Disclosure on Corporate Governance Issues in Bangladesh: A survey of the Annual Reports

Dewan Mahboob Hossain Assistant Professor Department of Accounting & Information Systems University of Dhaka Dhaka Bangladesh

Arifur Rahman Khan Assistant Professor Department of Accounting & Information Systems University of Dhaka Dhaka Bangladesh

Published in The Bangladesh Accountant, Quarterly Journal of Institute of Chartered Accountants of Bangladesh, January-March, 2006, pp. 95-99.

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Electronic copy available at: http://ssrn.com/abstract=1284973

Disclosure on Corporate Governance Issues in Bangladesh: A survey of the Annual Reports

Abstract

The paper investigates some corporate attributes that influence the corporate governance disclosure in Bangladesh. An OLS regression model has been used to analyze the data of 100 sample companies listed either with Dhaka Stock Exchange or Chittagong Stock Exchange in 2004. We find that some corporate attributes such as multinational affiliation, linkage of auditor with big four audit firms, concentrated ownership by sponsor and banking companies influence significantly on corporate governance disclosures. Key words: Corporate governance, disclosure.

Introduction
The huge accounting scandals by so many renowned companies (like Enron, Global Crossing, WorldCom, Adelphia) in the world have made the issue of corporate governance even more important these days than it was before. According to Pound (1995), Corporate governance is not, at its core, about power, it is about finding ways to ensure that decisions are made more effectively. Cadbury Report (1992) says, corporate governance is the system by which companies are directed and controlled. Actually it is the system within which directors and managers operate the organization with an objective of enhancing the shareholders value. Good corporate governance can ensure the optimization of the benefits drawn from the agency relationship between shareholders and corporate managers. Agency theory deals with the contractual relationship between at least two parties of which one is called the principal who engages the other party called agent to perform some services for them. According to Jensen and Meckling (1976) an agency relationship is .. a contract under which one or more (principles) engage another person (the agent) to perform some service on their behalf delegating some decision making authority to the agent. In corporate world, the shareholders appear as principles who delegate the function of day-to-day decision making to their agents who are called 2
Electronic copy available at: http://ssrn.com/abstract=1284973

managers and these managers are accountable to the shareholders for the proper utilization of economic resources of the firm. As all human beings try to act for their own interest, managers of the companies also try to do that. As a result of trying to fulfill their own interest, the managers may not work for the best interest of the shareholders. The concept of adverse selection and moral hazard are liable for that. That is why the agents should be always monitored by the principals and this monitoring is mainly done through scrutinizing annual accounts of the company. But it is also true that as annual accounts are prepared by the managers themselves, there remains a huge chance of manipulation in the accounts. To remove this difficulty, another party, the independent auditors, are employed. Auditors work as watch dogs and after scrutinizing the annual accounts they give reasonable assurance through their opinion to the stakeholders that the accounts give a true and fair view. Even then, there remains a chance of impairment of auditors independence. If auditors independence is impaired, there arises a chance that true and fair annual accounts will not reach to the hands of the shareholders. Thus the shareholders or the principals will not get the total picture whether their economic resources were utilized in the best way by the mangers (or their agents). As a result, proper corporate governance will not be ensured. It is said that to ensure corporate governance, the effectiveness of the Board and particularly of the non-executive Directors is to be enhanced by establishment of appropriate board sub-committees. The report of the Public Oversight Board (POB) of the SEC Practice Section of the AICPA (1993) states: Corporate Governance in the United States is not working the way it should . More effective corporate governance depends vitally on strengthening the role of the board of directors. Moreover, Fama and

Jensen (1983) proposed that non-executive directors can act as arbiters in disagreements among internal managers and carry out tasks that involve serious agency problems between internal managers and residual claimants. It is important that in order to ensure the effectiveness of the board, board sub-committees should be formed and these subcommittees facilitate the spread of the total workload of the board. These sub-committees will also assist in considering the important matters with greater concentration. The main types of sub-committees are audit committees, remuneration committees and nomination committees. Audit committee is one of the sub-committees of the board. An audit committee, which is mainly comprised of non-executive directors, can be said as an effective tool to ensure corporate governance in an organization. An audit committee can be defined as a sub-committee in the Governing Body (Board of Directors) that makes arrangements for the audit (starting form the appointment of the auditors) and also as a sub-committee of the Board, this committee tries to enhance the ability of the Board to fulfill its legal responsibilities and ensure the credibility and objectivity of the financial reports. Accountants International Study Group (1977) defined audit committee in a detailed way: A committee of directors of a corporation whose specific responsibility is to review the annual financial statements before submission to the board of directors. The committee generally acts as a liaison between the auditor and the board of directors and its activities may include the review of nomination of auditors, overall scope of the audit, results of the audit, internal financial controls and financial information for publication. Companies establish an audit committee within the Board of Directors to take active role in overseeing the companys accounting and financial reporting policies and practices

(Whittington and Pany, 2001). An audit committee must be composed with a majority of independent/non-executive directors who are neither officers nor employees of the company. That means, the most of the directors who are the parts of the audit committee should be Outside Directors who have no other relationship that may impair their independence (Whittington and Pany, 2001). This committee should represent the owners and not the management. The major dealings between the independent auditors and the governing body should be done through the audit committee. That means, this committee acts as a communication link between management, auditors and the governing body. This committee will try to ensure that auditors independence is not hampered. There is another board sub-committee that is called the remuneration committee that is responsible for analyzing the terms and conditions related to the employment of the senior management group. This committee reviews and scrutinizes several employee incentive schemes like bonuses, share option schemes etc. From the point of view of agency theory, the tasks of this particularly vary important because in order to mitigate agency problem it is very important to align the interests of management with the interests of the shareholders. Designing and implementing appropriate remuneration structure is a difficult as well as significant task for the companies. It is said that this committee should also be composed of non-executive directors. Nomination Committee is another important board sub-committee that has a twofold purpose: firstly, determining the adroitness required of a replacement or additional director or to approach prospective candidates and secondly, reviewing the performance of the total board and the contribution of the individual members of the board on a consistent basis.

In order to uphold proper corporate governance it is important to ensure shareholders rights. A good and transparent relationship with the shareholders is imperative in this case. Shareholders are the owners of the company and they have the right to elect (by voting) the directors and hold the directors accountable for the progress of the business. They can participate in the annual general meetings and uphold their thoughts and know about the company prospects. The shareholders should be informed as much as possible about the activities of the company. In order to make the shareholders informed about these issues on corporate governance, the organizations should report these issues in the annual reports. In case of Bangladesh, according to Karim, Islam and Chowdhury (1996), annual reports of the companies are considered as the most important source of information about a company and they use that for a variety of reasons.

Objective and Methodology of the Study

The main purpose of this study is to identify the magnitude of corporate governance disclosures by Bangladeshi companies. In this regard we would like to know the company attributes that might affect such disclosures.

This study has tested whether or not Bangladeshi companies are making corporate governance disclosures. In order to examine the level of corporate governance disclosures of the sample companies, a disclosures index was developed for the companies under study. Different issues relating to shareholder and management of the company have been considered to construct the index. There were 25 issues under consideration (See Table : 7).

For this research we have taken 100 companies of different categories enlisted either with Dhaka stock exchange or Chittagong stock exchange. The companies belong to different categories such as bank, insurance, textile, pharmaceutical and chemical, engineering and miscellaneous. Published annual reports of the aforesaid companies have been used as a secondary source. All these annual reports were for the year 2004 as this was the most recent year for which annual reports were available at the time of study. The index so developed was applied to the all the annual reports of the sample company. A dichotomous procedure was followed to score each of the company index. Each company was awarded a score of 1if the company appears to have disclosed the concerned disclosure and 0 otherwise. Once scoring of the companies completed, each company ended up with a score reflecting the number of disclosures against which it was found to have disclosed. Then the score of the respective company was divided by the total number of score. These scores were then used as dependent variable and we tried to explain possible corporate attributes that might explain variations in corporate governance disclosures of the companies under study. The hypothesis of the study can be specified as under: H 0 : There is no significant difference between corporate attributes and corporate governance disclosures.

Model specification
To provide primary evidence of the impact of corporate attributes on corporate governance disclosures of different enlisted companies in Bangladesh this paper uses

simple ordinary least square regression technique. The following regression has been estimated:

CGDISC = A + 1 LEV t + 2 NPTOSALE t + 3 Log ASSET t + 4 ACCOUNT t + 5 BANK t + 6 BIG4 t + 7 MNC t + 8 SPONSOR t + e t Where:
CGDISC LEV NPTOSALE Log ASSET ACCOUNT BANK BIG4 MNC SPONSOR = = = = = = = = = Corporate governance disclosure Debt to equity ratio Net profit to sales Natural logarithm of total assets Dummy variable, 1 if the company has professional accountant Dummy variable, 1 if the company is a banking company Dummy variable, 1 for a big 4 audit firm associate Dummy variable, 1 if the sample company is an MNC Dummy variable, 1 if the company has concentrated sponsor

LEV: The degree to which a firms financial structure is geared can have compliance with the corporate governance disclosure. The debt equity ratio has been used as a measure of leverage in the present study. We expect to have a positive relationship between leverage and corporate governance disclosure. NPTOSALE: Corporate profitability may affect the corporate governance disclosure. It might be easier for a profitable company to take necessary measures to concentrate on the issues of corporate governance and to disclose the same. Hence it is expected to have a positive relationship between net profit to sales and corporate governance disclosure Log ASSET: Natural logarithm of total asset has been considered in this study. Actually it represents the size attributes of a company. Turn over could have been used to consider the size attribute. But already we have considered turnover (sales) for net profit

to sales. So such consideration would result in multi-colinearity. For this study we expect to have a positive relationship between corporate governance disclosure and log of asset. ACCOUNT: The qualification of prepares can be considered as one of most important attribute for corporate governance disclosure. Ahmed and Nicholls (1994) found that qualification of the principal accounting officer of the reporting company did influence level in Bangladesh. It is always expected that professionally qualified accountant can pursue a policy for higher degree of disclosures than that of a nonprofessional accountant. Hence we expect to have a positive relationship between accountant variable and corporate governance disclosure. BANK: In December 2002, Bangladesh Bank, the central bank of Bangladesh, issued a circular advising the banks to formulate audit committees (Bangladesh Bank 2002). However, such requirements are yet to be incorporated in the Banking Companies Act (1991). Audit committee is one of the most core concerns of corporate governance. Besides banking sector in Bangladesh suffers from different anomalies featured by default culture (Siddiqui and Podder, 2002). So it is expected that banking companies might be more concerned about the issue of corporate governance and we therefore expect to have a positive relationship between banking company and corporate governance disclosure. BIG4: It is expected that large audit firms will be more concerned about their clients quality and amount of reporting in the annual reports. Any financial statement certified by any big 4 audit firm must be more credible than that of non-big 4 firms. Ahmed and Karim (2005) found that companies audited by big 4 audit firms comply

more with reporting requirements than that of others. For our study we expect to have a positive relationship between corporate governance disclosure and big 4 affiliation. MNC: It is expected that sample companies, which are subsidiaries of multinationals, will have better corporate governance mechanisms and internal control systems. Therefore, we expect to have a positive relationship between MNC and corporate governance disclosures. SPONSOR: Sponsor reflects the concentrated ownership (more than 50%) by the sponsors of the company. If ownership is concentrated by the sponsor in a company it is expected that the disclosure pattern might be influenced. Hence we expect to have a negative relationship between sponsor and corporate governance disclosure.

Result and analysis

The lowest level of disclosures observed in this study appears to be 0.24 (Table 3) which suggests that the company discloses only 24% of corporate governance disclosures applicable to this study. On the higher side the maximum level of disclosure was demonstrated by the company scoring 0.92 suggesting 92% of disclosures of the applicable items. Table 1 represents the mean of corporate governance disclosures by the sample companies. The mean score is 0.52 which indicates that on average the sample companies have made 13 disclosures regarding the issue of corporate governance. This average disclosure level is somewhat satisfactory given the fact that corporate governance disclosure is a relatively new phenomenon in our country. In the regression analysis, corporate governance disclosure score is found to be significantly influenced at 5% level by several attributes of the company such as BANK,

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BIG4, MNC and SPONSOR variable. Among these four variables only sponsor variable is negatively associated with corporate governance disclosure. On the other hand accountant variable is found to be negatively associated with the dependent variable, though it is statistically insignificant at 5% level. Other attributes of the company such as size (Log asset), leverage and net profit to sales have also been found to statistically insignificant at the same level. The F-stat for the regression model is 5.926 (significant at the 1% level). The model has an R-square of 0.546. It indicates that almost 55% of the variation in corporate governance disclosures by the reporting company could be explained by the significant explanatory variables. The correlation matrix suggests that there is no evidence of multicolinearity. To test heteroskedasticity, residuals were plotted in histograms to test their normality, and observed residuals were plotted against predicted values. Neither of these tests indicated any problem with heteroskedasticity.

Conclusion
From our study we find that in Bangladesh multinational affiliation, linkage of the auditor with big four audit firm, concentrated ownership and bank business have significant influences on corporate governance disclosures. Companies having MNC affiliation have their own reporting requirements. So they are always trying to concentrate the issue more than that of local companies. Likewise, auditors having linkage with big four audit firms have to always abide by their parent firms in respect of the certification of financial statements of their clients. So we can say that some of the companies are more concerned about the issue of corporate governance because of the having overseas connection either with their own or through their auditor. Sponsors are

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also influencing the reporting on corporate governance disclosure. Actually when the company is dominated by the sponsor it is most likely to be happened that the same company would be less accountable to the general shareholder as they will be the minority group. It so happens since there is no such regulatory measures to protect the minority interests. Banking companies are disclosing more than other companies since there were lot of allegations regarding the banking companies.

References
Accountants International Study Group (1977), Audit Committees, Current Practices in Canada, the United Kingdom and the United States. Ahmed, J. and Karim, W., (2005), Compliance to International Accounting Standards in Bangladesh: A survey of annual reports, The Bangladesh Accountant, JulySeptember, 2005, pp.23-41. Ahmed, K. and Nicholls, D., (1994), The impact of non-financial company characteristics on mandatory disclosure compliance in developing countries: the case of Bangladesh, The International Journal of Accounting 29: pp.62-77 AICPA (1993), Committee of Sponsoring Organizations (COSO), Journal of Accountancy, pp. 10-18. Cadbury, A. (Chmn) (1992), Report of the Committee of the Financial Aspects of Corporate Governance, Financial Reporting Council, London Stock Exchange, London. Fama, E.F. and Jensen, M.C. (1983), Separation of Ownership and Control, Journal of Law and economics, Vol. 26, No.2, pp. 301-326. Jensen, M.C. and Meckling, W.H. (1976), Theory of the Firm: Managerial Behaviour, Agency Costs and Ownership Structure, Journal of Financial Economics, Vol. 3, October, pp. 305-360. Karim, A.K.M.W., Islam, M.A., Chowdhury, A. (1996), Users perception of published accounts in Bangladesh: An empirical study, Dhaka University Journal of Business Studies, Vol. 17(1), pp. 211-233.

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Pound, J. (1995), The Promise of the Governed Corporation, Harvard Business Review, March. Siddiqui, J. and Podder, J., (2002), Effectiveness of bank audit in Bangladesh, Managerial Auditing Journal ,17, pp.502-510. Whittington, O. R. and Pany, K. (2001), Principles of Auditing and Other Assurance Services, Irwin McGraw-Hill, Boston. Appendix Table 1: Corporate governance disclosure Mean CGDISC
0.5261

SD
0.1660

Table 2: Descriptive statistics

Variables LEV NPTOSALE Log Asset ACCOUNT BANK BIG4 MNC SPONSOR Minimum 0.0000 -0.1500 1.2200 0.0000 0.0000 0.0000 0.0000 0.0000 Maximum 3.5000 0.3000 7.9900 1.0000 1.0000 1.0000 1.0000 1.0000 Mean 0.2040 0.0408 1.0108 0.3163 0.4183 0.4226 0.0333 2.9802 SD 0.4051 0.1989 1.5706 0.4674 0.4958 0.4965 0.1612 0.8032

Table 3: Five most and five least disclosing companies 5 Top disclosing companies Name of company Score Square Pharma 0.92 BEXIMCO Pharma 0.88 Square Textiles 0.88 BAT Bangladesh 0.80 Mercantile Bank 0.72 5 Lowest disclosing companies Name of company Score Lexco Ltd. 0.24 Apex Tannery 0.28 Beach hatchery 0.28 Miracle industries 0.32 German bangla food 0.32

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Table 4: Correlation matrix

ACCOUNT ACCOUNT Log ASSET BANK BIG4 LEV MNC NPTOSALE CGDISC SPONSOR 1.0000 0.3972 0.2097 0.2853 0.4003 -0.0681 -0.1387 0.2331 0.4739 1.0000 0.1803 0.1682 0.2615 -0.1507 -0.0816 0.1870 0.4666 1.0000 0.0463 0.2726 0.0463 0.2475 0.4663 0.4614 1.0000 0.0509 -0.1070 -0.1775 0.0949 -0.0652 1.0000 0.0324 0.4202 0.2988 0.5165 1.0000 0.0571 0.1538 0.0866 1.0000 0.0991 0.0311 1.0000 0.5654 1.0000 Log ASSET BANK BIG4 LEV MNC NPTOSA LE CGDISC SPONSOR

Table 5: Summary of model output

R-squared Adjusted R-squared S.E. of regression Sum squared resid Log likelihood Durbin-Watson stat 0.5461 0.3896 0.1294 1.4743 65.4093 1.6361 Mean dependent var S.D. dependent var Akaike info criterion Schwarz criterion F-statistic Prob(F-statistic) 0.5212 0.1656 -1.1630 -0.9241 5.9260 0.0000

Table 6: Audit delay regression results CGDISC = A + 1 LEV t + 2 NPTOSALE t + 3 Log ASSET t + 4 ACCOUNT t +

5 BANK t + 6 BIG4 t + 7 MNC t + 8 SPONSOR t + e t

Variables CONSTANT LEV NPTOSALE Log Asset ACCOUNT BANK BIG4 MNC SPONSOR Expected Sign ? + + + + + + + Coefficient 0.0129 0.0251 0.0519 0.0089 -0.0255 0.0699 0.0651 0.2030 0.1269 P values 0.1412 0.5984 0.5394 0.3681 0.4903 0.0394 0.0316 0.0174 0.0000

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Table 7: Issues considered to develop corporate governance disclosure index Serial no 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. Name of the Issue Details about the board members Responsibility of the board Authority and accountability of the board Activities of the board Appointment and rotation of the Board members Share holdings by the board members Chairmans statement Company prospect details Executive directors Non-executive directors Audit Committee Remuneration Committee Any other committee for proper functioning of the board Details about the Management team Shareholders right and control Relationship with the shareholder Maintenance of corporate affairs division Voting power of the shareholder Notice of AGM in due time Agenda of the AGM Appointment of auditors Internal control system Compliance with different legal requirements Risk perception Detail activities of the company

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