Description

Good corporate governance, in principle, has an important role to play in influencing management decision-making, aligning their objectives and activities with what’s best for shareholders. In particular that’s been reported as meaning less earnings management and quicker, more frequent disclosures to the stock market.

But is it really as simple as that? Past research has shown practices to vary by country. There’s evidence of less disclosure with increased involvement by outside board members in Singapore; in Japan, ‘better’ corporate governance is not accompanied by more timely price discovery. Perhaps even, sometimes, corporate governance is a substitute for disclosure and transparency?

In our research, we used cross-country data from 23 OECD countries. This meant we could access a far greater range and variety of examples, and make comparisons between countries. Our main sample was made up of firms with financial years ending between 1 January 2003 and 31 December 2008. We looked at company announcement information from more than 2,000 different firms, and share prices relating to 5,800 different firms. Data for company announcements were sourced directly from the stock exchanges wherever possible but for some countries alternative sources were used as the data were unavailable from the stock exchange directly, such as Perfect Information for the UK. This data includes all firm announcements and provides a comprehensive measure of firm documents released to the market.

To determine the levels of corporate governance (CG) in each company we used Institutional Shareholder Services (ISS) CG data to create an index of ‘good’ CG practice.  This includes an assessment of the function of the board and its committees, stock ownership and compensation of directors, and provisions in the firm’s charter, taking in to account the level of independence of the main board committees (audit, nomination and remuneration) which perform important roles in assisting the main board. In particular the audit committee will have oversight of financial reporting and disclosures made by the firm; as well as responsibility for monitoring the internal audit and independent external audit process. The existence of these kinds of structures should improve overall disclosure and transparency.

The research asked questions about the association between ‘better’ CG and disclosure (in terms of

the number of documents released to the stock exchange), as well as the timeliness of disclosures, and the speed with which value relevant information is incorporated into share prices – important aspects of a firm’s transparency. To assess the timeliness of prices we focused on the flow of information to the market up to the time of the company’s annual earnings release and we assess the speed with which that information is integrated into share prices. We also then investigated differences across countries with different levels of investor protection and litigation pressure.

Our results suggest better CG is associated with a greater number of disclosures to the stock market (i.e. a complementary relationship between CG and firm disclosure). This is consistent with research carried out for Australia, Canada and Japan. Our analysis of the timeliness of disclosures suggests better-governed firms are more timely on the whole at releasing documents to the stock market. Also in common law countries, better governed firms increase the timeliness of documents relating to bad news items, demonstrating a conservative bias.

But when it comes to transparency, we find better CG is not associated with more timely price discovery. This would suggest firms with better CG substitute governance processes for greater transparency, proxied by more timely release of information to the share market, or alternatively that market participants take longer to digest the greater amount of information disclosed by better-governed firms. Additional analysis suggests CG is effective at increasing the timeliness of prices for firms in common law countries where there is a low level of firm disclosure (relative to their industry and country).

Our analysis also considers the impact of share ownership. Firms with greater proportions of closely held shares are associated with fewer disclosures, which is consistent with the view that firms controlled by insiders are less willing to release information to outside parties. We also find evidence that closely held shares are associated with more timely good news (in documents and in prices).

Future work we have in progress examines the effect of CG and ownership on analyst following and the properties of analyst forecasts. As the results of this study show, better-governed firms release more information. So the question remains: is this information processed effectively by analysts, and if so, how is it reflected in attributes of their forecasts? The answer may shed further light on our results for the timeliness of price discovery and help explain some unexpected findings.