Ownership Structure Effect on the Extent of Segment Disclosure: Evidence from Malaysia

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Procedia Economics and Finance 2 ( 2012 ) 247 – 256

2nd Annual International Conference on Accounting and Finance (AF 2012)

Ownership structure effect on the extent of segment disclosure: evidence from

Malaysia

a*

_{Jalila J.,}

b

_{Devi S.}

Department of Accounting and Finance, Faculty of Business and Management, University Putra Malaysia, Serdang, 43400 Selangor, Malaysia

Department of Financial Accounting & Auditing, Faculty of Business and Accountancy, University of Malaya, Lembah Pantai, 50603 Kuala Lumpur, Malaysia

Abstract

This study examines the relationship between family and founding family ownership, government link companies (GLC) ownership, foreign ownership and widely dispersed ownership and segment disclosure provided by Malaysian listed firms. This study presents a more detailed analysis of segment information disclosure by utilizing both financial and non-financial data to compute the segment disclosure index that is a more robust measure of segment disclosure. We find that the increase in the family and founding family ownership influences the segment disclosure, while the GLC, foreign ownership and widely dispersedownership have no significant effect on the segment disclosure. We also find that size of the audit firm; listing status and leverage have a significant effect on the segment disclosure.

Selection and/or peer-review under responsibility of Global Science and Technology Forum Pte Ltd

Keywords: segment disclosure; family and founding family; government link companies; foreign; institutional; widely dispersed.

1. Introduction

The emergence of globalised economies have changed the way the financial information is prepared in the form of consolidated financial statements in order to cater for the growing internationalization of market trade and the prospect of most highly diversified, conglomerates and multinational companies. The

*_{Corresponding author. Tel.: +0-006-012-6562062} Email address: jalilajohari@yahoo.com

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consolidated financial statement is very crucial in showing the overall profitability, risk and the potential growth of the firms. In some ways the quality of financial information is useful to investors and analysts who undeniably rely heavily on such information in deliberating and comprehending how the various components of a complex enterprise behave economically. Therefore, the growing diversification and complexity of business enterprise, have called for the adoption of international accounting standards (now referred to as International Financial Reporting Standards) on segment disclosure which are perceived to add value to the firms’ financial reporting and thus satisfy the needs of most users. However, the quality of segment disclosures is found to decline in terms of value relevance as the firms incline to hide certain information regarding the segment activities. Nevertheless, the use of segment information in investment analysis is indisputable (AIMR, 1993). Thus the demand for better disaggregated segment information is very essential in assessing firm performance [Chartered Financial Analysts Institute (CFAI), (2006)]. The segment information is extremely important but the information provided by firms is average to below average in quality and has declined tremendously.

Prior research has investigated several issues regarding segment reporting but no study has yet examined the impact of various ownership structures on the extent of segment disclosure. Ownership structure remains as a matter of concern in most emerging market such as Malaysia, where there is concentrated ownership and control by a major shareholder, either family or state. Agency theorists posit a separation of ownership and control of the firm (Jensen and Meckling, 1976), causing potential agency problems resulting from conflicts of interest between the management and owners. The agency problem can be categorized as TYPE I and TYPE II. Type I agency problem indicates the effect of misalignment between management and owners and Type II agency problem indicates the entrenchment effect between majority owner and minority owners. In the case of Type I agency problem: “Alignment effect”, there is a separation of ownership and control of the firm and corporate management. The agency costs arise when the shareholders invest in the business but do not playing an active role in the management of the firm. As a result the managers has opportunity to act not in the best interest of the owner; “managers opportunism”. In the Type II agency problem: “Entrenchment effect”, occurs when the owners are also the managers. Generally, this phenomenon occurs mostly in family firms. The owners tend to be predators to the minority shareholders; “owner opportunism” (Shleifer and Vishny, 1997; Morck and Yeung, 2003).

In prior literature the effect of ownership on disclosures are discussed from two broad areas aspects: affect either on voluntary or mandatory disclosures which is proxies for transparency. The mandatory disclosures represent the minimum information required to be disclosed in the annual report, whilst voluntary disclosure refers to the additional information over and above the mandatory disclosure (Ho and Wong, 2001) which basically can be accessed from the chairman’s report, management discussion and analysis and operational and financial result. Moreover, the effect of the ownership structure on financial reporting aspects, including disclosures, has been discussed by many researchers. Among the issues raised is the effect associated with the concentrated ownership versus the non – concentrated ownership either in developed or developing countries. Fan and Wong (2002); Wang (2006); and Hashim and Devi (2008) discussed effect on earnings in formativeness and earnings management. Ali et. al. (2007); Huafang (2007); Chen, Chen and Cheng (2008); Chau and Gray (2010); investigated the effect on quality of disclosure (voluntary and mandatory disclosure) and Wan Hussein (2009) examined the effect on the early, full and half adopters of segment disclosure. Most of the prior studies proved that the entrenchment effect of the concentrated ownership,, consisting of founding family firm and family firm, tend to be different. The entrenchment effect of founding family firms shows they are “less likely to engage in opportunistic behaviour in reporting accounting earnings because it potentially could damage the family's reputation, wealth and long-term firm performance (Shleifer and Vishny, 1997; Morck, Shleifer and Vishny, 1988 and Morck and Young, 2003) and family firm instead are inclined to report high quality financial information. Prior studies also discussed the

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impact of large ownership structure such as the effect of institutional ownership or block ownership (Jiang, Habib and Hu, 2010) on the voluntary disclosure. However, the prior studies’ investigation on segment disclosures has not considered the impact of the various ownership structures using a comprehensive measure of segment disclosure.

Therefore, this study investigates the effect of the various ownership structures on the extent of segment disclosure. The dimensions of ownership structure in this study are shown to have strategic implications for the firms and the way management exercises power over the firms’ economic activities which is related to the firms’ segment activities. This study differs from Hussein (2009) which uses the level of adopters as proxy of transparency. Instead, in this study the extent of segment disclosure is measured by the segment disclosure index (SDI) which is developed using the financial and non–financial information disclosed by the firm as required presently under Financial Reporting Standard (FRS) 114 and other disclosures in the chairman’s statement or in management discussion and analysis. The purpose of extending the research instrument by including the content analysis approach as a tools to aids our understanding of the type of segment information that the organization are disclosing in their annual report so that we could investigate the extent of segment disclosure more comprehensively. The detailed investigation of elements segment activities’ disclosures from various sources within the annual report ensures a more robust effort to seek evidence whether the firms choose to remain opaque and reluctant to disclose high quality of segment disclsore as a result of the ownership structure.

2. Literature Review and Hypothesis Development

2.1. Managerial Ownership

It is evidenced that the disclosure orientation is very much influenced by the ownership type (Gelb, 2000). Managerial ownership is a type of ownership whereby the CEO or executive directors have certain percentage of ownership in the firms. In the case of managerial ownership, it is recognized as being crucial in generating greater alignment of interest between the management and shareholder (Jensen and Meckling, 1976; Demsetz, 1983; Shleifer and Vishny, 1986). The alignment effect arises due to fact that the increased shareholding by management may affect the control over the board. Hence, the traditional agency problem can be mitigated by enhancing the managerial ownership and thus increasing the managers’ incentive to provide more disclosure. Eng and Mak (2003) confirm this notion and show that lower managerial ownership has a negative effect on voluntary disclosure. Therefore, in the case of segment reporting we expect that the alignment effect between controlling owners and minority shareholder will give the controlling owners an incentive to avoid detailed financial information given the discretionary nature of the segment reporting standard. H1: There is a negative relationship between the managerial ownership and the extent of segment disclosure.

2.2.Family and Founding Family Ownership

In the case of the East Asian countries the controlling–shareholders holding more than 50% ownership is common and the separation of ownership and control is most pronounced among family-controlled firms (Thillainathan, 1999; Clessens et. al. 2000). Especially, the disclosure orientation of firms in Hong Kong and Singapore is influenced by the form of their ownership and management structure (Lam, Mok, Cheung, & Yam, 1994; Mok, Lam, & Cheung, 1992). However, in developing countries such as Malaysia the managerial ownership is predominantly more likely to occur when the manager is a founder of the firm or member of founding family (Classen et. al. 2002). The listed firms are usually controlled by a family group rather than

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institutional investors. Even in Malaysia and Thailand most of the listed firms is controlled by family. Morck (1996) argued that closely held firms are better able to engage in political lobbying than widely held firms. The family–controlled firms have limited incentive to disclose segment information over and above the mandatory requirement as compared to the widely –held firms. In the case of family firms, the owner- managers have created Type II (entrenchment effect) agency cost whereby the control held by the owner– managers over whelm the minority shareholder (Morck et. al. 1988; Morck, 1996; Shleifer and Vishny, 1997; Morck and Yeung, 2003). Wang (2006) evidenced that family firm’s report better quality of earnings in terms of lower absolute abnormal accrual, larger earnings and less persistent loss components. While Ali et. al. (2007) shows that family firms have larger earnings response coefficient, less positive discretionary accrual, greater predictability of cash flows and provide voluntary disclosure of bad news through earnings signal. Similarly, Jaggi et. al. (2007) show that the monitoring quality by the outside directors is reduced in family–firms which consequently lower the quality of reported earnings in Hong Kong. We therefore, hypothesize that family-firms have less incentive to disclose higher level of segment disclosure due to lower demand for this information and due to the discretion held by the owner – manager in making this disclosure: H2: There is a negative association between family and founding family ownership and the extent of segment disclosure.

2.3.Government Link Corporation (GLC) Ownership

The Government Link Corporation (GLC) is a type of corporation that is controlled by the Malaysian government via the Federal Government – Linked Investment Companies (GLICs). According to Putrajaya Committee GLC (PCG) high performance, (2007) GLCs are defined as companies that have a primary commercial objective and in which the Malaysian Government has a direct controlling stake through Khazanah, Ministry of Finance (MOF), Kumpulan Wang Amanah Pencen (KWAP), and Bank Negara Malaysia (BNM). The GLCs are also controlled by other federal government linked agencies such as Permodalan Nasional Berhad (PNB), Employees Provident Fund (EPF) and Tabung Haji. Apart from percentage ownership, controlling stake also refers to the government’s ability to appoint board members, senior management and make major decisions (e.g. contract awards, strategy, restructuring and financing, acquisitions and divestments etc.) for GLCs either directly or through Government Link Investment Companies (GLICs)

.

The role played by the GLC in the selected firms is that they have a right to appoint the members on boards of directors, as well as monitoring and controlling the decisions made by the boards. The government connection in the firms is mainly through share ownership, subsidizing activities, tax incentives and grants. In Malaysia the Government-linked companies (GLCs) dominate several sectors of the economy and account for 34% of the market capitalization of the Bursa Malaysia (Asian Development Outlook 2004 Update, Silver Book, 2006). The government share ownership is mainly affected through the government linked companies which are expected to have greater disclosure in order to mitigate the higher agency cost and to monitor any dysfunctional governance structure of the companies that they hold the ownership. In fact, Eng and Mak (2003), evidence significant relationship between government ownership with increased disclosure.

H4: There is a positive association between the GLC ownership structure and the extent of segment disclosure

2.4.Foreign Ownership

The foreign ownership is a type of ownership whereby the companies have certain percentage of foreign investors that invest in the domestic market. The foreign investors, who are likely to be less informed investor

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and coming from more transparent regimes may demand for high disclosure of financial information as compared to the local investor who are more informed and may be able to access the financial information that they need. The high disclosure of corporate information may reduce the incentives for the investors to pay more for costly private information. However, Ananchoticul (2007) and Mangena and Tauringana (2007) found that foreign investors tend to become part of insider shareholders when they have control over the firm and react like other local investors which result in weak corporate governance and consequently result in low level of disclosure. Unlike the other developing countries Malaysian firms generally have low level of foreign ownership as stated by Abdul Samad (2002) that foreign shareholdings comprise of 5.01 percent in Malaysian public listed companies. Hence, these foreign investors are expected to react more alike the minority shareholders concerning the disclosure, in which they prefer firms to provide high disclosure in turn to protect their investments. Haniffa and Cooke (2005) in their study found a significant relationship between corporate social disclosures. Hence we expect a positive association between the foreign ownership and extent of segment disclosure.

H5: There is a positive association between the foreign ownership and extent of segment disclosure

2.5.Widely dispersed ownership

Widely dispersed ownership is a type of ownership that has diverse shareholder bases. Widely dispersed ownership is a dichotomy set of ownership with the concentrated ownership. In some cases the widely dispersed ownership are named as modern type of business structure. Widely-held firms were first studied by Bearle and Means (1932) who showed that the typical large corporation in the US has become widely dispersed among a very large number of small shareholders. The shareholding of many large corporations were found to be very small indeed – in percentage terms – often less than 1% of the voting stock. Berle and Means (1932) exerted that no shareholding could be sufficiently powerful to be able to influence the management and that therefore such companies could not meaningfully be considered to be controlled by their owners. Theoretically dispersed ownership increase the agency costs the consequently effect the degree of information asymmetry between the organization and its shareholders which indeed bring an adverse investor reaction. As a result Fama and Jensen (1983) suggest that dispersed ownership structure may have incentive to provide more segment information to shareholders. In the study done by Chau and Gray (2002), and Hannifa and Cooke (2002) find a positive relationship between the dispersed ownership and voluntary disclosure, while others support a negative relationship (e.g. Barako et al., 2006; Brammer and Pavelin, 2006) or even no association (e.g. Eng and Mak, 2003). Given these mixed result in predicting the sign of the relationship between dispersed ownership and segment disclosure. Hence, we posit the following hypotheses. H6: There is a positive association between widely-held ownership and the extent of segment disclosure 3. Methodology

The selection of the sample firms is from Malaysian listed firms on Bursa Malaysia. The unit of analysis used is an annual report of the listed firms taken from securities commission listing website (Street et. al. 2000) and also from the CompuStat database. This comprehensive research data is taken for sample firms covering the annual report from the financial period (years) end of 2008. The sample data is taken from the end 2008 because Malaysia introduced significant institutional changes since 2007 to strengthen the corporate governance climate as well as moving to convergence of accounting standards with the International Financial Reporting Standards. The data is selected from the annual reports of groups that is likely to contain a high percentage of foreign operations [Nichlos and Street (2007), Tsakumis et. al (2006) and Boonlert U (2006)]. The data is selected from listed firms from all category of industry excluding companies operating in banking,

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finance, trust and insurance industry since these firms’ are highly regulated and governed by the Central Bank (reference). In addition, the listed firms must disclose both/either line of business segment and geographic segment consistently in their annual reports and these firms have consistent accounting year-end.

3.1.Segment Disclosure Index

The segment disclosure index is address the issue that the financial disclosure is too abstract that cannot be measured directly as stated by Cooke and Wallace (1989). It is suggested t the use of an index can be a proxy in getting the overall quality of financial information disclosed by firms. In this study, the robust disclosure index is developed directly through self–constructed index based on the mandatory disclosure checklist in accordance to the IAS 14 (R) and the voluntary–disclosure checklist developed by Wang, Sewon and Clairborn (2008). The checklist is based on the relevant disclosure requirement of Malaysian firms listed in Bursa Malaysia and a review of relevant literature. The segment disclosure index is aspired by the content analysis method which is commonly done in measuring the other accounting disclosures such as corporate social responsibility (CSR) (Amran and Devi, 2008; and Haniffa and Cooke, 2002). However no study has used content analysis in measuring the extent of segment disclosure. The purpose of using content analysis as way of measuring the extent of segment disclosure is to ensure that extent of segment disclosure is measured more objectively, systematic and reliable as stated by Krippendorf (1980) and Guthrie and Parker (1990). As argued by Hermann and Thomas (1997) that the extent of segment disclosure can be measured by as the number of financial statement disclosed per item but the tools used seems to be not robust enough and the extensive observation are expected in order to highlight in the narrative statement regarding the segment disclosure. As such, that the quantity and quality incorporated mutually, in the scoring system the observation on financial information will be coded based on the segment element as 0 or 1 depending on whether the segment financial information is consistently disclosed in the annual report or not. While the non – financial information will be coded using the topic – based analysis method used by Robb, Single and Zarzeski (2001) as recommended, by the Jenkins report in Australia, Canada and the US. Whereby the categories used in their disclosure scoring sheet are based upon the list of non – financial information items desired by users which is used by Jenkins committee. In the case of segment disclosure the item which is highlighted as the information desired by user is basically 4 item namely the line of business, geographical disclosure, competitor analysis and market share analysis as highlighted by Chau and Gray (2002) and further extended by Wang, Sewon and Clairborn (2008) who provided a detailed list of the market share analysis, discussion of industry trends – prior, discussion of industry trends – future and proportion of raw material purchase local other than both line of business and geographical quantitative disclosure. (The total of 4 non – financial in formations for segment disclosure and a total of 27 item of the financial information as highlighted in FRS114 were included.

SDINX = a + β1 MANOWN + β2 FOFAM + β3 INST + β4 GLC + β5 FOREIGN + β6 WIDEDISP + ∑ Control Variables + "ε" j

4. Result and Discussion

4.1.Descriptive Result

Table 1 provides the descriptive statistics. We note that segment disclosure index shows an average of 3.7 which is lower than the average level. The low level of segment disclosure is surprisingly unexpected as requirement under the accounting standard is very clear and the corporate governance initiatives require the management to be transparent. The level of ownership on the other hands shows that the family and founding family ownership contribute 11%, GLC’s contribute 3.9% of the total sample. While managerial ownership

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contribute 12.9% of the total sample respectively. Foreign ownership forms only 3% of the total sample and there are 10 firms with widely-held ownership in the total sample.

4.2.Regression Result

Table 2 shows the result of the regression and indicate that this model is significant with the adjusted R2_0.157

(p<0.001). This model supports the hypothesis H2, with the percentage of family and founding family TABLE 1: Descriptive Statistics

Min Max Mean STD Deviation

FFOUOWN .00 .66 .1099 .19126 GLCOWN .00 .62 .0386 .11145 MANOWN .00 .58 .1289 .17599 FOROWN .00 .59 .0300 .09399 DISPOWN .00 1.00 .1067 .30972 SZFIRM 6.00 10.00 8.4267 .74498 SZAUFR .00 1.00 .5667 .49720 LISTAT 1.00 35.00 12.2667 7.11994 LEV .00 193.96 24.4568 33.04793 PROFIT -28.30 15.82 2.7082 6.73125 ANALYST .00 1.00 .2533 .43638 SDINX .06 .65 .3722 .09919 TABLE 2: Regression Beta t Sig (Constant) 3.082 .002** FFOUOWN -.166 -1.868 .064* GLCOWN .026 .311 .756 MANOWN .124 1.311 .192 FOROWN -.120 -1.463 .146 DISPOWN .060 .663 .508 SZFIRM .008 .099 .921 SZAUFR .184 2.291 .024** LISTAT .278 3.391 .001*** LEV .229 2.865 .005** PROFIT .029 .373 .710 ANALYST -.017 -.217 .828

Notes: Significance at: *10; **5; 1*** percent level

R2_0.230 Adjusted R2 _0.157 F- Statistic 3.127 Sig 0.00

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shareholding being significant in this model, suggesting that the higher the percentage of shareholding by family and founding family, the lesser the extent of segment disclosure. The difference in the family and founding family ownership reveals the variation in the extent of segment disclosure. The other variables such as the size of audit firm, represented by the Big – 4 audit firms is significant, the number of years of firms’ listing in Bursa Malaysia and leverage also indicate significant effect on the extent are of segment disclosure. The significant effect of family and founding family on the extent of segment disclosure is consistent with the study done by Wan Hussein (2009)which shows that the family and founding family have less incentive to disclose all the segment information.

5. Conclusion

This study shows that the level of segment disclosure is not associated with GLC’s, institutional, foreign, and managerial and widely dispersed ownership structures. Instead the variation in the extent of segment disclosure is explained only by the family and founding ownership. The findings of this study suggest that the family and founding family ownership which represent more concentrated ownership structure as compared to widely dispersed ownership have an effect on the extent of segment disclosure. The findings of this result is not consistent in the study done by Wang (2006); Ali et. al. (2007) and Wan Hussein (2009) as their studies shows that the family firm is associated with a higher likelihood of increased segment disclosure. While in this study shows otherwise, whereby the family and founding family ownership have negative association with the extent of segment disclosure. In addition to that the firms that have been audited by Big 4 show an increase in the extent of segment disclosure. The greater the years of the firms’ listing in Bourse Malaysia the greater the extent of segment disclosure and the higher the level of leverage also have significant effect on the extent of segment disclosure.

The point of interest to be discussed based on the result is the GLC’s that should ensure there are mechanisms to increase the level of segment disclosure have failed in playing their role and putting their effort to increase the level of transparency. The role of the managerial and foreign ownership to trigger higher segment disclosure are fall short and in consequences the convergence effort are not in line with the level of disclosure as portrayed in this study. As a result the future study upon this matter must be considered what is mediating and moderating factor that might contribute to the extent of segment disclosure in order to get an overall view, why the level of segment disclosure are very low.

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