Corporate governance and forward-looking disclosure: Evidence from China

Accepted Manuscript Title: Corporate Governance and Forward-looking Disclosure: Evidence from China. Author: Sun Liu PII: DOI: Reference:

S1061-9518(15)00023-3 http://dx.doi.org/doi:10.1016/j.intaccaudtax.2015.10.002 ACCAUD 203

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Journal of International Accounting, Auditing and Taxation

Received date: Revised date: Accepted date:

16-2-2014 25-9-2015 1-10-2015

Please cite this article as: Liu, S.,Corporate Governance and Forward-looking Disclosure: Evidence from China., Journal of the Chinese Institute of Chemical Engineers (2015), http://dx.doi.org/10.1016/j.intaccaudtax.2015.10.002 This is a PDF file of an unedited manuscript that has been accepted for publication. As a service to our customers we are providing this early version of the manuscript. The manuscript will undergo copyediting, typesetting, and review of the resulting proof before it is published in its final form. Please note that during the production process errors may be discovered which could affect the content, and all legal disclaimers that apply to the journal pertain.

Corporate

Governance

and

Forward-looking

Disclosure:

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Evidence from China.

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Sun Liu

International Business School Suzhou,

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Xi’an Jiaotong-Liverpool University,

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[email protected]

SIP, Suzhou, 215123

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China

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111 Ren’ai Road, Dushu Lake Higher Education Town,

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Corporate Governance and Forward-looking Disclosure: Evidence from China.

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Sun Liu International Business School Suzhou Xi’an Jiaotong-Liverpool University 111 Ren’ai Road Dushu Lake Higher Education Town, SIP, Suzhou, 215123 [email protected]

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Corporate Governance and Forward-looking Disclosure: Evidence from China ABSTRACT

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This paper investigates the association between a range of corporate governance mechanisms and forward-looking disclosure (FLD) in a low information environment: the Chinese stock

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markets. It finds that the implementation of certain monitoring and control mechanisms, such as financial expertise on audit committees and independent directors on the board of directors,

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can improve the extent of FLD. However, the size of the supervisory board and separating the roles of the CEO and the chairman of the board of directors is of little help in explaining any

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improvement in FLD. In contrast, ownership structure appears to play an essential role in

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determining FLD policies. Indeed, listed firms with high levels of foreign ownership and fewer pyramidal layers in their ownership structure tend to disclose more forward-looking

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information. Of particular interest, the association between state ownership and FLD is likely

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to be non-linear (an inverted U-shape), and the inflection point at which the association becomes negative occurs at a state ownership over 33 percent. In summary, this study

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provides new evidence on the impact of corporate governance mechanisms on FLD in China’s unique institutional environment.

Key words: Corporate Governance, Forward-looking Disclosure, Information Asymmetry, China

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1. Introduction Under the principal agent model, information asymmetry can considerably influence

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the contractual relationship, as agents who benefit from their private information lack incentives to reveal their insights. As such, there is a demand for corporate information

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disclosure by the principal and other information users (Beyer et al., 2010; Machio-Stadler,

Perez-Castrillo, & Watt, 2001). As a vital source of corporate information, forward-looking

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disclosure (FLD) can be an essential factor to assist information users to better understand what a firm’s previous and present performance may be in the future (Bozzolan, Trombetta,

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& Beretta, 2009; Robert, 2010). In recent years, the research on forward-looking narratives in

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financial reports has been gaining increasing prominence. However, most studies focus on the usefulness, predictive value, and value relevance of FLD in developed markets (Athanaskou

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& Hussainey, 2014; Beyer & Dye, 2012; Hussainey & Walker, 2009; Rogers & Stocken, 2005;

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Wang & Hussainey, 2013). The research on FLD in emerging markets is sparse. China is an interesting case because of its unique institutional environment. For

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example, listed Chinese firms typically have a more complex ownership structure than those in the West, and a considerable proportion of listed companies’ shares are held by the government. Concentrated state ownership can impede corporate information transparency and trigger conflicts of interest between the state and minority shareholders (Su, Xhu, & Phan, 2008). Consequently, the Chinese government has recently imported a stream of advanced corporate governance mechanisms from developed nations, with the aim of strengthening the internal monitoring and control of listed firms and improving the information environment of Chinese stock markets. In the meantime, Chinese accounting standards (CAS) have been gradually harmonized with international accounting standards (IAS/IFRS). Moreover, the China Securities Regulatory Commission (CSRC) issued the Principles of Contents and

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Formats for Financial Disclosure by Listed Chinese Firms in 2002, requiring a forwardlooking statement to be provided in financial reports. The convergence of CAS with IAS/IFRS and the development of financial disclosure regulations obviously aim to facilitate

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listed firms’ mandatory disclosure by providing more value-relevant information to investors. Additionally, the government has recently issued a series of polices on equity incentive plans

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for listed firms to mitigate the interest conflicts of the agent and the principal and to facilitate corporate information transparency. However, reforms in the legal and political systems have

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largely lagged behind, as a result of the government’s concerns regarding losing control of

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large listed firms and the safety of state assets. Therefore, while the economic system is largely market-oriented, the legal and political systems are still strongly influenced by the

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communist ideology (Allen, Qian, & Qian, 2005). The unique features of China’s institutional environment, along with the development of FLD regulations by the CSRC, provides an

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Chinese firms.

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opportunity to investigate the impact of improved corporate governance and FLD by listed

The following observations have been made from an analysis of a sample of SHSE

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(Shanghai Stock Exchange) listed firms’ forward-looking statements and financial data over the period 2008–2012. First, although the majority of listed firms have complied with the CSRC’s disclosure regulations by providing a forward-looking statement in their financial reports, these statements contain far more qualitative (soft) information than quantitative (hard) terms. Second, consistent with early studies, this investigation finds that the extent of FLD is positively associated with foreign ownership (Owusu-Ansah, 1998; Wang, Sewon, & Claiborne, 2008), independent directors (Beeks & Brown, 2006, Donaldson & Davis, 1994; Tam, 1999, 2000), and financial expertise on the audit committee (Badolato, Donelson, & Ege, 2014), and negatively related to complex pyramidal ownership structure (Chang & Wong, 2004; Fan & Wong, 2002). Interestingly, the impact of state ownership on FLD is

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likely to be non-linear (an inverted U-shape). Initially, the impact is positive when the level of state ownership is lower than 33 percent (the inflection point). However, the impact becomes negative when the state owns more than one-third of listed firms’ equity. In contrast

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to the study by Ding, Zhang and Zhang (2007), this study does not find any non-linear association between managerial ownership on FLD for SHSE-listed firms. Also, it finds that

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the size of the supervisory board and separating the roles of the CEO and chairman of the board of directors is of little help in explaining any improvement in FLD.

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The contribution of this study to corporate governance and disclosure research lies in

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the following areas. First, it reconciles and extends the ongoing research on the determinants of corporate disclosure in developing markets (Bai et al., 2004; Beeks & Brown, 2006; Chen

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et al., 2014; Eng & Mak, 2003; Gul & Leung, 2004; Owusu-Ansah, 1998; Wang et al., 2008). To the best of the author’s knowledge, this is the first research paper that investigates the

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impact of corporate governance on FLD in a large emerging market. In particular, this study

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provides new evidence of a non-linear association between state ownership and FLD. Second, it examines the success of the Chinese government’s importation of a wider range of

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corporate governance mechanisms than prior studies have done (Chen et al., 2014; Ding et al., 2007; Wang et al., 2008; Yeh et al., 2009). For example, this research demonstrates that more financial expertise on an audit committee can improve its role in facilitating the extent of FLD, while the use of a complex pyramidal ownership structure by the government to mask its continued control over listed firms can exacerbate agency problems and make FLD less transparent. Also, it examines the combined effect (incentive-alignment vs. management entrenchment) of managerial stockholding on managers’ willingness to provide more valuerelevant information, such as forward-looking narratives, in listed firms’ financial reports. This study therefore increases our understanding of the determinants of corporate disclosure in an institutional environment that is characterized by concentrated state ownership and

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complex ownership structures. The remainder of this study is organized as follows: The next section reviews developments in China’s accounting and corporate governance regulations, previous

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corporate governance and disclosure research, and develops the study’s hypothesis. The sample selection and research methodology are presented in Section 3, and Section 4 reports

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the empirical findings and analysis. The final section summarizes and concludes the study.

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2. Background and Hypothesis

2.1. China’s Stock Market, Accounting and Corporate Governance Systems

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In accordance with the economic liberalization and reform policy introduced by the Chinese government in the late 1970s, the SHSE and Shenzhen Stock Exchange (SZSE) were

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re-established in the early 1990s, aiming to modernize ailing state-owned enterprises (SOEs). However, they remain relatively underdeveloped and many listed companies are still directly

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or indirectly owned or controlled by the state, raising the possibility of conflict of interest

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between the controlling shareholders (the state and its agencies) and outside investors (Su et al., 2008). Moreover, while La Porta, Lopez-de-Silanes and Shleifer (2008) classify China’s

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legal system as being of German civil law origin, a unique feature of China’s legal tradition is that the judicial system is not independent from the government’s administrative system, and politics and adjudication are often mixed (Chen, 2003). Indeed, private property rights were recognized by China’s legislative system for the first time in March 2004 during the second session of the Tenth National People’s Congress Meeting. However, the definition and explanation of private property rights within listed Chinese firms remain “fuzzy”, and violation of private property rights by the government, especially at the local government level, remains relatively common (Deng, 2009; Sanders & Chen, 2005). Given the concentrated state ownership, unclear laws governing private property rights, and a lack of judicial independence, China’s political institutional norm is in favor of protecting state

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interests instead of the rights of individuals. Hence, corporate managers and auditors have little incentive to actively communicate with minority or individual investors, which can lead to high levels of information asymmetry (Brown, Beeks, & Verhoeven, 2011; Chen, 2003).

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China’s old accounting system, borrowed from the Soviet Union in the 1950s, had been a tool to facilitate the government’s administration of SOEs and to safeguard the state’s

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interests. It was therefore ill-equipped to meet the needs of stock market participants for

comprehensive information for investment decision-making (Tang, Chow, & Cooper, 1994).

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Thus, the Ministry of Finance (MoF) issued a series of accounting reforms commencing with

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the Accounting Regulations for Experimental Listed Companies and the Accounting Standards for Business Enterprises (ASBE) in 1992. These regulations borrowed many

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accounting principles from Western accounting, in particular the International Accounting Standards Committee. Further regulations in 1998 (Accounting Regulations for Listed

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Companies) and 2000 (revised ASBE) brought “accounting practice in China more closely in

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line with international practices, including a requirement to recognize impairment losses on receivables, inventories, investment, fixed assets, intangibles, and other assets” (Pacter &

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Yuen, 2001, p. 1). Similarly, the MoF approved four auditing pronouncements in 2002 (Specific Independent Auditing Standards, Equivalent International Auditing Standards, Independent Auditing Practice Pronouncements, and Equivalent International Auditing Standards) largely based upon international auditing standards. While these regulations succeeded in bringing Chinese accounting and auditing more into line with international accounting and auditing practices, some significant differences still existed with Chinese accounting rules, generally resulting in less informative accounting information. For example, there were very few requirements for fair value accounting. In line with the government’s economic policy, new corporate governance rules also were introduced, initially through the State-owned Industrial Enterprises Law of China

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(SOEs Law) in 1988. As Tam (2000) documented, this development “has taken a top-down legalistic approach by transplanting the basic structures of corporate governance from the external market based model found in Anglo-American systems” (p. 53). However, while

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these corporate governance rules have been introduced, the system of related laws and regulations that ensure the efficiency of the corporate governance model have not been

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effective, and the government focuses rather less on how the corporate governance concepts and practices are interpreted and applied in the Chinese social, economic, and legal context

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(Li, 2008). For example, there is a need for an impartial judicial system that effectively

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protects the interests not only of controlling shareholders, but also of minority shareholders as well as active markets for corporate control and managerial talents (La Porta et al., 1998,

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2002). As a result, the Chinese corporate governance system, despite importing the “best practices” from the West, does not work in their proposed way. In particular, the highly

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concentrated state ownership triggers interest conflicts between minority and controlling

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shareholders, as there is a growing concern that the government may make political objectives the top priority over the corporation’s commercial interests, and then potentially

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misuse its controlling shareholder position to expropriate the minority shareholders’ interest (Su et al., 2008). In order to mitigate the interest conflicts between the government and other shareholders, the CSRC has issued the Code of Corporate Governance of Listed Firms in January 2001 and revised it in October 2005. The Code was especially designed to protect minority shareholders’ interests by requiring the controlling shareholder(s) not to act in a detrimental way to other shareholders’ legal rights and interests, such as by taking advantage of their position to adversely restructure the listed company’s assets. Furthermore, the Code stresses the importance of the timeliness and accuracy of corporate information disclosure. It particularly points out that listed firms should not only disclose the compulsory information mandated by regulations, but reveal other information that may impact the decision-making

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of shareholders and stakeholders. Obviously, this aims to introduce a solid corporate governance system by elevating the requirements on corporate information disclosure and tightening the supervision of corporate management.

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In addition to the development of new corporate governance rules, the CSRC issued new corporate disclosure regulations—the Administrative Measures on Information

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Disclosure by Listed Firms (AMID)—in January 2007, which came into effect immediately. In light of the new disclosure regulations, all listed firms are required to make periodic

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disclosures of their business activities, financial performance, forward-looking narratives,

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corporate governance and ownership structure. Moreover, listed firms must publish their quarterly reports within one month following the end of the first and third quarters of a fiscal

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year, and interim reports within two months following the end of the first half of the fiscal year. Annual reports are required to be made publically available within three months

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following the end of a fiscal year, and be audited by a qualified CPA firm. However, quarterly

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reports are free from the external audit requirement, while interim reports need to be externally audited only if listed firms plan to pay dividends, transfer reserves into share

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capital, or use reserves to offset losses in the next half of the fiscal year (Piotroski & Wong, 2013). Furthermore, in order to improve the accountability of periodic reports, senior managers and directors are required to sign their consent or dissent with the reports. If external auditors issue a modified audit opinion, directors are required to provide a specific explanation on the matter. Apart from these periodic reporting requirements, listed firms need to file specific reports on “major events” that are not known to investors and may considerably affect the price of listed firms’ stock (Piotroski & Wong, 2013). Previous studies suggest that the 2007 AMID has had a positive impact on the information environment in the Chinese stock markets. For example, Gong and Marsden (2014) report strong evidence that the 2007 AMID significantly increased the level of price-sensitive information disclosed by

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listed firms. 2.2. Hypothesis Development Because of the separation of ownership and control, the principal engages the agent to

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perform services on behalf of the principal, which involves the delegation of some decisionmaking authority to the agent. Once the contractual relationship is established, the agent

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obtains information on the environment that will determine which effort level is the most

adequate (Jensen & Meckling, 1976). However, it is difficult for the principal to observe the

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agent’s effort and to know whether the agent’s effort is optimal. Under information

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asymmetry, the agent may act in his/her own best interests, rather than those of the principal. This can cause the problem known as “moral hazard with hidden information” (Machio-

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Stadler et al., 2001). The principal therefore establishes various monitoring and control mechanisms, such as corporate governance, to mitigate this problem and improve corporate

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transparency (Beeks & Brown, 2006; Eng & Mak, 2003).

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There is much evidence that financial reporting and disclosure are primarily determined by the preparers’ incentives, which are shaped by the institutional environment,

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including corporate governance, ownership, and control characteristics (Ball, 2001; Ball, Ashok, & Joanna, 2003; Dobler, 2008; Heitzman, Charles, & Zimmerman, 2010; Leuz, Nanda, & Wysocki, 2003; Zechman, 2010). Given the rapid changes in China’s corporate governance practices in recent years, coupled with the unique features of the Chinese economic, political and legal environments, this study develops the following research hypotheses, presented below. 2.2.1. Ownership Structure The ownership structure of a company is likely to affect its disclosure policy in a number of ways. For instance, with dispersed ownership structures, US and UK companies tend to use market mechanisms to discipline managers, and alleviate agency costs through

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improved corporate disclosure (Pratt & Storrar, 1997). In contrast, German and French companies have more concentrated ownership structures, and block holders rely on insider monitoring mechanisms to obtain corporate information. Financial reporting and disclosure

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therefore appears to be less in demand in these Code Law countries (Archambault & Archambault, 2003; La Porta et al., 1998). A stream of empirical studies has investigated the

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relationship between disclosure and ownership structure in specific countries, with mixed results. For example, Eng & Mak (2003) document that the block holder ownership of

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Singapore listed firms is not related to disclosure, while Fan and Wong (2002) report that

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concentrated ownership has a negative impact on the informativeness of earnings in East Asian nations.

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Chinese firms typically have a more complex share ownership structure than in the West, with shares being of four types: non-tradable state shares; legal person shares, which

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are held by other SOEs and tradable with the approval of the CSRC or the government;

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domestic individual or A-shares, held by private Chinese citizens; and employee shares, which are non-tradable until the firm allows them to be traded. In addition, some firms also

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have foreign shares, whether B-shares (listed on the SHSE or SZSE), H-shares and RedChips (listed on the Hong Kong Stock Exchange), L-shares (listed on the London Stock Exchange), or N-shares (listed on the New York Stock Exchange). Most listed Chinese firms were initially state-owned, and the state still has a strategy

of control of “large and crucial” industries. Thus, approximately 30 percent of listed firms’ shares are directly held by the government, 30 percent by legal persons and 30 by the general public (SHSE Statistical Yearbook, 2008). This concentrated state ownership could impede the development of high quality corporate disclosure, as the government and its agencies are insiders who can directly obtain private information from entities (Armstrong, Guay, & Weber, 2010; Firth et al., 2007). Furthermore, the preponderance of state ownership may

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result in less effective management monitoring and internal control, which is likely to also negatively impact on corporate disclosure. However, some early studies argue that block holders could be effective monitors of a firm’s activities, because they frequently retain the

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ability to intervene in the firm’s strategic decisions, and then have incentives to ensure an information environment sufficiently transparent so as to remain well informed about the

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firm’s activities (Borokhowich et al., 2006; Klein, 2002). Therefore, block holders are willing to improve corporate disclosure for their own ends, such as to boost the share price if they

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have good news that is unknown to outsiders, or to lower the cost of equity capital (Haw et al.,

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2010). Indeed, Wang et al. (2008) report that the level of voluntary disclosure by B-share firms is positively associated with state ownership. Given that previous studies provide mixed

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evidence, it is expected that:

H1: There is a relationship between the extent of FLD and the level of state ownership.

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Moreover, the concentrated state ownership could trigger “principal-principal”

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conflicts, as minority shareholders are concerned about the potentially misuse of the controlling shareholder position by the government to expropriate their interests (Su et al.,

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2008). To mitigate these principal-principal conflicts, the government has committed to reduce its presence in publicly listed firms. The State-owned Assets Supervision and Administration Commission (SASAC), a central government agency, was established in 1999 to play a key role in this plan. More specifically, State-owned Asset Management Companies (SOAMCs) were founded under the SASAC to divest state ownership stakes in publicly traded firms. State-owned shares have been removed from the “state share” to “institutional shares” category, placing those shares in SOAMCs and under control of the SASAC. Consequently, the number of shares held by the state in listed firms has gradually declined (Ding et al., 2007). Given that the SOMACs are usually owned by central and local government administrative offices, transferring the “state share” to “institutional shares”

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category actually masks continued state ownership over publicly listing through a pyramidal ownership structure (Wang, Guthri, & Xiao, 2011). Some researchers argue that under this pyramidal ownership structure, the government or its agencies could delegate decision-

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making authority to managers without giving up its control over listed SOEs. As a result, the political costs derived from government interference in listed firms’ operations can be

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mitigated, and managers are likely to induce high-power incentives and improve firm

performance (Fan, Wong, & Zhang, 2007; Lin & Li, 2008; Qian, 1996; Wang et al., 2011).

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However, other studies document that empowered managers may act in self-interest at the

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expense of shareholders, such as by expropriation of substantial gains from listed firms, especially if there is no effective monitoring and control system in place (Aghion & Tirole,

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1997). Furthermore, additional pyramidal layers in ownership structure could exacerbate agency problems, making corporate information less transparent, because information at the

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bottom of the pyramid typically travels through multiple layers to reach the top, and

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managers in the intermediate layers, constrained by their own self-interests, may not disclose corporate information to top management in a timely and objective manner (Aghion & Tirole,

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1997; Baker, Robert, & Kevin, 1999). This view is empirically supported by Fan and Wong (2002) in that controlling owners of East Asian firms typically use stock pyramids to leverage their control, resulting in reduced informativeness of their accounting earnings. Given the above competing views provided by the early literature, it is predicted that: H2: There is a relationship between the extent of FLD and the number of layers in a firm’s pyramidal structure. Since the 1980s, foreign multinational companies have invested heavily in China’s manufacturing sector through establishing joint-venture enterprises with domestic firms. However, because of the unfamiliar social environment and their lack of local connections and networks, foreign shareholders are likely to face high levels of information asymmetry (Wang et al., 2008). Therefore, foreign investors are more likely to invest in Chinese firms 14

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that are already well-governed and that produce high quality corporate information. Bai et al. (2004) find that listed Chinese firms that issue foreign shares are likely to have higher market value. In order to alleviate these high levels of information asymmetry for foreign investors,

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the CSRC requires that joint-venture enterprises must adopt a “dual reporting strategy”, in which their annual reports must be prepared in line with both CAS and international

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accounting standards (IAS/IFRS). Furthermore, these enterprises must engage foreign CPA

firms (normally Big-4) to audit their annual reports. It is widely accepted that IAS accounting

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regulations are superior to the CAS, implying that the reconciliation and dual reporting

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mechanism should improve the reliability of corporate information. Because enterprises with foreign investment must abide by these additional reporting and auditing requirements, they

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disclose more corporate information. Several early empirical studies report that listed Chinese firms with high levels of foreign ownership tend to voluntarily disclose more corporate

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hypotheses:

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information (Wang et al., 2008; Xiao, Yang, & Chee, 2004). This leads to the following

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H3: There is a positive relationship between the extent of FLD and the level of foreign ownership. Jensen and Meckling (1976) argue that agency costs will decline as managerial

ownership rises, because with the increase in managerial ownership, managers will pay a larger share of these costs and are less likely to squander corporate wealth. Moreover, Stulz (1988), Morck, Shleifer and Vishny (1988) and Shleifer and Vishny (1989) document that if managers own only a small fraction of shares, managerial ownership can help to align the interests of managers and shareholders by constraining the consumption of perks and engagement in sub-optional investment policies (incentive alignment effect). However, if managers control a substantial fraction of shares, they tend to entrench themselves and then indulge their preferences for non-value-maximizing behaviors (management entrenchment effect). Given the two competing views, a stream of early accounting and corporate finance 15

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studies find that the impact of managerial ownership and firm performance is likely to be non-linear (Adams & Santos, 2006; Florackis, Kostakis, & Ozkan, 2009; Hu & Zhou, 2008; McConnell & Servaes, 1990; McConnell, Servaes, & Lins, 2008).

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In China, managerial ownership falls into the category of employee shares, and the overall level of managerial ownership in listed Chinese firms is relatively low. For example,

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prior to 2005, a listed Chinese firm was only allowed to allocate up to 2.5 percent of its total outstanding shares to its employees when going public, and managers could not be granted

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company shares in any other way, although they could purchase shares on the stock market

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using their personal funds (Hu & Zhou, 2008; Wei, Xie, & Zhang, 2005). Also, unlike Western enterprises, which use equity incentives widely to align management and

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shareholders’ interests, for most listed Chinese firms, managerial compensation is more closely linked to accounting results, such as sales or profits, instead of the stock price

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(Groves et al., 1994). Consequently, managers are tempted to engage in opportunistic

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earnings and disclosure management, in order to secure their own performance-related pay, but at the expense of shareholders’ interests (Su et al., 2008). Therefore, since 2005, the

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Chinese government has issued a series of policies on the implementation of equity incentive plans for listed firms. For example, the Trial Measures for the Administration of Equity Incentive Plans of Listed Firms was issued by the CSRC in 2005, and the MoF and the SASAC jointly issued the Trial Measures of Implementing the Equity Incentive System by State-Controlled Listed Firms (Domestic and Overseas) in 2006. Later, the CSRC issued the Memorandum on Issues Concerning Equity Incentives (No.1, No.2, and No.3) in 2008. The main purpose of these policies is to mitigate agency costs by aligning the interests of managers and shareholders, especially minority shareholders. Therefore, with the increase in managerial ownership, managers are less likely to withhold private information and engage in disclosure management. Nasir and Adbdullah (2004) support this view by documenting that a

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high level of managerial ownership leads to improved voluntary disclosure in Malaysia. On the contrary, the management entrenchment hypothesis by Shleifer and Vishny (1989) argues that excessive insider ownership can be counterproductive and result in increased incentives

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for opportunistic earnings and disclosure management. Moreover, investigating the combination of the incentive alignment effect and management entrenchment effect,

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Sánchez-Ballesta and García-Meca (2007) and Ding et al. (2007) find that there is a nonlinear (inverted U-shape) relationship between managerial ownership and earnings

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management. These findings suggest that at a low level of managerial ownership, the

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incentive alignment effect dominates the management entrenchment effect, but above a certain level, the management entrenchment effect is the dominating factor. Therefore, it is

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predicted that:

H4: There is a non-linear relationship between the extent of FLD and the level of managerial ownership.

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2.2.2. Role of Independent Directors and the Supervisory Board

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The board of directors is another key element of corporate governance, and its

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composition can considerably affect a company’s disclosure practices (Roche, 2005; Solomon, 2007). There are two different board structures, either the unitary board that is commonly adopted by US and UK companies, or the dual board widespread in mainland EU companies. The UK/US unitary or one-tier board is characterized by the importance of independent directors, who are expected to play the central role of control, acting as a counterweight to executive directors. On the other hand, the particular feature of the dual board model is the existence of both a management board and a supervisory board. While the two boards are expected to co-operate closely, the management board is responsible for daily business management and business strategy development, and the supervisory board is supposed to regularly provide independent advice to, and supervision of, the management board. More importantly, the supervisory board can appoint management board members and 17

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decide upon senior managers’ and executives’ compensation (Franks & Mayer, 2001). As such, both independent directors and supervisory board members need transparent, timely and comprehensive corporate information as a necessary means of management monitoring

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and internal control. This view is supported by several prior studies documenting that there is a positive relationship between the proportion of independent non-executive directors (INDs)

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and the comprehensiveness of financial disclosure (Beeks & Brown, 2006; Gul & Leung,

2004). However, Yermack (1996) reports that firm value of large US industrial corporations is

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negatively associated with board size, suggesting more members on the board of directors

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could impede the board’s efficiency.

China’s corporate governance infrastructure has been established recently by

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borrowing “the best ideas and practices” from developed nations, such as the US, the UK, Germany, and Japan. For example, listed Chinese firms adopt a hybrid model, combining a

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dual board structure with the presence of independent directors. However, different to the

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superior-subordinate relationship between the supervisory board and management board in EU nations (e.g., Germany or France), China’s supervisory board has no rights to vote on any

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decisions made by the management board and to appoint or remove directors and managers (Cho & Rui, 2009; Hu, Tam, & Tan, 2010). Although the Company Law (1993) stipulates that the supervisory board is responsible for monitoring directors’ decision-making process and reviewing internal financial affairs to ensure the accuracy and completion of financial reports, without the voting rights, the performance of China’s supervisory board is found to be largely ineffective and members of the board have been deliberately sidelined by directors and managers (Chen, Firth, & Xu, 2009; Dahya et al., 2003; Tam, 1995). Indeed, Ding et al. (2010) provide empirical evidence that listed Chinese firms with larger supervisory board size tend to have higher executive compensation but lower pay-performance sensitivity, suggesting poor corporate governance quality. Thus, in light of above discussions, it is

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predicted that: H5: There is positive relationship between the extent of FLD and the proportion of independent directors.

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H6: There is a negative relationship between the extent of FLD and the size of the supervisory board. 2.2.3. Dominant Person

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According to the UK Cadbury Report (1992), having no dominant person who can gain “unfettered” control over the board shows that the power between board members is

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well-balanced. Additionally, Donaldson and Davis (1994) document that splitting the roles of

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the chairman and the chief executive (CEO) demonstrates a corporate performance initiative that can mitigate the principal-agency problem and lead to more independent decision-

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making. If board members are more independent from senior managers and executives, for the purpose of effective monitoring and control board directors will require great extents of

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corporate disclosure. However, Daily and Dalton (1997) document that the improvements

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thought to arise from splitting these roles may be a case of wishful thinking, given that there is lack of persuasive empirical evidence to support the above theory in practice.

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For many listed Chinese companies, the CEO, chairman, and most senior managers

and directors are appointed by the controlling shareholder (the state). Therefore, it is unlikely that board members are independent from executive managers, and decision-making by the director board must be in line with the interests of the state, regardless of whether the roles of CEO and chairman are entitled to one person. As such, to split the roles of CEO and chairman is less likely to fundamentally change the features of a Chinese directorial board and improve corporate disclosure practices. Although the separation of the chief executive and chairman roles may not necessarily result in greater corporate disclosure (Daily & Dalton, 1997), this study still anticipates that: H7: There is a negative relationship between the extent of FLD and the combined roles of CEO and chairman of the board. 19

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2.2.4. Financial Expertise on the Audit Committee It is widely accepted that audit committee members who have accounting and finance

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backgrounds are in a better position to evaluate financial reporting quality and to understand auditors’ judgments. As a result, having such members on the committee can enhance its

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oversight role in the financial reporting process, and lead to improved corporate disclosure

(Mangena & Pike, 2005; McDaniel, Martin, & Mines, 2002). For example, Section 407 of the

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Sarbanes-Oxley Act (SOX) of 2002 required publicly listed US firms to disclose designated

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financial experts in an effort to “enhance investor’s confidence in the fairness and integrity” of financial reports. Furthermore, in 2003 the Securities Exchange Commission suggested

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that having at least one financial expert on the audit committee should improve financial reporting quality, and this view is supported by early empirical studies. Mangena and Pike

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(2005) document that the extent of interim disclosure is positively associated with audit

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committee financial expertise. Badolato et al. (2014) provide evidence of a significant negative relationship between financial expertise on the audit committee and levels of

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earnings management. In China’s case, the State Economic and Trade Commission and the CSRC jointly issued the Code of Corporate Governance for Listed Firms in 2002, requiring listed firms to establish an audit committee (under the board of directors) with the main responsibilities of proposing to hire or fire external auditors, overseeing internal audit processes, and examining financial reporting and disclosure. Also, the Code specifies that the majority of audit committee members must be independent directors, and at least one member on the committee must have accounting or related financial management expertise. When a listed firm’s audit committee possesses the knowledge necessary to understand technical auditing and financial reporting, the effectiveness of the committee is improved, resulting in less earnings and disclosure management. It is therefore expected that:

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H8: There is a positive relationship between the extent of FLD and the proportion of financial expertise on audit committee. 3. Sample Selection and Research Design 3.1. Sample selection

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The sample consists of all Chinese firms listed on the SHSE with financial data available on the China Stock Market and Accounting Research database for the period 2008–2012. This

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study chooses SHSE listed firms mainly because many of these are restructured SOEs and still under the influence or control of the state. The test period starts from 2008 to avoid the

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potential effect of changes in Chinese accounting standards on FLDs, because the new ASBE

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that came into force on 1 January 2007 is considerably different to the previous one; the new ASBE is largely in line with IAS/IFRS.

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Listed firms’ corporate governance information, including ownership structure, the board of directors and supervisory board, is available from their annual reports. Therefore,

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the listed firms’ annual reports were downloaded from the CSRC approved corporate

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disclosure website (http://www.cninfo.com.cn/). Following previous studies (Chen et al., 2014; Wang et al., 2008), financial institutions were excluded from the sample. These selection

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criteria yielded a sample of 4,253 firm-year observations. 3.2. Measuring the Extent of FLD In 2002 the CSRC issued the Principles of Contents and Formats for Financial

Disclosure by Listed Chinese Firms, requiring all listed firms to provide a forward-looking statement in their annual reports, and this disclosure regulation was revised in 2007. The revised 2007 disclosure regulation provides certain guidelines on what types, and what extent, of corporate information should be included in the forward-looking statement. However, there is still some space left for listed firms to disclose forward-looking information in a discretionary manner. Moreover, FLD items, such as a listed firm’s internal strategies and external competitive and regulatory environment, can be of a very diverse nature. In

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particular, these disclosure items can be characterized by a different degree of verifiability. Hutton, Miller and Skinner (2003) and Brockman and Cicon (2013) document that certain forward disclosure information, such as managerial earnings forecasts, are vital to investors’

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decision-making, because unlike “soft talk”, it is verifiable and can enhance the creditability of a forward-looking statement. Therefore, the extent of FLD is measured as 0 for firms that

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fail to provide a forward-looking statement, 1 for firms that provide such a statement but

without any quantitative information (e.g., managerial earnings forecasts), and 2 for firms

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that provide a forward-looking statement with quantitative information.

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3.3. Empirical Model

An ordered probit model was employed to examine the impact of corporate

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governance on listed Chinese firms’ FLD. Therefore, the extent of FLD is used as dependent variables, and the explanatory variables consist of a range of corporate governance

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mechanisms. Specifically, following Sánchez-Ballesta and García-Meca (2007) and Ding et

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al. (2007), managerial ownership and quadratic managerial ownership are used to test the potential non-linear association between managerial ownership and FLD. In addition,

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following prior studies, the firm size, performance, demand for external finance, leverage, market-to-book ratio, external auditors, and a regional economic development dummy were added as control variables (Archambault & Archambault, 2003; Bozzolan et al., 2009; Chen et al., 2014; Meek, Roberts, & Gray, 1995). Furthermore, because some Chinese firms have issued B-shares (foreign shares) and/or listed on foreign stock exchanges, two dummy variables were employed to control for B-shares and cross-listing. As such, the detailed form of the test model is presented below: Prob( FLD it )    1 SOit   2 FOit   3 LAYER it   4 MOit   5 MOit2   6 INDit   7 SUPit   8 DPit   9 F _ EXPit   1 LnTAit   2 ROCE it   3 EFD it   4 LEV it   5 M / Bit   6 BIG 4 it   7 B _ SH it   8 C _ LIST it  22

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  9 R _ DEVit   j  10 jYearDummie s j  k  11k IndustryDummies k   it

Where:

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FLD = the extent of FLD, 0 for firms failing to provide a forward-looking statement, 1 for firms that provide such statement but without any quantitative information, and 2 for firms providing a forward-looking statement with quantitative information;

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SO = the level of state ownership = (the number of state-owned shares/total number of shares outstanding)*100 percent;

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FO = the level of foreign ownership = (the number of shares held by foreign investors/total number of shares outstanding)*100 percent; LAYER = the number of layers in a firm’s pyramidal ownership structure;

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MO = the level of managerial ownership = (the number of shares held by senior managers/total number of shares outstanding)*100 percent;

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IND = the proportion of independent directors to board size; SUP = size of the supervisory board;

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Otherwise;

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DP = the dual role, 1 where the roles of CEO and chairman are combined, and 0

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F_EXP = the proportion of financial expertise (audit committee members who have previous or current employment in accounting or finance and/or membership of a professional accounting or financial body) on the audit committee;

LnTA = natural logarithm of the firms’ total assets; ROCE = return on capital employed = profit before interest and tax/(capital & reserves + long-term liabilities)*100 percent;

EFD = dependence on external financing = (capital expenditure – the net cash flow from operations)/total net assets*100 percent; LEV = leverage = long-term liabilities/(capital & reserves + long-term liabilities)*100 percent; M/B = Market value to book value of total net assets; BIG4 = dummy variable for auditor reputation. 1 for Big-4 CPA firms, 0 otherwise; B_SH = B-share dummy, 1 for firms issuing B-shares, and 0 otherwise;

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C_LIST = cross-listing dummy, 1 for firms listed on foreign stock exchanges (including Hong Kong stock exchange), and 0 otherwise;

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R_DEV = regional economic development dummy, 1 for firms’ headquarters in the developed southeastern coastal areas (including Gangdong, Jiangsu and Zhejiang provinces), Beijing and Shanghai, and 0 otherwise. 4. Empirical Results and Analyses

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4.1. Descriptive Statistics

The descriptive statistics are presented in table 1. First, the median and the third

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quartile of the extent of FLD are 1 and 2, respectively, suggesting that the majority of listed firms have complied with the disclosure regulation by providing a forward-looking statement

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in their annual reports, but less than half of the statements contain quantitative information. As would be expected, the mean and median of state ownership (SO), at 32.47 percent and

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37.14 percent, are noticeably larger than those of foreign ownership (FO), at 4.41 percent and

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0. Also, given that the mean and median of the number of layers in ownership structure

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(LAYER) are 3.38 and 3, respectively, it appears that a pyramidal ownership structure is widely adopted by listed firms. Moreover, the overall levels of managerial ownership (MO)

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in listed Chinese firms are relatively low, as although the maximum value of MO is 66.7 percent, the mean, median and third quartile are 2.53 percent, 2.11 percent, and 4.52 percent, respectively. With respect to the proportion of independent directors (IND) and the size of supervisory board (SUP), around 30 percent of directorial board members are independent directors, and a typical supervisory board consists of 3 to 4 individuals. Moreover, the third quartile of the dominant person dummy (DP) is 0, suggesting that most listed companies have separated the roles of CEO and chairman of the board. Lastly, it appears that roughly onethird of audit committee members are financial experts, as the mean and median of F_EXP are 0.37 and 0.33, respectively. INSERT TABLE 1 ABOUT HERE

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4.2. Multivariate analysis Before running the multivariate analysis, the variance inflation factor (VIF) was used to identify any potential multicollinearity among the independent and control variables.

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Given the threshold criterion, which is a VIF of 10 (Neter, Wasserman, & Kutner, 1989) or a Pearson correlation of 0.9, table 2 shows that there is no evidence of multicollinearity.

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Outliners were identified, and the winsorization technique was used to limit the effect of

these extreme values in the data. The (unreported) results obtained using the winsorized data

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were qualitatively similar to the results (using the original/non-winsorized data) reported here.

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INSERT TABLE 2 ABOUT HERE

Table 3 reports the results of the ordered probit regression between the extent of FLD

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and a series of corporate governance variables. Two models that exclude and include control variables are both significant, with pseudo R-square values of approximately 15.7 percent and

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21.6 percent, respectively. H2 is supported, with the number of layers in the pyramidal

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structure (LAYER) being negatively significant at five percent for both models. This indicates that the use of a complex ownership structure by the state to mask its continued

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control over listed firms results in low levels of FLD, as self-interested managers are likely to withhold their private information, increasing information asymmetry between managers and investors. Furthermore, consistent with H3, FO is positively associated with FLD at a significance level of five percent for Model B. This result supports the argument of OwusuAnsah (1998) that FO can help local firms to improve their disclosure practices, and is in line with the findings of Xiao et al. (2004) and Wang et al. (2008). It also helps explain the findings of Yeh et al. (2009) that minority shareholders appear to be less concerned about agency problems when FO is higher. Moreover, consistent with H5, the proportion of independent directors (IND) is positively associated with FLD at significance levels for both models. This supports the argument that a high proportion of independent directors on the

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board of directors can enhance the board’s effectiveness in monitoring the management team, and thus reduce information asymmetry (Beeks & Brown, 2006; Gul & Leung, 2004). H8 is also supported, as FLD is positively associated with the proportion of financial expertise on

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the audit committee (F_EXP) at significance levels of one percent for both models. The findings is in line with the previous studies’ arguments that more financial expertise on audit

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committee can improve management disclosure incentives and/or enhance internal

monitoring mechanisms, resulting in low levels of earnings and disclosure management

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(Badolato et al., 2014; Mangena & Pike, 2005).

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INSERT TABLE 3 ABOUT HERE

However, the remaining hypotheses—H1, 4, 6, and 7—are not supported. The

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correlation between SO and FLD is not statistically significant. Although the size of the supervisory board (SUP) and DP are negatively associated with FLD, this is not significant at

d

any level. However, the findings are consistent with the argument of Tam (1995), Dahya et al.

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(2003) and Ding et al. (2010) that large supervisory boards appear to operate ineffectively, and Daily and Dalton’s (1997) view that separating the roles of CEO and chairman of the

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board does not necessarily lead to improved corporate disclosure. Furthermore, although MO is positively associated with FLD and quadratic managerial ownership (MO2) is negatively related to FLD, the associations are not statistically significant. This may be because managers own a very small faction of listed Chinese firms’ equity, the incentive alignment effect of MO is insignificant.

Turning to the control variables, the company size and performance variables LnTA and

ROCE, are positively associated with the extent of FLD at significance levels of one percent for Model B, as would be expected. Moreover, consistent with prior studies (Bozzolan et al., 2009), FLD is positively related to the cross-listing dummy (C_LIST) at a significance level of one percent, suggesting that Chinese firms cross-listed on foreign stock exchanges are

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likely to have a greater extent of FLD. Although prior Chinese disclosure studies document that international auditors (normally the Big-4 CPA firms) can help local companies improve their corporate disclosure practices (Wang et al., 2008), this study fails to find a significant

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and positive association between auditing (BIG4) and FLD. This may be due to the fact that many listed Chinese firms do not disclose any quantitative and verifiable information in their

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forward-looking statements. Consequently, there is no need for external auditing if such

quantitative information is unavailable in the statements. Moreover, the relationship between

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market-to-book ratio (M/B) and FLD is negative and significant at the five percent level,

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supporting the argument by Chen et al. (2014) that because of many Chinese firms’ dependence on personal networks and connections (or Guanxi) for business success, high

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value firms are less likely to voluntarily disclose detailed business information, such as future business strategies and investment plans, as this would expose such valuable networks and

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connections to the public and increase proprietary costs. Lastly, the regional economic

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development dummy (R_DEV) is positively related to FLD at a significant level of ten percent, indicating that listed firms headquartered in developed areas (e.g., the southeastern

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coastal provinces, Beijing and Shanghai) tend to disclose more forward-looking information. This finding is in line with the view that financial reporting and disclosure practices are “endogenously determined by real economic and political factors that are local in nature” (Ball, 2006, p. 18).

4.3. Robustness and Additional tests 4.3.1. Alternative Measure of the Extent of FLD In the above primary tests, the extent of FLD is measured on the basis of (1) whether a forward-looking statement is provided in listed firms’ annual reports, and (2) whether the statement includes any quantitative information. This approach may be criticized for not being precise. For example, even among listed firms that disclose quantitative and verifiable

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information, the levels of such disclosure may differ considerably among firms. One may disclose only one piece of quantitative information, while another may disclose multiple pieces. Therefore, following prior studies (Cooke, 1989a, b; Ho & Wong, 2001; Owusu-

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Ansah, 1998; Wang et al., 2008) and the FLD requirements mandated by the CSRC (2007 version), a disclosure index (see Appendix A) was developed to alternatively measure the

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level of FLD. All 22 items are equally weighted, with each item scored 1 if it was disclosed,

or zero otherwise. Given that some companies may not have certain items to disclose (e.g., no

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planned new investment projects), this study employs the relative index approach to avoid

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incorrect penalties for items that are inapplicable to disclosure: m

n

i 1

i 1

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FLDI i   Di /  Di Where:

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FLDI = FLD index; D = 1 if item i is disclosed, and 0 otherwise; m = number of actual items disclosed n = aggregation of all applicable items

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INSERT APPENDIX A ABOUT HERE A multivariate linear regression was employed by using FLDI as the dependent

variable. Explanatory and control variables are the same as those used in the ordered probit model.

INSERT TABLE 4 ABOUT HERE

The results, as presented in table 4, are largely similar to those reported in table 3. FO,

IND, and F_EXP are still positively associated with FLDI at significance levels. Also, the association between FLDI and LAYER remains negative at a significance level of five percent. However, in contrast to the results in table 3, the association between SO and FLD becomes positive and significant at one percent for Model A and ten percent for Model B.

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This result supports H1 and indicates that high levels of SO can facilitate management’s disclosure incentives and reduce information asymmetry (Ferguson, Lam, & Kee, 2002; Wang et al., 2008).

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Overall, the robustness test results are largely consistent with those in the primary

certain boardroom attributes. 4.3.2. Additional Test for the Association between SO and FLD

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analysis, suggesting that listed Chinese firms’ FLD is determined by ownership structure and

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Using linear models, table 3 reports a positive but insignificant association between

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SO and FLD, while in table 4, the positive association becomes significant at the 10 percent level. The test results therefore are mixed. As discussed in section 2.2.1, given concentrated

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SO, the state and its agencies are actually insiders who can directly obtain corporate information through private channels, resulting in less effective monitoring and control and

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low levels of corporate disclosure (Armstrong et al., 2010; Firth et al., 2007). However, if

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levels of SO are relatively low, the state can only have a limited influence on listed firms. Accordingly, unlike insiders, the state may not be able to directly access private corporate

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information. It therefore may be willing to promote an information environment sufficiently transparent so as to monitor the firm’s activities for its own ends. For example, the state may require timely and objective corporate information disclosure by listed firms to ensure the safety of state assets. In addition, the state may have an incentive to develop a good reputation for information transparency to attract foreign investments (Wang et al., 2008). As such, the impact of SO on FLD may depend on levels of SO, or whether the state becomes the insider in listed firms, and the relationship between FLD and SO may be non-linear. Following early accounting and corporate governance studies (Adams & Santos, 2006; Ding et al., 2007), this study first employs the quadratic model to further test such a relationship. The test results, as reported in table 5, show that the extent of FLD is positively

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associated with SO at a significance level of one percent, but negatively related to quadratic state ownership (SO2) at a significance level of five percent for both models. This indicates that the association between SO and FLD appears to be an inverted U-shape (non-linear) with

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an inflection point around 33 percent. This finding suggests that relatively low levels of SO (≤ 33 percent) could enhance the effectiveness of internal monitoring and control, resulting in

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more value-relevant corporate information disclosure; but at high levels (> 33 percent), SO has a negative effect on FLD, because the government or its agencies become the insiders

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who can directly obtain private information from managers.

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INSERT TABLE 5 ABOUT HERE 4.3.3. Alternative Measures of Selected Control Variables

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Some of the control variables can be measured in a variety of alternative ways. For example, size was proxied in prior studies not only by total assets, but also by total sales,

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number of employees, number of shareholders, or market value. Hence, the ordered probit

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model was re-run, first using the log of market value and then again with the log of total sales instead of the log of total assets. Similarly, instead of using ROCE as a measure of

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profitability, ROA was used, as in prior studies (Wang et al., 2008), and the model was re-run for this variable. In addition, early Chinese stock market research also employed growth rate of operating revenue and growth rate of operating profit, rather than M/B, to control for growth opportunities (Chen et al., 2014). This study therefore re-ran the ordered probit model for these two alternative growth variables. The test results (untabulated) indicate that the alternative methods of measuring size, profitability, and growth opportunities fail to result in any qualitative differences. 5. Summary and Conclusion Recent years have witnessed the new corporate governance regulations, the requirements for listed Chinese firms to disclose forward-looking information in their

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financial reports, along with the new government policies on equity incentive plans. This therefore provides a research opportunity to investigate whether the extent of FLD is driven by improved corporate governance in China’s unique institutional environment setting. Using

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a sample of all SHSE listed firms for the period of 2008 to 2012, this study finds that, consistent with early studies (Beeks & Brown, 2006; Fan & Wong, 2002; Mangena & Pike,

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2005; Owusu-Ansah, 1998; Xiao et al., 2004), high levels of FO, more independent directors on the board, and more financial expertise on the audit committee can strengthen monitoring

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and control mechanisms and/or improve managers’ disclosure incentives, leading to a greater

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extent of FLD. On the other hand, the use of a complex pyramidal ownership structure appears to have a negative impact on the extent of FLD. Furthermore, there is a non-linear

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(inverted U-shape) association between SO and FLD, with the inflection point at around 33 percent. This suggests that if owning no more than one-third of listed firms’ equity, the state

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can act as an effective monitor and encourage greater FLD for its own ends, but that higher

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levels of SO impede the efficiency of internal monitoring and control mechanisms, making FLD less transparent. However, this study does not find any non-linear relationship between

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MO and FLD. Moreover, it fails to find any significant correlations between FLD and two boardroom characteristics: the size of the supervisory board and the dual roles of CEO and chairman of the board of directors. Overall, the results suggest that the extent of FLD is primarily determined by the ownership structure and certain boardroom attributes. The main contribution of this study to the literature on the determinants of corporate

disclosure is to provide new evidence of a non-linear relationship between SO and FLD. Also, compared to early Chinese corporate disclosure studies (e.g., Chen et al., 2014; Ding et al., 2007; Wang et al., 2008), it looks at the impact of a wider range of corporate governance mechanisms, such as financial expertise on the audit committee and equity incentives, on managers’ willingness to disclose more value-relevant corporate information. Furthermore,

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the empirical findings may be of interest to policymakers for evaluating the use of a pyramidal ownership structure to indirectly control listed firms and the implementation of equity incentive plans to mitigate the agency costs by aligning the interests of managers and

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shareholders.

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ip t cr us 1st Quartile 1.00 14.61 0.00 3.00 0.00 0.18 3.00 0.00 0.22 15.07 8.50 -9.33 2.46 0.59 0.00 0.00 0.00 0.00

M an

Minimum 0.00 0.00 0.00 2.00 0.00 0.00 3.00 0.00 0.11 13.13 -256.96 -258.05 0.00 0.16 0.00 0.00 0.00 0.00

ed

Std. Dev. 0.553 21.360 8.706 0.987 2.917 0.053 1.002 0.309 0.198 1.297 23.090 33.550 17.384 0.246 0.406 0.128 0.207 0.482

ce pt

Table 1 Summary Statistics (n = 4,253) Mean FLD 1.39 SO 32.47 FO 4.41 LAYER 3.38 MO 2.53 IND 0.36 SUP 3.67 DP 0.11 F_EXP 0.37 LnTA 15.87 ROCE 14.73 EFD 3.89 LEV 18.88 M/B 0.74 BIG4 0.21 B_SH 0.055 C_LIST 0.05 R_DEV 0.637

Median 1.00 37.14 0.00 3.00 2.11 0.33 3.00 0.00 0.33 15.73 13.17 1.55 14.21 0.75 0.00 0.00 0.00 1.00

3rd Quartile 2.00 53.64 4.14 4.00 4.52 0.38 5.00 0.00 0.45 16.88 19.88 16.54 32.98 0.92 0.00 0.00 0.00 1.00

Maximum 2.00 83.90 53.73 7.00 66.71 0.63 7.00 1.00 0.91 19.75 232.07 218.02 63.08 2.01 1.00 1.00 1.00 1.00

Ac

FLD = the extent of FLD, for firms failing to provide a forward-looking statement, 1 for firms providing such statement but without any quantitative forward-looking information, 2 for firms providing a forward-looking statement with quantitative information; SO = (the number of state-owned shares/total number of shares outstanding)*100 percent; FO = (the number of shares held by foreign investors/total number of shares outstanding)*100 percent; LAYER = the number of layers in a firm’s pyramidal ownership structure; MO = (the number of shares held by senior managers/total number of shares outstanding)*100 percent; IND = the proportion of independent directors to the board size; SUP = size of the supervisory board; DP = dominant person, 1 where the roles of CEO and Chairman are combined, and 0 otherwise; F_EXP = proportion of financial expertise on the audit committee; LnTA = natural logarithm of firm’s total assets; ROCE = return on capital employed, profit before interest and tax/(capital & reserves + long-term liabilities)*100 percent; EFD = external financing dependence, (capital expenditure – net cash flow from operations)/total net assets; LEV = leverage, long-term abilities/(capital & reserves + long-term liabilities)*100 percent; M/B = market value to book value of total net assets; BIG4 = dummy variable for auditor reputation, 1 for firms choosing one of the big 4 CPA firms as an external auditor, 0 otherwise; B_SH = B-share dummy, 1 for firms issued B-shares, 0 otherwise; C_LIST = cross-listing dummy, 1 for firms also listed on foreign stock exchanges (including the Hong Kong stock exchange), 0 otherwise; R_DEV = regional economic development dummy, 1 if the firms’ headquarters are in developed Southeast coastal areas (including Gangdong, Jiangsu, and Zhejiang provinces), Beijing and Shanghai, 0 otherwise.

40

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cr

ip t SO

LAYER

MO

IND

SUP

DP

ROCE

-0.08

LAYER

-0.11*

0.14***

MO

-0.21**

0.13**

-0.02

IND

-0.19***

-0.05

0.11**

EFD

M/B

LnTA

LEV

BIG4

B_SH

C_LIST

F-EXP

M an

FO

FO

us

Table 2 Pearson correlation matrix (n = 4,253)

SUP

0.28**

0.13

0.02

0.03

-0.01

DP

-0.14**

0.23***

-0.18**

-0.01

0.01

-0.13**

ROCE

0.13**

0.10*

-0.01

0.05

0.04

0.05

EFD

-0.06

-0.07

-0.14**

0.01

0.02

0.01

0.04

M/B

-0.04

0.16**

0.03

-0.06

-0.12**

-0.05

0.16**

-0.20***

0.12**

LnTA

-0.06

0.35***

0.02

0.35***

0.09

0.18**

0.27**

0.03

0.09*

0.22***

-0.01

ed

0.01

-0.13**

-0.06

-0.14**

0.25***

-0.02

-0.01

0.03

-0.11**

0.33*

0.19***

0.42**

0.11**

0.42***

0.10*

0.07

0.02

0.28**

0.14**

-0.01

-0.05

0.13**

0.48**

0.14***

B_SH

--0.01

0.21***

0.12**

-0.14**

0.03

-0.12**

0.01

0.06

-0.03

-0.01

-0.04

-0.17***

ce pt

LEV BIG4

0.34***

C_LIST

-0.06

0.34**

0.03

0.17***

-0.05

0.07

-0.08

0.12**

-0.09*

0.02

0.14**

-0.14**

0.16***

-0.11**

F_EXP

0.13**

-0.08

0.02

-0.08

0.01

0.04

-0.08

0.09*

-0.01

-0.03

0.13

0.04

0.19***

0.34***

-0.06

R_DEV

0.30**

-0.03

0.15**

0.02

-0.13**

0.03

0.05

-0.06

-0.02

-0.05

0.13**

-0.02

0.24***

0.25***

0.16**

0.07

Ac

***,**,* Significant at the 1 percent, 5 percent, and 10 percent levels (two-tailed test); see Table 1 for definitions of variables.

41

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Table 3 Impact of Corporate Governance Mechanisms on FLD (n = 4,253) Model B

Coefficient

Z-Stat.

Coefficient

SO

+/-

0.041

1.50

0.014

0.66

FO

+

0.017

1.41

0.115

2.05**

+/-

-0.175

-3.73**

-0.375

-3.45**

+

0.187

0.73

0.899

0.86

-

-0.113

-2.33**

-0.076

-1.45

IND

+

4.011

1.99**

3.865

2.73***

SUP

-

-0.137

-0.52

-0.152

-0.95

DP

-

-0.674

-1.08

-0.797

-1.29

F_EXP

+

1.594

3.82***

1.758

4.85***

LnTA

+

0.539

3.46***

ROCE

+

0.027

2.96***

EFD

+

0.002

0.05

LEV

+

0.018

0.54

+

-0.763

-2.12**

+

0.239

0.81

B_SH

+

0.215

0.79

C_LIST

+

3.976

4.40***

R_DEV

+

0.397

1.68*

M/B

us

an

M

Ac ce p

BIG4

d

MO

te

LAYER

Year dummies

Yes

Industry dummies

Yes

Pesudo

15.7%

Z-Stat.

ip t

Predicted sign

cr

Model A

21.6%

***,**,* Significant at the 1 percent, 5 percent, and 10 percent levels (two-tailed test); see table 1 for definition of variables.

42

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Table 4 Robustness Test Using the Relative Disclosure Index (n = 4,253) Model A

Model B

Coefficient

T-Stat.

Coefficient

T-Stat.

SO

+/-

0.041

2.84***

0.008

1.87*

FO

+

0.005

1.93*

0.044

2.29**

+/-

-0.109

-1.89*

+

0.465

1.38

-

-0.017

-3.41***

-0.011

-3.09***

IND

+

0.322

0.64

0.134

2.07**

SUP

-

-0.170

-1.03

-0.319

-3.06***

DP

-

-0.026

-0.96

-0.291

-0.28

F_EXP

+

0.099

1.98**

1.094

2.61***

LnTA

+

0.003

0.57

ROCE

+

0.024

1.86*

EFD

+

0.001

0.08

+

0.002

0.53

+

-0.047

-2.23**

LEV

cr -0.005

-2.24**

0.934

1.05

us

an

M

Ac ce p

M/B

d

MO

te

LAYER

ip t

Predicted sign

BIG4

+

0.027

1.77*

B_SH

+

0.104

0.96

C_LIST

+

0.189

4.14***

R_DEV

+

0.017

3.34***

Year dummies

Yes

Industry dummies

Yes

Adjusted

16.4%

23.2%

***,**,* Significant at the 1 percent, 5 percent, and 10 percent levels (two-tailed test); see table 1 for definition of variables.

43

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Table 5 Additional Test for the Association between SO and FLD (n = 4,253) OLS Model

Coefficient

Z-Stat.

Coefficient

T-Stat.

+

0.0307

2.23**

0.0218

2.86***

-

-0.0051

-2.37**

-0.0034

-2.83***

+

0.019

1.89*

+/-

-0.133

-2.90***

+

0.871

-

-0.734

IND

+

SUP

SO

ip t

Predicted sign

cr

Ordered Probit Model

1.84*

-0.014

-2.68**

0.63

0.024

1.03

-1.43

-0.015

-3.17***

0.506

2.18**

0.119

1.90*

-

-0.017

-0.79

-0.011

-2.40**

DP

-

-0.022

-1.02

-0.019

-0.67

F_EXP

+

0.096

3.07***

0.080

2.32**

LnTA

+

0.003

2.24**

0.009

1.38

ROCE

+

0.001

2.36**

0.002

3.28***

+

0.003

0.71

0.001

0.29

+

0.020

0.46

0.057

1.33

M/B

+

-0.033

-1.99**

-0.049

-2.51**

BIG4

+

0.046

0.74

0.054

1.49

B_SH

+

0.207

0.76

0.103

0.87

C_LIST

+

0.182

4.24***

0.022

5.02***

R_DEV

+

0.025

2.83***

0.006

3.29***

EFD

an

M

Ac ce p

LEV

d

MO

te

LAYER

us

0.002

FO

Year dummies

Yes

Yes

Industry dummies

Yes

Yes

Pesudo

25.1% 33.7%

Adjusted

***,**,* Significant at the 1 percent, 5 percent, and 10 percent levels (two-tailed test); see table 1 for definition of variables. 44

Page 44 of 45

Appendix A The FLDI Qualitative discussion about the firm’s future growth opportunities 1 Quantitative discussion about the impact(s) of the future growth opportunities

3

Qualitative discussion about the firm’s future challenges

4

Quantitative discussion about the impact(s) of the future challenges

5

Qualitative discussion about the firm’s next year’s operating plans

6

Quantitative discussion about the next year’s sales target

7

Qualitative discussion about the business plans that will be taken to achieve the sales

us

cr

ip t

2

an

target

Quantitative discussion about the next year’s earning target

9

Qualitative discussion about the business plans that will be taken to achieve the

M

8

earnings target

Qualitative discussion about the business plans that will be taken to increase the firm’s market share

d

10

Quantitative discussion about planned new investment projects

12

Qualitative discussion about planned new investment projects

Ac ce p

te

11

13

Quantitative discussion about any political risks

14

Qualitative discussion about the impact(s) of political risks

15

Quantitative discussion about any financial risks

16

Qualitative discussion about the impact(s) of financial risks

17

Quantitative discussion about any industry or market risks

18

Qualitative discussion about the impact(s) of industry or market risks

19

Qualitative discussion about the next financial year’s cash flow

20

Quantitative discussion about the next financial year’s cash flows

21

Quantitative discussion about future capital expenditure plan(s)

22

Qualitative discussion about future capital expenditure plan(s)

45

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