity is the dependent variable (refer to Figures 6 .4 and 6 .5 , Section 6 .5) shows that the distribution of the regression residuals is very close to normal distribution. As the final measure and for an easier interpretation of the study results, the natural log value of the standard deviation was multiplied by negative 1 , so that, higher value would reflect better qual ity of earnings. 1 04 Table 6. 1 : Definition and Measurement of Variables Variable Definition Measurement DQ Disc losure qual i ty Total d isc losure score from company financial (the extent of d isc losure) report as per d i sclosure index. (a count of the i ndex items disc losed d iv ided by the number of items appl icable to each part icu lar company) EQ Earn ings qual ity Standard dev iation of residuals of a regression of (accruals qual ity) current accruals on prior period, current period and future cash flows from operation, change in revenue and plant, property and equipment ( i .e . modified Dechow and Dichev [2002] model) . For the final measure, the standard deviation IS transformed using natural log and then mu lt ip l ied by - I . OWN Government ownersh ip Square root of the percentage of government ownership_ of company* . GOLD Existence of a golden I i f there is a golden share i n the company's share (control rights equ ity; 0 otherwi se. through a golden share) POL Presence of pol i t ic ian/s I if there is pol it ic ian/s on the board; 0 otherwise. on the board of d irectors CG Corporate governance Total score from company annual report as per strength corporate governance i ndex. (a count of the index items disclosed d iv ided by the number of items appl icable to each part icu lar company) S IZE S ize Natural log of total assets. LEV Leverage Natura l log of the ratio of total l iab i l i t ies to total assets. L I ST L ist ing status I i f a company is l i sted; 0 otherwise. AGE F i rm age Natura l log of number of years s ince the date of incorporation. INDUSTRY I ndustry dummies 1 for compan ies belonging to the i ndustry of consumer product (CONS), industrial product ( I PROD), trad ing (TDG), plantat ion ( PLANT), construction (CONST), hotel ( HOTEL), technology (TECH), and infrastructure ( INFRA); 0 otherw ise. Property is taken as the reference industry group. Y EAR Year dummies I if the years 2000, 200 I , 2002 or 2003 are i nvolved; 0 otherwise. The year 1 999 is taken as the reference year. Note : * The square-root transformation was used because t here were companies i n the sample w i th zero percentage of government ownersh ip . The log transformation cannot take zero or negati ve n umbers. 1 05 6.2 DESCRIPTIVE ANALYSIS 6.2. 1 Sample Characteristics With regards to pol itical influence, the descriptive statistics reported in Table 6.2 suggest political influence is strong. A majority (87 percent) of the sample (company-year observations of 299 compames, 1 999 to 2003) have some government ownership. Although only 3 percent of the sample companies have a golden share, a substantial number of the companies (39 percent) have at least one politician on their board of directors. Listed companies make up 86 percent of the sample and non-l isted companies make up the remaining 1 4 percent. The sample companies represent nine major industry sectors, with the property sector act ing as a reference group. Al l variables showed in Table 6.2 ( in parentheses) are the dichotomous variables used in the subsequent analyses. Table 6.2: Descriptive Statistics of Sample (Company-years N=1495') Sample/variable Frequency Percentage Companies with government ownersh i p 1 300 87 Companies with pol i t ic ian/s on Board (POL)2 580 39 Companies wi th a golden share (GOLD)2 40 3 Companies by l ist ing status (L/STY: L i sted 1 280 86 Non-l i sted 2 1 5 1 4 Samples by industry : Property (taken as reference) 1 90 1 3 Consumer products (CONS)2 1 5 5 1 0 I ndustrial products (!PROD)2 3 70 2 5 Trading (TDG)2 385 26 Construction (CONSTY 1 30 9 Plantation (PLANT)2 1 60 1 1 Hotel (HOTEL)2 35 2 I nfrastructure (!NFRA)2 35 2 Technology (TECH)2 35 2 Note: 1 299 companies for five years ( 1 999-2003) . 2 1dentified as d ichotomous variables (see Table 6 . 1 for the definit ion and measurement of the variables). 1 06 Table 6.3 reports on the statistics of government ownershi p and sample company characteristics which were identified as continuous variables. As shown in the table, the mean square root percentage of government ownership is 4.06. Total assets range from Malaysian ringgit (MYR) 48,000 (e3 87) to MYR 60 bi l l ion (e 1 7 9 1 ), with a geometric mean of MYR 355 mi l l ion (e 1 2 78) . The geometric mean of the leverage ratio is 0 .36 (e-102) with a range of 0.006 (e-5 1 2) to 9.8 (e2 28) . The geometric mean firm age i s 20.7 years (e3 03) since incorporation, but ages range up to 1 02 years (e4 63) . Table 6.3 : Descriptive Statistics of Government Ownership and Company Characteristics (Identified as Continuous Variables) Variab le Mean Median M in Max Std Dev Square root percentage of 4.06 3 .40 0 1 0 3 .26 government ownersh ip (OWN/ Natura l log of total assets (SIZE/ 1 2 .78 1 2 .95 3 .87 1 7 .9 1 1 .93 Natural log of leverage (LEV) 1 - 1 .02 -.90 -5 . 1 2 2 .28 .93 Natural log of age (AGE) ' 3 .03 3 .20 - .54 4.63 .74 Note: 1 Identified as cont inuous variables (see Table 6. 1 for the defi n it ion and measurement of the variab les). 6.2.2 Financial Reporting Quality and Corporate Governance Strength Table 6.4 reports a descriptive analysis of the disclosure qual ity, earnings quality and corporate governance strength of the sample companies (see Table 6 . 1 for the measurement of the variables). Table 6.4: Descriptive Statistics of Disclosure Quality, Earnings Quality and Corporate Governance Strength Variable Mean Median M in Max Std Dev Disc losure qua l ity (DQ) ' .63 .64 .38 .87 . 1 1 Earnings qua l i ty (EQ) ' 2 .36 2 .50 - 1 .55 4.9 1 1 .07 Corporate governance strength (CG) ' . 58 . 58 .29 .86 . 1 2 Note: 1 Ident ified as continuous variables (see Table 6 . 1 for the defin i tion and measurement of the variables). 1 07 Disclosure scores ranged from 0.38 to 0 .87 with a mean of 0.63 . Thi s indicates that, on average, companies i n Malaysia only disclose 63 percent of the total items expected by the disclosure index, with a large variation among the sample compames. In terms of earnings qual i ty, it should be noted that the values reported in Table 6.4 are the natural log transformed values multiplied by negative 1 . Comparing the untransformed earnings qual i ty mean and median values (and without multiplying the values with negative 1 ) of 0.205 and 0.082 respectively with the mean and median estimates of accruals quali ty reported by F rancis et al. (2005) of 0.044 (mean) and 0.03 1 (median); and Franci s et al . , (2008b) of 0.0 1 6 (mean) and 0.0 1 2 (median), the untransformed mean and median values of the current study are larger. The larger values should be expected as the current study included both l isted and non-l isted companies, where the untransformed mean and median were influenced by large variations in terms of cash flows, sales revenues and property, plant and equipment (the components of the modified Dechow and Dichev (2002) model) . Francis et al . (2008b) used large and healthy l isted US companies where there seem not much variation in each component of the modified Dechow and Dichev (2002) model and involved multi-year period estimation. These, taken as a whole would greatly reduce the mean of their earnings quality. Corporate governance scores range from 0.29 to 0 .86 with a mean of 0 .58 . On average, companies in Malaysia only practise 58 percent of the items expected by the corporate governance i ndex. The data shown in Tables 6.3 and 6.4 are not seriously non-normal : means and medians are roughly equal, and only a few extreme values are more than three standard deviations from the mean. The statistical test for the presence of outliers was carried out (refer to Section 6 .5 ) and the amount of outliers found was deemed acceptable . 1 08 6.3 UNIV ARIATE AND BIV ARIA TE ANALYSES The univariate analysis carried out in the study involved an analysis of means and the bivariate analysis involved a correlation analysis. The results of the analyses are reported in the fol lowing subsections. 6.3 . 1 Analysis of Mean Values between Listed and Non-listed Companies Table 6 .5 reports mean values of disclosure quality, earnings quality, corporate governance strength, government ownership and other continuous variables for various subsets of the data. Panel A compares the mean values of l isted and non­ l isted companies, and panel B compares the mean values of companies with and without political influence (at thi s stage, if a company has at least one pol itical influence measure - government ownership, a golden share or at least one pol it ic ian on i ts board of directors, it is c lassified as a pol itically influenced company). There are substantial differences between mean values of all variables for l isted and non-l isted companies. The difference for each variable is statistically different at p 1: .!! -2 .. .. .. ... "' .. a:: -4 -6 Dependent Variable : EQ IC.l 0 �0 u � � ' �q, oOo o o (b <%> -4 ·2 Regression Standardised Predicted Value Figure 6. 7 Histogram of Standardised Residuals of Regression 3 Dependent Variable : CG Regression Standardised Residual Mean =-2 .96E-1 4 Std _ Dev =0 994 N ="1 ,494 1 3 1 Figure 6.8 Normal Probability Plot (P-P) of Standardised Residuals of Regression 3 Dependent Variable: CG l .o,.--------------------..,---------, ..a 0 Ci. 0.8 E 0.6 ::J u � t: 0.4 Gl a. X w 0.2 0.0·-'--------1""--,-----.---..---,.---,--------' 0 0 0 2 0 4 0.6 0.8 1 0 Observed Cum Prob Figure 6.9 Scatter Plot of Standardised Residuals of Regression 3 -4 -3 Dependent Variable: CG 0 8 -2 -1 0 0 0 0 Regression Standardised Predicted Value 1 32 Figure 6. 1 0 H istogram of Standardised Residuals of Regression 4 1 50 � 1 00 r:::: ... ::::11 0'" � ...._ Dependent Variable : DQ �J . �A�IIII II I I I�I �� -4 -:2 0 2 4 Regression St:andardised Residual Mean =-1 .1 1 E-1 4 Std. Dev. -0.993 N -1 .494 Figure 6.1 1 Normal Probability Plot (P-P) of Standardised Residuals of Regression 4 ..Cl 0 CL. 0.8 E 0.6 ::J u "'Cl :! u 0.4 ... Q. )( w 0.2 0.0 Dependent Variable : DQ 0.2 0.4 0.6 0.6 1 .0 O bserved Cum Prob 1 33 Figure 6. 1 2 Scatter Plot of Standardised Residuals of Regression 4 -;; ::J ..., ·;;; .. a: 2 ..., .. .. � "' ..., 0 c: � c: 0 ·u; -2 .. � "' .. a: ·3 Dependent Variable: DQ 0 ·2 ·I Regression Standardised Predicted Value Figure 6. 13 Histogram of Standardised Residuals of Regression 5 Dependent Variable : EQ 200 1 50 =-u <:: ... ::> .,... � 1 00 u... 50 0 -4 -2 0 2 Regression Standardised Residual fv'leon --1 .67E-1 5 Std . Dev . =0.993 N =·1 ,494 1 34 Figure 6. 1 4 Normal Probability Plot (P-P) of Standardised Residuals of Regression 5 ..a 0 a: 0.6 E 0.6 ::J u ... ... t;: 0.4 ... c. )( w 0.2 0.0 Dependent Variable: EO 0.2 0.4 0.6 O B 1 0 Observed Cum Prob Figure 6. 1 5 Scatter Plot of Standardised Residuals of Regression 5 Dependent Variable : EO � ���Oo <>coO 0 �cP 0 o vilc:-sh!p Structure In order to further analyse the effect of government ownership on financial reporting quality and corporate governance strength, the percentage of government ownership was divided i nto four types of government ownership structure: 0 percent; less than 20 percent; 20 percent to 50 percent; and more than 50 percent (fol lowing Chu & Cheah, 2006 and Thomsen & Pedersen, 1 996). Less than 20 percent ownership is regarded as the minority structure (MIN), 20 percent to 50 percent ownership is regarded as the dominant minority (DOMTMIN) structure, and more than 50 percent ownership is c lassified as the majority structure (MAJ). These variables are dummy variables ( 1 if a firm is identified as having government ownership of either less than 20 percent or 20 percent to 50 percent or more than 50 percent; and 0 otherwise). Non-government ownership (0 percent) structure is used as a reference group. These variables replaced the original government ownership variable (OWN) in all regressions. The results are reported in Table 6 .2 1 . 1 5 1 Table 6.2 1 : Results of Regressions Using Different Types of Government Ownership Structure Regression ( I ) Regression (2) Regression (3) Regression (4) Regression (5) DQ EQ CG DQ EQ Coeff t-stat Coeff t-stat Coeff t-stat Coeff t-stat Coeff t-stat MIN .006 1 .3 7 1 .240* * * 3 .220 . 0 1 1 * 1 .9 1 2 .002 .520 .234 *** 3 . 1 39 ( .027) ( . 1 1 2 ) ( .009) ( . 1 09 ) DOMTMIN .0 1 0** 2. 1 00 .28 1 * ** 3 .208 .030* * * 4.470 .000 -.042 .265 * * * 3 .006 ( .037 ) ( .098) ( . 00 1 ) ( . 093 ) MAJ .043* * * 8 .39 1 .245 *** 2 .686 .044* * * 6.27 1 .028 * * * 6.058 .222 ** 2.398 ( . 1 77 ) ( .098 ) ( . 1 1 4) ( .089) GOLD -.0 1 1 - 1 .296 .243 1 . 58 1 - .0 1 7 - 1 .444 - .005 -.690 .252 1 .640 (- .0 1 7 ) ( .037) ( -.008) ( .038) POL - .064* * * -2 1 . 7 1 4 - .247 * * * -4. 766 - .04 1 * * * - I 0.3 1 8 - .049 * * * - 1 8.444 -.225 *** -4. 1 95 ( -.296) (- . I 1 3 ) ( -.22 1 ) (- . 1 03 ) CG . 350* * * 5. 302 - . 1 42 1 . 576 S IZE .0 1 1 * ** 1 2 .635 .223* * * 1 3 .880 .003 ** 2 . 1 78 .O i l * * * 1 3 . 1 73 .22 1 * ** 1 3 .775 LEV - .004** -2.496 -.292* * * - I 0.978 - .00 1 -.649 -.003 * * -2.487 -.29 1 * ** - 1 0.956 LIST . 1 66*** 27.557 .078 .73 1 . 1 84* * * 22.425 . I 01 * * * 1 6.546 -.020 -. 1 63 AGE .003 1 .406 - . 0 1 8 - .532 -.007** -2.606 .005* * * 3 .0 1 0 - .0 1 5 -.425 CONS .003 .54 1 .220* * 2.272 . 0 1 1 1 .500 .000 -.200 .2 1 4** 2.2 1 0 ! PROD -.023 *** -5 .034 - .094 - 1 . 1 60 - .008 - 1 .257 - .020* * * -5 .042 -.090 - I . I 09 TDG -.003 -. 704 .000 .003 -.007 - 1 .085 .000 -. 2 1 1 .004 .047 PLANT .002 .283 .065 .659 - .006 - .846 .004 .78 1 .068 .694 CONST -.005 -.824 .022 . 2 1 9 . 003 .446 -.006 - 1 . 1 80 .020 .20 1 TECH -.0 1 4 - 1 .483 -.4 1 3 -2. 504 .007 .553 -.0 1 6** - 1 .989 -.4 1 6** -2.528 HOTEL .006 .64 1 .825* * * 5 .077 .028 2 .2 1 0 - . 004 -.472 . 8 1 1 * * * 4.980 INFRA -.024** -2.536 .4 1 3 ** 2.483 -.045* * * -3 .49 1 - .008 -.983 .436** 2.6 1 7 YOO .003 .726 - .023 -. 320 .0 1 0* 1 .80 1 .000 - . 1 52 -.028 -.393 YO I .063 *** 1 5 .354 -.052 - .7 1 2 . 1 22* * * 2 1 .860 .020*** 4. 852 -. 1 1 7 - 1 .399 Y02 .082*** 20.0 1 1 - .064 - .877 . 1 60* * * 28.527 .026*** 5 .824 -. 1 49 - 1 .644 Y03 .085*** 20.634 -.05 1 - .694 . 1 73 * * * 30.69 1 .025 *** 5. 302 - . 1 42 - 1 . 526 I ntercept .297*** 24.365 -.909* * * -4.2 1 3 . 309* * * 1 8 .53 1 . 1 89*** 1 5 .893 - 1 .073*** -4.48 1 R2 .78 .34 .70 . 83 .34 Adj . R2 .78 .33 .69 . 83 .33 Note: F igures i n parentheses are the standard ised coeffic ients to examine a med iating effect. * * * S igni lieant at pr emerging d i f"li..:rcnces markets. i n the examines levels or transparency and d isc losure among countries. regions. and economic sectors and pnn ides an cxplonllor) anal) sis of the correlat ion or transparency and disc losure wi th oll"ncrsh ip structures and valuat ions. To exam i ne t he relat ionsh ip between li rms'_d i sc losurcs and measures or soc ial respons ib i l ity Result Qua l i ty concerns arise if l ir rns apply conservat i v e account ing consistent ly wi thout any change i n account i ng met hods or est imates. There is an i n format ion gap between stakcholders · expect at ions and the disc losure provided by the compan ies. Asian emerging markets exh ib i t greater transparency and d isc losure li.> l lowing recen t currency. bank i ng. and equ ity market crise>. F loat i s pos i t i vely corn:lated wi th transparency and disc losure. Valuation is a lso pos i t ively correlated 11 i t h transparency and disc losun.:. consistent with the notion that the market places a premium on compan ies 11 ith lower asymmetric i n li.>rmat ion problems. A pos i t i ve relat ionsh ip between d i sc losure level and corporate social rcsponsib i I i t) . 1 97 Author(s) Year FRQ I n terpretation Determination of Qual ity Purpose of Study Result Barth, Cram and 200 1 EQ Uses Dechow et a l . " s ( 1 991l ) model To i nvest igate the ro le or accruals i n D i saggregat i ng e:�rnings i n to cash !low Nel son (a model or the accrual process). pred ict ing future cash !lows. and S I:\ major accrual components - change in accounts receivable. change i n i nventory. change in accounts payable. deprcc iat ion. amort ization. and other accruals - s ign i licant ly enhances the pred ict i ve abi l i ty or earnings. Leuz and 2000 DQ DQ = the level or d i sc losure. Tu study German lirms that have Firms that commit to i ncreased levels or Yerrecch ia Prox ies rur the i n lormat ion swi tched from the C Jerman to an d isclosure garner economical ly and asymmetry component : the bid-ask i n ternat ional report ing regime ( 1 /\S stat is t ica l ly s ign i licant benelits. spread. trad ing vo lume i n lirm or Un ited States G/\1\ P). thereby shares. and share price vo lat i I i ty. commi ll i ng themsel ves to i ncreased levels or d i sc losure. Bushee and Noe 2000 DQ /\ IMR ·s rat i ng. To i nvestigate w hether a lirm·s F inns w i th h igher d isclosure qual i ty d i sclosure practices arrect the hav e greater i nst i tut ional ownersh ip. but 1\ h igher rat i ng i nd icates h igher composi t ion or i ts inst i tut ional the part icu lar types or i nst i tut ional d i sc losun.: qual i ty. i n vestor ownersh i p and i ts stock i nvestors allracted to greater d i sc losure return v olat i l i ty . hav e no net impact on ret urn v olat i l i ty. Chen and Jaggi 2000 DQ DQ = th..: d i sclosure extensi veness To exam ine the relat ionsh ip between The rat io or INDs to the total number or or each i tem o r mandatory comprehensive l inancia l d i sclosures d i rectors on corporate boards i s uw d isclosure. and the proport ion or i ndcpcntknt posi t i vely asslH:iatcd wi th the No or i tems: t h i rty Fol loii S the Wal l ace and Nas..:r non-exccut iv..: d i rectors ( INDs) on comprehensi veness or linancial ( 1 995 ) i ndex. corporate boards. and whether d i sc losur..:s. and th i s association is l�tm i l : control has an impact on th i s 1\'eaker ror l�1mi ly contro l led lirms associat ion. compared to non- l�un i l \' contro l lcd lirms. 1 98 Author(s) Year FRQ Interpretation Determ ination of Quality Purpose of Study Resu lt Vafeas 2000 EQ EQ = earnings in l(lrlllat i vent.:SS To exam in..: w h..:ther the l ·:arnings of lirms wi th tht.: smal lest ( prox ied by tht.: earnings-returns informativen..:ss of ..:arnings varies boards in tht.: sample ( wi th a m in imum of rei at ionsh ip which i s examint.:d 11 ith the li·act ion of outside d i rectors livt.: board members ) arc pcn.:c ivcd as through Spcarman rank correlat ions serv ing on the hoard and board s ize. being more i n format i vc by market between income be for..: part ic ipants. 1 3y contrast. there IS no extraordi nary items de llatcd by ..:videnc..: that board composi t ion assets and median-ad.i usted stock mi t igat..:s the earn ings-returns re lat ion. returns across the range of outsider representation ). Cote l l i . Garcl io l . 1 999 DQ The Sll' iss F i nancial Anal) st To investigate the in l lucnce of The absolute abnormal returns arc not Asner and Federat ion ( SAFAIM )' s rat i ng. Swiss lirms· d i sc losure pol icy and s ign i licant ly affected by the qual i ty of i Tuchschmid the i r linancia l analysts · coverage on the l i rm·s annual reports d isc losure. A h igher rat ing ind i cates h igher stock price abnormal react ions to the d i sc losure qua l i ty. publ icat ion of the annual r..:pons. I Hea ly et al . 1 999 DQ A IMR's rat i ng. To investigate " hcthcr linns bene lit The d isclosur..: rat i ng i ncreases arc lh1m expand..:d voluntary disc losure accompanied by increases in sample A h igher rat i ng ind icates h igher by examin ing changes in capital lirms· stock returns. ins t i lllt ional 1 d i sc losure qua l i ty . market factors associated w i t h ownership. analyst fol lowing. and stock increases in analyst d isclosure l iqu id i ty . ratings. Scngupta 1 998 DQ FAF's score. To investigate the l i nk between a A sign i licant n..:gat ivc associat ion 1 l irm ·s overa l l d i sc losure qual i ty and between a linn·s overa l l cl i sc losurc A h igher score ind icates h igher its cost or debt linanc ing. qual i ty and two a l ternat ive measures or a d isc losure qual i ty. l irm·s incremental borrowing cost : ( I ) , the yield to maturity and ( 2 } the ..:flcct ive in terest cost to the issuer. i 1 99 Author(s) Botosan S loan Lang and Lundholm Wright Year 1 997 1 996 1 996 1 996 FRQ Interpretation DQ uw No. of items: s ixty-three EQ DQ DQ and the existence o f' an SEC Account ing and Aud i t i ng En forcement Rclcasc against a firm or its aud itor. Determination of Qual ity Us.:s 011 n developed d isc losure inde:-; ( DSCORE ) to mcasun: d i sc losure leve l . The h igher the l evel or d i sclosure ( score). the h igher the d i sc losure qual ity. l l igh-qual i ty earnings - earnings composed primari ly or operat ing cash flows. Low-qual i ty earnings - earnings composed principal ly or accruals . FJ\F's score/rat i ng. J\ h igher score ind icates h igher d i sc losure qual i ty. DQ = J\1 M R · s rat i ng. J\ h ighcr rat i ng ind icates h igher d i sc losure qua l i ty. Purpose of Study To c:-;aminc the associat ion b.:twccn d isc losurc lcvcl and the cost or cqu ity capi ta l by regress ing firm­ speci fic cst irnatcs or cost or cqu it) capi ta l on market b..:ta. firm s ize and a scl l�constructcd measure or d i sc losure level . To invest igate whether market part ic ipants use a re lat i vely s imple measure or the qual i ty or reported earnings based on publ ic ly avai lable i n format ion. To c:-;aminc the re lat ionsh ip between thc d isclosurc pract ices or firms. thc number or analysts l'll l low ing and propcrt ics or the analysts· earnings I(H·.:casts. To invcst igate thc n.: lat ionsh ip bet11 ccn corporate govcrnancc characteristics and the qual ity or financial report i ng. Result For !inns rol lowing associated cap i ta l . that attract a low analyst - greater d isclosure i s w i th a lower cost of equ i ty For !inns wi th a h igh analyst fo l lowing ­ no evidence or an associat ion between d i sc losure l evel and cost or equ i ty capi ta l . F i rms 11 here accruals arc large and pos i t i ve : I ) .:arnings tend to decl ine over the nc:-;t three y.:ars b.:cause or reversals or account i ng accruals: 2 ) the largest accrual reversals arc attr ibutable to current accruals: and 3 ) the stock prices of these firms decl ine over the t h ree-year period. and these stock price decl i nes arc related to a predictable dec l i ne in earn ings. F i rms '' ith more i nformat ive d i sc losure pol ic ies havc a l arger analyst fo l low ing. more accurate analyst earnings forecasts. kss d i spersion among ind i v idual analyst lorccasts and less volat i l i ty in forecast rcv isions. J\ negat ivc correlat ion between the rRQ measurcs and the prcscncc o f' i ns iders and ·grcy d i rectors on the audi t commi ttcc. 200 Author(s) Wal lacc and Naser Hossain . Perera. and Rahman Wal l ace, Naser and Mora Cooke Year 1 995 1 995 1 994 1 993 FRQ Interpretation DQ uw No . of i tems: t h i rty DQ uw No or i tems: n i nety- five DQ uw No of i tems: s ixtet:n DQ uw No . or i tems: 1 95 Determ ination of Quality Uses 011 n developed i ndex to determ ine d isclosure qual i ty . A h igher index score ind icates better d i sclosure qual ity. DQ = the extent of d i sc losures. Uses own developed i ndex. A h igher index score ind icates the more i n format ion d isclosed. the h igher the qua l i ty . DQ = the comprehensi veness or d i sc losure. Uses own developed i ndex. A h igher i ndex scorc i nd icates h igher d i sc losure qua l i ty . DQ = the lc1 cl of d isclosure. Uses own developed index. 1\ h igher i ndex score h igher d isclosure qual ity. i nd icates Purpose of Study To exam i ne the relat ionsh i p between d isc losure qual i ty and lirm · s characteristics - asset s i1.c. scope o r business and pro li ts. To exam ine the re lat ionsh i p between li vc li rm-spcci lie characterist ics and the l evel or accoun t ing i n format ion voluntari ly disc losed by compan ies l i sted on New Zealand Stock Exchange (NZSE) . To invest igate whether the d i fferences i n the deta i l s o fTcred on selected i n format ion i tems i n the annual reports m i rror the d i lfcrenccs in the firms characterist ics and whcthcr the firm characterist ics lound to be re levant in the previous countr) d i sc losure arc a lso impl icated i n Spain . To i nvestigate the d isclosure level of Japanese corporate annunl reports - d i fferences in the extent of d i sc losure by compan i es that arc classi lied by quotation status and the analysis extends to both the Commercia l Code (CC) and the Securi t ies and Exchange Law ( S I -: 1 . ) . Result Disc losure qual i ty varies pos i t ive ly wi th asset s ize and the scope or business operat ions but negat ive ly w i th pro li ts. F inn · s s ize. fore ign l i st i ng status and leverage arc sign i licantly related to the extent or vo luntary d isc losure hut assets­ in-place and types of auditor arc not sign i licant explanatory variables. Samplc lirms wi th h igher ( lower) structure ( wi th asset s ize or total sales serv ing as a proxy ) tend to offer more ( less) comprehensive d i sc losure in their annual reports and accounts: thost: with h ighcr ( lower) operat ional performanec as determined by l iqu id ity tend to ol"l"er less ( more ) comprehens ive d i sc losure: wh i l e lirms that arc l isted on the Madrid and Valencia stock exchanges tend to provide more comprehensive d isclosure than those arc not l i sted. The lcvel of d i sc losure in the SEL nccounts is greater than the domest ical ly l i sted and un l i sted companies i n the CC accounts . Disclosure 1 11 the CC nccounts by un l i sted and domest ica l ly l i sted compan i es is very l im i ted - restricted to mandatory i tems. Un l isted companies prclcr to keep as much i n formation as possib le secret. 20 1 Author(s) Year AI ford. Jones. 1 993 Leftwich and Zmijewsk i Lev and 1 993 Th iagarajan l mhoff 1 992 Jones 1 99 1 Biddle and 1 989 Saudagaran FRQ Interpretation EQ EQ EQ EQ DQ w No of i tems: 296 WG: weight i ng is based on l i terature. - - -- ---- Determination of Quality EQ = account ing i n format ivcncss ( measured by i n lormat ion content and t ime l iness for account ing earn ings). EQ = earn ings persistence. Two i nd icators of persistence: the earnings response coenic ient and future earnings growth. De lines earnings qual i ty ""to be overa l l subject ive assessment of the re levance. rei i ab i I i ty. and comparabi I ity of the accoun t ing data··. Employs analysts · j udgements of accoun t i ng qual i ty as the qual i ty measures. An est imate of the d i scret ionary component of total accrua ls is used as the measure of earnings management rather than the d i scret ionary component of a s ing le accrua l . DQ = the level of l inancia l d isclosure. Uses own d.::vcloped index. A h igher index score ind icates h igher d i sclosure qua l i ty. Purpose of Study To compare the i n lormat ion content and t imel iness of account ing earnings in several countri es using the Un i ted States as a benchmark . To determ ine the value of corporate securi t i es by e:-;am in ing key val ue- dri vcrs. such as earn ings. risk. growth. and compet i t i ve pos i t ion. To exam ine security analysts· percept ions of firms· account ing qual i t) to understand how d i iTcrenccs in account ing qual i ty are related to observable account ing characteris t ics. To test whether lirrns t hat would bcnc l i t from import re l ief ( e.g . . tar i ff increases and quota reduct ions ) attcrnpt to decrease earnings through earnings management during import re l ief invest igat ions by the Un i ted States I TC. To i nvestigat.: the associat ion bet\\·cen linancir iden t i fy i ng Th..: resul ts of the study show that a 1 2- assets. serious financia l problems in v ariabk econom..:tr ic system is both savi ngs and loan associat ions. accurate and pract ical for at least three semi-annual periods preced ing the serious problem data. The system involves ( I ) quadrat ic d iscr iminant analysis. and ( 2 ) a composi te S&L rat ing based on thn:e two-group d i scrim inant models . --- - 204 Author(s) Year Barrett 1 976 Buzby 1 975 Buzby 1 974 FRQ I nterpretation DQ W & UW Seventeen categories of informat ion . WG: l i terature and researcher· s own judgement. DQ w No. of i tems: t h i rty-n i ne WG: Financia l analysts. DQ Determination of Qual ity DQ = the extent unci qual i ty of l inancia l d i sc losure. Uses own developed d isclosure i ndex. 1\ h igher i ndex scon: ind icates better qual i ty. DQ = the extent of d i sc losure of selected items. Uses own developed i ndex. 1\ h igher i ndex scon: ind icates hetler qual ity. Purpose of Study To exam ine the overa l l extent of l inancia l d i sclosun: and the degrec of comprchcnsivcncss of lirms' l inancia l statements i n scvcn d i ffcrcnt countrics namcly U n i ted Statcs. Un i ted K i ngdom. Japan. Francc. Germany. Sweden and Netherlands. To i nvestigatc the relat ionsh ip het\\ecn a sub-component of adequate d i sc losurc - the cxtcnt to which selected items of i n format ion arc prcscntcd i n corporate annual rcports and the t \\ O lirm ·s characterist ics - size and l ist ing status. Result l 'hc ovcra l l level of corporate linancial d i sc losure stcad i ly improves throughout the period of study. 1\ wide variance between the overa l l level of d i sclosure of American and Bri t ish lirms. and the lirms from the other live countries. The American and Br i t ish linns· l inancial statements arc considerably mon: comprehensive in terms of inc lud i ng the resu l ts of related companies and of tak ing a broad view of i ncome related i tems than those of the lirms located i n thc other f ive countr ies. The French !inns have less d i sc losure and less comprehensive linancia l statements than the l irms i n any of the other s ix nat ional samples. The extent of d i sclosure i n annual reports is pos i t i v cly associ atcd w i t h the size of the company· s assets and is not affected by l i st ing status. DQ = the cxtcnt of d ise losun.: of To measure the rc lat ivc importancc Many of the i tems arc inadequately sclected i tems. and/or thc extent of d isc losure of d i sclosed 1 11 the sample and the W Uses O\� n deve loped i ndex. sclected typ�s of linanc ia l and non- corn.:lat ion bet\\CCil thc re lat i ve No. of i tems: t h i rty-n ine 1\ h igher i ndcx scorc ind icates better l inancia l i nformat ion in annual importancc of the i tems and the cxtcnt of WG: Financia l analy sts. l Ua l i ty. re 1orts. thc ir d isclosure 11 as sma l l . 205 Author(s) Year FRQ I nterpretation Determination of Quality Purpose of Study Result Baker and Haslem 1 973 DQ DQ= i n lormat ion in li)rmat ivencss. To exam ine the i n format ion needs Factors related to expectat ions about the of ind i v idual i nvestors in their future arc the most h igh ly regarded by w analyses of common stock. the i nvestors. I nd iv idual investors are No. of i tems: th i rty- a lso i n terested in h i storical factors three WG: I nvestors Singhvi and Desai 1 97 1 DQ Uses i ndex developed b) Ccrf To ident i fy some of the The corporat ions w h ich d i sc lose ( 1 96 1 ) w i th another s ix i tems added. characterist i cs of corporat ions in the inadequate i n lormat ion arc l i kely to be: w Un i ted States w h ich arc associated ( a ) smal l i n s ize as measured by total No. of i tems: t h i rty- four 1\ h igher index score ind icates better w i th the qua l i ty of corporate assets. ( b ) smal l in s ize as measured by WG: Securi ty analysts qual i ty . d i sc losure. number of stockholders. ( c ) fi·ec li·om l is t ing requ i rements. ( d ) audi ted by sma l l CP/\ lirms. ( c ) less pro li tablc as measured by rate of return. and ( I) less prolitablc as measured by earn i ngs margin . Pankotf and 1 970 DQ DQ = usefu lness of i n li.mnation ( the To measure the usefu l ness of No empirical support lor the be l ief that V irgi l extent to which i n formation account ing and other i n fi.Jrmation to account ing i n lonnation is genera l ly and uw faci l i tates dec ision making) . prolcss ional securi ty analysts who h ighly usefu l tor dec ision-mak ing. No. of i tems: t h i rty-five part ic ipate as subjects i n their laboratory stock market. Ba l l and Brown 1 968 EQ 1 -:Q = earn ings usefu lness. To assess the usefulness of ex ist ing Of a l l the i n format ion about an account ing income numbers by ind iv idual firm t hat becomes avai lable examin ing the ir i n format ion content during a y ear. one-ha I f or more is and t ime l i ness. captured in that ycar·s i ncome number. The annual income report does not rate h ighly as a t ime ly medium. since most of i ts content ( about 85 to 90 percent ) i s captured by more prompt media which perhaps i nc lude i n terim reports. 206 Author(s) Year Beaver 1 968 Key: DQ: D isclosure q ual ity EQ: Earn ings qual i ty UW: Unweighted W: Weighted WG: Weighted group FRQ Interpretation EQ Determination of Qual ity EQ = earnings i n format i veness ( in formation content ). A l irm·s reported earnings is assumed to have i n format ion content if i t leads to a change in i nvestors· assessments of the probabi l i ty d i stri bution of ruturc returns (or prices). Purpose of Study Result To e:-;amine the e:-;tent to w h ich I nvestors do look d i rect ly at reported COllllllOn stock investors perceive earnings and do not use other variables earnings to possess in f(mmltional to the e:-;clusion of reported earnings. v a lue. News announcements occurring prior to the earn ings report do not ent i rely pre- empt the in formation content of reported earnings. 207 APPENDIX B: LIST OF COMPANIES USED IN THE STUDY C O M P A N Y STATUS I . A&M Realty Bhd L 2 . Advance Synergy Capital Bhd L 3 . Aj inomoto (Malaysia) Bhd L 4 . A l iran lhsan Bhd L 5 . A l um in ium Company of Ma laysia Bhd L 6. Amalgamated Containers Bhd L 7 . Amway (Malaysia) Holdings Bhd L 8. Ancom Bhd L 9 . Ann Joo Resources Bhd L 1 0 . Antah Hold ings Bhd L 1 1 . Aqfa Sdn Bhd L 1 2 . Asas Dun ia Bhd L 1 3 . Asia F i le Bhd L 1 4 . Asia Pac ific Land Bhd L 1 5 . Astral Asia Bhd L 1 6 . Ay er H ita m Tin Dredging Bhd L 1 7 . Batu Kawan Bhd L 1 8 . Bayou Bay Development Sdn Bhd NL 1 9. BCB Bhd L 20 . BCIC Holdings Sdn Bhd NL 2 1 . Behrang 2020 Sdn Bhd N L 22 . Benta Wawasan Sdn Bhd N L , � _.) , Betjaya Land Bhd L 24. Betjaya Sports Toto Bhd L 25 . B ina Daru laman Bhd L 26. B ina Puri Hold ings Bhd L 27 . B inaraya PK INK Sdn Bhd N L 28 . B loomingdate Advet1 isment Sdn Bhd NL 29. Boustead Hold ings Bhd L 30 . Box-Pak (Malaysia) Bhd L 3 1 . Brem Holdings Bhd L .., , .)_ , Brit i sh American Tobacco (Malaysia) Bhd L 33 . Bukit Kati l Resources Bhd L 34. Bus i ness & Budget Hotels ( Penang) Sdn Bhd L 35 . C . l Holdings Bhd L 36 . Camerl in Group Bhd L 37 . Carlsberg Brewery (Malaysia) Bhd L 38 . Cement I ndustries of Malaysia Bhd L 39 . Central I ndustrial Bhd L 40. Chem ical Company of Malaysia Bhd L 4 1 . CHG Industries Bhd L 42 . Ch in Teck Bhd L 43 . Choo Bee Metal I ndustries Bhd L 44. C indee Development Sdn Bhd N L 45 . Computer Forms (Malaysia) Bhd L 46 . Cosway Corporation Bhd L 47 . Country Heights Hdg. Bhd L 48 . Cyc le & Carriage B intang Bhd L 49. Dai Hwa Hold ings (M) Bhd L 50. Daiboch i P last ic Bhd L 5 1 . Damansara Realty Bhd L 208 COMPANY STA T U S 52. Datuk Keramat Hold ings Bhd L 53 . Daya Perumahan Sdn Bhd NL 54. DFZ Capital Bhd L 55 . Digi .Com Bhd L 56. Dijaya Bhd L 57 . DKLS Industries Bhd L 58 . DNP Holdings Bhd L 59. Dolom ite Corporation Bhd L 60. DRB-H ICOM Bhd L 6 1 . Dutch Lady M i l k Industries Bhd L 62 . E&O Property Development Bhd L 63. Eastern Pac ific Industries Bhd L 64. Ecofirst Conso l idated Bhd L 65 . Edaran Otomobi l Nasional Bhd L 66. Ekovest Bhd L 67. Ekran Bhd L 68. Eksons Corporation Bhd L 69. Eng Teknologi Bhd L 70. Esso Malaysia Bhd L 7 1 . F A Peninsular Bhd L 72. Faber Group Bhd L 73 . F ACB Industries I ncorporation Bhd L 74. Far East Hold ings Bhd L 75 . Formosa Proson ic Bhd L 76. Fountain V iew Development Bhd L 77. Fraser & Neave Ho ldings Bhd L 78. General Corporation Bhd L 79. Genting Bhd L 80. George Kent (Malaysia) Bhd L 8 1 . George Town Bhd L 82. G lenealy P lantat ions Bhd L 83. Goh Ban Huat Bhd L 84. Goh Holdings Bhd L 85 . Go lden Hope P lantation Bhd L 86. Golden Pharos Bhd L 87. Golden Plus Hold ings Bhd L 88. Gopeng Bhd L 89. G PQ Sdn Bhd N L 90. Grand Central Ents. Bhd L 9 1 . Gu inness Anchor Bhd L 92 . Gu la Perak Bhd L 93 . G uthrie Rope! Bhd L 94. Harwood Timber Sdn Bhd N L 95 . Hexza Corporation Bhd L 96. H ighlands & Lowlands Bhd L 97. H irotako Hold ings Bhd L 98. Ho H up Construction Bhd L 99. Ho Wah Genting Bhd L 1 00 . Hock Seng Lee Bhd L l 0 l . H ub l ine Bhd L ! 02 . l -Bhd L ! 03 . I JM Corporation Bhd L 209 COM PANY STAT U S 1 04 . I nch Kenneth Kajang Bhd L 1 05 . I ndustrial Concrete Bhd L 1 06 . l nnoprise Capital Sdn Bhd N L 1 07 . l ntan Uti l ities Bhd L 1 08 . I ntegrated Logistics Bhd L 1 09 . I ntegrated Rubber Company Bhd L 1 1 0 . l ntegrax Bhd L I I I . l nt i Un iversal Hold ings Bhd L 1 1 2 . 10 1 Corporat ion Bhd L 1 1 3 . 1 0 1 Oleochemical I ndustries Bhd L 1 1 4 . l poh Cargo Terminal Sdn Bhd L 1 1 5 . l reka Corporation Bhd L 1 1 6 . l sedecor Bina Sdn Bhd N L 1 1 7 . Is land & Pen insu lar Bhd L 1 1 8 . Java I ncorporated Bhd L 1 1 9 . Jeroco Plantation Sdn Bhd L 1 20 . Johan Ceramics Bhd L 1 2 1 . Johan Holdings Bhd L 1 22 . Johor Land Bhd L 1 23 . J T I nternational Bhd L 1 24 . Keck Seng (Malaysia) Bhd L 1 2 5 . Kedah Resort Sdn Bhd N L 1 26 . Keladi Maj u Bhd L 1 27 . Kelkon Sdn Bhd NL 1 28 . KESM Industries Bhd L 1 29 . KFC Hold ings Bhd L 1 3 0 . KFS Supp011 Services Sdn Bhd NL 1 3 1 . Kia L im Bhd L 1 32 . Kian Joo Can Factory Bhd L 1 3 3 . K IG G lass Industrial Bhd L 1 3 4 . Kim Hin Industry Bhd L 1 3 5 . Konsot1ium Logistik Bhd L 1 3 6. Kossan Rubber I ndustries Bhd L 1 3 7. KPJ Health Care Bhd L 1 3 8 . Kramat T in Dredging Bhd L 1 39. Kretam Hold ings Bhd L 1 40 . K TPC Construction Sdn Bhd L 1 4 1 . Kuala Lumpur Kepong Bhd L 1 42 . KUB Malaysia Bhd L 1 43 . Ku l im (Malaysia) Bhd L 1 44. Kul im Golf & Country Resort Sdn Bhd N L 1 45 . Kul im Techno-City Sdn Bhd NL 1 46. Kumpu lan F IMA Bhd L 1 4 7. Kumpu lan Guthrie Bhd L 1 48. Kurn ia Setia Bhd L 1 49. Ladang Rakyat Terengganu Sdn Bhd N L 1 50. Ladang Serasa Sdn Bhd N L 1 5 1 . Lafarge Malayan Cement Bhd L 1 52 . Land & General Bhd L 1 53 . Landmarks Bhd L 1 54. Lati tude Tree Holdings Bhd L 1 5 5 . Leader Un iversal Holdi ngs Bhd L 1 56 . Linear Corporation Bhd L 2 1 0 CO M PA N Y STAT U S 1 57 . Lingkaran Trans Kota Bhd L 1 58 . L ingui Developments Bhd L 1 59 . Lion I ndustries Corporation Bhd L 1 60 . L ityan Holdings Bhd L 1 6 1 . LKPP Corporat ion Sdn Bhd N L 1 62 . LKT I ndustrial Bhd L 1 63 . Magnum 4D Bhd L 1 64 . Magnum Corporation Bhd L 1 65 . Mains Holdings Sdn Bhd NL 1 66 . Malakoff Bhd L 1 67 . Malayan F lour M i l l s Bhd L 1 68 . Malayan Un ited I ndustries Bhd L 1 69 . Malaysia A ica Bhd L 1 70 . Malaysia A i r l ine Systems Bhd L 1 7 1 . Malaysia A i rports Hold ings Bhd L 1 72 . Malaysia Smelt ing Company Bhd L 1 73 . Malaysian Mosaics Bhd L 1 74 . Malaysian Pacific I ncorporated Bhd L 1 75 . Malaysian Resources Bhd L 1 76 . Mamee-Doub le Decker Bhd L 1 77 . Marco Holdings Malaysia Bhd L 1 78. Measat G lobal Bhd L 1 79. Mechmar Corporation Bhd L 1 80. Mega First Corporation Bhd L 1 8 1 . Mentakap Rubber Company Bhd L 1 82 . Meta Corp Bhd L 1 83 . Metroplex Bhd L 1 84 . M inho (M) Bhd L 1 85 . MMC Corporat ion Bhd L 1 86. Muhibbah Engineering Bhd L 1 87 . Mu lpha I nternational Bhd L 1 88. Mu lt i Vest Resources Bhd L 1 89. Mu lt i-Purpose Ho ld ing BHD L 1 90 . Naluri Corporation Bhd L 1 9 1 . Nanyang Press Ho ld ings Bhd L 1 92 . Nationwide Express Corporation Bhd L 1 93 . Negara Propert ies Bhd L 1 94. egeri Road Stones Sdn Bhd NL 1 95 . Negeri Sembi lan Cement I ndustries Sdn Bhd NL 1 96. Negri Sembi lan Oil P lantation Bhd L 1 97 . Norsechem (Sabah) Sdn Bhd N L 1 98. OCB Bhd L 1 99. Olympia I ndustries Bhd L 200. Opus I nternational Bhd L 20 I . Pad iberas Nasional Bhd L 202. Pan Malaysia Corporation Bhd L 203 . Pantai Holdings Bhd L 204. Paracorp Bhd L 205 . Parkmay Bhd L 206. Pasdec Corporation Sdn Bhd N L 207. Pasdec Holdings Bhd L 208. Pe langi Bhd L 2 1 1 COM PA N Y STA T U S 209. Pel ikan I nternational Bhd L 2 1 0 . Pengurusan K PRJ Ranh i l l Sdn Bhd N L 2 1 1 . Pentanah Sdn Bhd NL 2 1 2 . Perak Corporation Bhd L 2 1 3 . Perusahaan Sadur Timah Bhd L 2 1 4 . Petal ing Garden Bhd L 2 1 5 . Petronas Dagangan Bhd L 2 1 6 . Petronas Gas Berhad L 2 1 7 . Pi lecon Engineering Bhd L 2 1 8 . Pintaras Jaya Bhd L 2 1 9. PK Resources Bhd L 220. PKPS Agro I ndustries Sdn Bhd NL 22 1 . PKPS Feed M i l l Sdn Bhd N L 222. PLB Engineering Bhd L 223 . PM Cultural & Tourism Sdn Bhd N L 224. PNE PCB Bhd L 225. PNSB Insurance Brokers Sdn Bhd NL 226. Prestar Resources Bhd L 227 . Prime Ut i l it ies Bhd L 228 . Proton Hold ings Bhd L 229. PSC I ndustries Bhd L 230. Puncak N iaga Hold ings Bhd L 23 1 . Ramatex Bhd L 232 . Rel iance Pac ific Bhd L � � � _.) .) . Riverview Rubber Bhd L 234 . Road Bu i lder (M) Ho ldings Bhd L 235 . Rohas-Euco I ndustries Bhd L 236 . Sabah Melale I ndustries Sdn Bhd NL 237 . Safeguards Corporation Bhd L 238 . Sarawak Enterprise Company Bhd L 239 . Sarawak Oi l Palms Bhd L 240. Saujana Consol idated Bhd L 24 1 . Scientex I ncorporated Bhd L 242. Seal Incorporation Bhd L 243 . Se laman Sdn Bhd N L 244. Se langor Properties Bhd L 245 . Shangri-La Hotels (M) Bhd L 246. S i lverstone Corporation Bhd L 247 . S ime Darby Bhd L 248. S ime UEP Properties Bhd L 249. S indora Bhd L 250 . South Malaysia I ndustries Bhd L 25 1 . Southern Acids (M ) Bhd L 252 . Southern Steel Bhd L 253 . Sri i Bhd L 254 . Star Publ ications (M) Bhd L 255 . STI DC Bel ian Hold ings Sdn Bhd N L 256 . Subur Tiasa Bhd L 257 . Sungei Bagan Rubber Bhd L 258 . Sunway C ity Berhad Bhd L 259 . Sunway C ity Sdn ( l poh) Sdn Bhd N L 260. Sunway Ho ldi ngs I ncorporated Bhd L 2 1 2 CO M PA N Y STATUS 26 1 . Tal iworks Corporation Bhd L 262. Tanjong Publ ic L im ited Bhd L 263 . Tanjung Manis Sawm i l l Sdn Bhd NL 264. Tasek Corporation Bhd L 265 . TDM Bhd L 266. Tebrau Teguh Bhd L 267. Teka la Corporation Bhd L 268. Teknologi Tenaga Perlis NL 269. Telekom Malaysia Bhd L 270. Tenaga asional Bhd L 27 1 . TH Group Bhd L 2TJ.. The Store Corporat ion Bhd L 273 . Thong Guan I ndustries Bhd L 274. Time Engineering Bhd L 275 . Tiong Nam Logistics Bhd L 276. Tractor Ma lays ia Holdings Bhd L 277. Tradewinds Corporation Bhd L 278 . Tru-Tech Hold ings Bhd L 279 . TSH Resources Bhd L 280. UAC Bhd L 28 1 . UDA Hold ings Bhd L 282 . UEM Bui lders Bhd L 283 . UMW Hold ings Bhd L 284. Un isem (M ) Bhd L 285 . Un ited Chem ical I ndustries Bhd L 286 . Un ited Ma lacca Bhd L 287 . Un ited P lantat ion Bhd L 288. U PA Corporation Bhd L 289. Utusan Melayu Bhd L 290. Wembley I ndustries Hold ings Bhd L 29 1 . W ijaya Baru G lobal Bhd L 292. Worldwide Hold ings Bhd L 293 . Worldwide Ventures Sdn Bhd NL 294. WTK Holdings Bhd L 295 . Ya Horng E lectronics Bhd L 296. Yee Lee Corporat ion Bhd L 297. Yeo H iap Seng (Malaysia) Bhd L 298. YTL Corporation Bhd L 299. YTL Power Bhd L Key: L - L isted compan ies; NL - Non-l i sted compan ies 2 1 3 APPENDIX C: INTERVI EW SCHEDULE Introduction Thank interviewee for his/her time Mention nature and relevance of the research Background information Company"s name Company's status: l isted/non-listed Position umber of years in the position umber of years in the company Other positions in the last five years Date(s ) interviewed Opening questions I . Reasons behind the exi stence of the company 2. Role( s ) of companies/GLCs in Malaysian economic development Financial reporting I . How are financ ial reports prepared in your company? ( Fol low-up if necessary: is respondent involved; role of managers; final approval ) 2 . How do you decide whether to disclose information beyond what i s required by law? ( Follow-up: respondent's opinion about reasons; factors considered; influence of auditor, industry norms. regulations, professional consultants) 3 . Who are the most important readers o f your a1mual reports? ( Follow-up: how much contact do you have with them?) 2 1 4 Earnings targets 1 . Have you ever been close to miss ing an earnings target? 2. a ) If so, what act ions did you take? b) If not, what actions should companies take to meet earnings targets? 3 . Is it i mportant that company earnings should be predictable? Why does it matter? Political influence 1 . Who are the most important people m in fluencing your dec i sions as a CEO/Chairman? 2. How much influence do the people have on your financ ial report ing deci sions? ( Fol low-up : clari fy? relative important of different group? example? ) . Closing remarks Ask whether there is anything to add Promise a copy of the transcript and summary of overall findings. 2 1 5 APPENDIX D : A SUMMARY OF MAJOR FINDINGS AND A COMPARISON WITH THE FINDINGS OF PRIOR STUDIES Variables Current Study Reviewed Prior Studies Conclusion Regression (1 ) and (2) Hypothesis l Dependent Variable: d isclosure qual ity (DQ): Supp01t research hypothesis 1 : I ndependent Variables: S ign ificant and posit ive: Political lnjluence: Eng & Mak ( 2003 ) Po l it ica l in f luence is assoc iated Government Ownersh ip (GOY) S ign i ficant and pos i t ive S ign i ficant and negat ive: with low fi nanc ia l reporting Aggarwa l ( 1 999); Kothari ( 200 I ) ; Zhuang qua l i ty but on ly if po l it ical ( 1 999) ; Naser & Nuse ibeh ( 2003 ) in fl uence refers to the existence of pol i t ic ian/s on the board . Golden share (GOLD) Not- s ign i ficant - Po l it ic ian/s on the board ( POL) S ign i ficant and negative - S ize (S IZE) S ign i ficant and pos i t ive S ign i ficant and posit ive: Buzby ( 1 975 ) ; Cahan et a l . (2005 ) ; Kent & Stewart (2008 ) ; Krishnan & Zhang ( 2005 ); S i nghvi & Desa i ( 1 97 1 ) ; Lang & Lundholm ( 1 993 ) ; Chow & Wong-Boren ( 1 987 ); Cooke ( 1 989) ; Eng & Mak ( 2003 ); Han i ffa & Cooke (2005 ) 2 1 6 Leverage ( LEV) S ign i ficant and negat ive S ign ificant and negat ive: Eng & Mak ( 2003 ) S ign ificant and pos it ive: I nchaust i ( 1 997) Not-sign i ficant : Chow & Wong-Boren ( 1 987) ; Raffournier ( 1 995 ) ; Wal lace & Naser ( 1 995 ), Ahmed & N ichol l s ( 1 994 ) L ist ing status ( LI ST ) S ign ificant and pos it ive S ign i ficant and pos i t ive: Raffourn ier ( 1 995 ); Cooke ( 1 989 ) ; S i nghvi & Desa i ( 1 97 1 ) : 1 -lossa in , Perera & Rahman ( 1 995 ) ; Chow & Wong-Boren ( 1 987 ) Age (AGE) S ign ificant and posit ive S ign i ficant and posit ive : Chow & Wong-Boren ( 1 987) ; Cooke ( 1 989); S i nghvi & Desa i ( 1 97 1 ) ; Cheng and Courtenay (2006) S ign i ficant and negative: Ho & Wong (200 I ); Raffournier ( 1 995 ) Dependent Variable: earnings quality (EQ) I ndependent Variables: Political Influence: Government Ownersh ip (GOY ) S ign ificant and pos i t ive - Golden share (GOLD) Not- sign i ficant - 2 1 7 Pol it ic ian/s on the board ( POL) S ize (S IZE) Leverage ( LEV) L i st i ng status ( L I ST ) Age (AGE) - -·-- Sign i ficant and negative S ign ificant and pos i t ive Sign i ficant and negative S ign i ficant and pos i t ive Not- s ign i ficant - S ign i ficant and posi t ive : Cahan et a l . ( 2008); Chaney et a l . ( 2007 ); Dechow & D ichev ( 2002 ); Lee & Choi ( 2002 ); Myers et a l . , ( 2003 ) S ign i ficant and negat ive : Shen & Chih ( 2007) S igni ficant and negat ive : Sweeney ( 1 994) S ign i ficant and posi t ive : Sun, L iu & Wang (2005 ) ; Dechow & Sk inner (2000) Not-s ign i ficant : Chung & Kal lapur ( 2003 ) S igni ficant and posi t ive : Vander Bauwhede et a l . ( 2003 ) S ign i ficant and pos it ive Doy le. Ge & McVay (2007) M yers et a I . ( 2003 ) S igni ficant and negat ive : Chen, Chen & Su ( 200 I ) Myers et a l . ( 2003 )- th i s study used various measures of EQ 2 1 8 Regression (3) Hypothesis 2 Dependent Variable: Corporate Support research hypothesis 2 : Governance Strength (CG) I ndependent Variables: Pol it ica l i n fl uence is assoc iated Political lnjluence: with weak corporate governance Government Ownersh ip (GOY) S ign i ficant and pos i t ive S ign i ficant and posit ive: but on ly i f po l it ical i n fluence Ang & Ding (2006), Xu et a l . , ( 2005 ) refers to the ex istence of Golden share (GOLD) Not- s ign i ficant - po l it ic ian/s on the board. Pol i t ic ian/s on the board ( POL) S ign i ficant and negat ive - S ize (S IZE) S ign i ficant and posit ive S ign i ficant and pos it ive: Narn & Nam (2005 ), Yerrnack ( 1 996 ) Not-s ign i ficant : Ang & Ding (2006) Leverage ( LEV) Not- s ign i ficant Not-s ign i ficant : Ang & Ding ( 2006 ); Charitou et a l . , ( 2007) L isti ng status (LI ST) S ign ificant and posi t ive S ign i ficant and posit ive: Charitou et a 1 . , (2007) Age (AGE) S ign ificant and negat ive - Regression ( 4) and (5) Hypothesis 3 and Hypothesis 4 Dependent Variable: disclosure Support research hypothesis 3: quality (DQ) Independent Variables: After contro l l ing for po l it ica l Corporate Governance (CG) S ign ificant and posi t ive S ign i ficant and pos i t ive: i n fluence, corporate governance (a fter contro l l ing for Kent & Stewart ( 2008 ); Beekes & Brown strength is associated with low po l it ica l i n fluence) ( 2006); Bedard, Chtourou. & Courteau fi nancial report ing qua l ity but 2 1 9 (2004 ): Chen & Jaggi (2000 ): Aj inkya et a l . on ly i f fi nanc ial report ing ( 2005 ), Leung & Horwitz (2004 ): Leftwich et qua l i ty refers to d isc losure a l . ( 1 98 1 ) : Han i ffa & Cooke ( 2005 ): Ho & qua l i ty . Wong (200 I ) : Wright ( 1 996) However these studies do not control for po l it ical in fiuence and used an ind iv idual or a Support research hypothesis 4 : combination of several corporate governance mechan isms Corporate governance strength med iates the re lat ionsh ip between pol it ical i n fl uence and fi nancial report ing qua l i ty . Government Ownersh ip (GOY ) S ign i ficant and pos i t ive S igni ficant and posit ive: Eng & Mak ( 2003 ) S ign i ficant and negat ive: Aggarwal ( 1 999); Kothari (200 I ); Zhuang ( 1 999): Naser & Nuse ibeh (2003 ) Golden share (GOLD) Not- sign i ficant - Pol i t ic ian/s on the board ( POL) S ign i ficant and negat ive - S ize (S IZE) S ign i ficant and pos i t ive S ign i ficant and posit ive : Buzby ( 1 975 ) ; Kent & Stewart (2008 ) : Krishnan & Zhang (2005) ; S inghv i & Desai ( 1 97 1 ): Lang & Lundholm ( 1 993 ): Cahan et a l . (2008) : Chow & Wong-Boren ( 1 987 ); Cooke ( 1 989): Eng & Mak (2003 ): l- lan i ffa & Cooke ( 2005 ) 220 Leverage (LEY) S ign ificant and negat ive S ign i ficant and negat ive : Eng and Mak ( 2003 ) S ign i ficant and posi t ive : l nchaust i ( 1 997 ) Not s ign i ficant: Chow & Wong-Boren ( 1 987) ; Raffournier ( 1 995 ) ; Wal lace & Naser ( 1 99 5 ), Ahmad & Nichol l s ( 1 994 ) L ist i ng status (L IST) S ign i ficant and posit ive S ign i ficant and posit ive : Raffourn ier ( 1 995 ); Cooke ( 1 989); S inghv i & Desa i ( 1 97 1 ) ; Hossa in , Perera & Rahman ( 1 99 5 ); Chow & Wong-Boren ( 1 987 ) Age (AGE) S ign i ficant and pos i t ive S ign i ficant and posit ive: Chow & Wong-Boren ( 1 987) ; Cooke ( 1 989); S inghvi & Desai ( 1 97 1 ); Cheng & Courtenay ( 2006) S ign i ficant and negat ive: Ho & Wong ( 200 I ) ; Raffourn ier ( 1 995 ) 22 1 Dependent variable: earnings qual ity ( EQ) I ndependent Variables: Corporate Governance (CG) Government Ownersh ip (GOY) Golden share (GOLD) Pol it ic ian/s on the board ( POL) Not- signi ficant (after S ign i ficant and posit ive: contro l l ing for po l it ical Chtourou, Bedard & Courteau (2004 ); Saleh in fl uence ) et a l . , ( 2007); Dechow et a l . , ( 1 996) : Lara et a l . ( 2007); Shen & Ch i h (2007) ; Chen et a l . , ( 2008): K le in ( 2002 ) ; Peasne l l e t a l . , (2005 ) However these studies do not contro l for pol it ical i nfl uence and used an ind iv idual or a comb ination of several corporate governance mechan isms except for Shen and Ch ih ( 2007) and Lara et a l . , ( 2007) who used a corporate governance index Significant and pos i t ive - Not- s ign i ficant - S ignificant and negat ive - ------ - - ----- -- - -- - -- --- -- I I I I I I 222 S ize ( S IZE) Leverage (LEV) L i st i ng status (LI ST) Age (AGE) S ign i ficant and posi t ive S ign i ficant and negat ive Not- s ign i fi cant Not- sign ificant - - S ign i ficant and pos i t ive: Cahan et a l . ( 2008) ; Dechow & Dichev · ( 2002 ); Lee & Choi ( 2002 ); Myers et a l . (2003 ) I I I S ign i ficant and negat ive: I I Shen & Ch ih ( 2007) I Sign i ficant and negat ive: Sweeney ( 1 994) I I S ign i fi cant and posit ive: I I Sun et a l . 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