The Impact of Corporate Governance on Internet Financial Reporting

Andrea Kelton
Doctoral Student
University of Tennessee
Department of Accounting and Information Management
637 Stokely Management Center
Knoxville, TN 37996-0560
akelton@utk.edu

Ya-wen Yang
Assistant Professor
University of Miami
Department of Accounting
316 Kosar-Epstein Building, 5250 University Drive
Coral Gables, FL 33146-6531
yyang@miami.edu

December 3, 2004

Please do not quote, copy or electronically transmit without permission

 The Impact of Corporate Governance on Internet Financial Reporting

ABSTRACT: This study investigates the effect of corporate governance mechanisms on

Internet financial reporting (IFR) behavior. We rely upon agency theory to predict an association
between the extent of a firm’s Internet disclosure behavior and its corporate governance
structures. We measure corporate governance by shareholder rights, ownership structure, and
board composition. We develop a disclosure index to measure IFR activities in the Investor
Relations sections of a sample of publicly traded US firms. Specifically, we measure IFR by
disclosure content, presentation format, required filings, voluntary disclosures, and corporate
governance disclosures. Results indicate that firms with weak shareholder rights and a higher
percentage of independent directors are more likely to engage in IFR. Interestingly, these firms
are also more likely to provide disclosure regarding their corporate governance structures on
their corporate web sites. As corporate governance and disclosure are considered necessary
measures to protect shareholders, our results provide empirical evidence to policy makers and
regulators for implementing new corporate governance requirements and IFR guidelines.

Keywords: Internet financial reporting, corporate governance, voluntary disclosure

2
1. Introduction

The Internet is a unique information dissemination tool in that it encourages flexible

forms of presentation and permits communication with an unlimited number of potential and

existing shareholders. Currently, the majority of Internet financial reporting (IFR) practices is

voluntary1 and, for the most part, unregulated. Financial information provided on corporate web

sites varies across companies and ranges widely from required Securities and Exchange

Commission (SEC) filings to various unaudited and forward-looking voluntary disclosures. In

addition, IFR supports presentation methods that are not available in traditional, paper-based

financial reporting, such as hypertext, multiple file formats (i.e. pdf, text-based), and multimedia.

Prior research has examined the incentives and determinants of the level of information provided

on a firm’s web site and the format in which the information is presented. For example,

Debreceny et al. (2002) conduct a cross-country analysis and show that firm size, listing on U.S.

securities market and the level of technology are significantly positively associated with the level

of Internet financial reporting. Ettredge et al. (2002) investigate the characteristics of IFR firms

and document a significant positive association between voluntary Internet financial disclosures

and factors such as firm size, demand for external capital, information asymmetry, and disclosure

quality ratings.

This paper differs from prior research in that we turn to the qualitative side of the Internet

disclosure decision and examine the impact of corporate governance mechanisms on IFR.

Specifically, we examine the impact of shareholder rights, ownership structure, and board

1
Recently, regulatory bodies have begun requiring companies to make certain financial information available on
their corporate Web sites. For example, the New York Stock Exchange (NYSE) requires its listed company’s Web
sites “to include its corporate governance guidelines and the charters of its most important committees” (NYSE
2003).

3
composition on Internet-based financial disclosures. Recent empirical work on the association

between disclosure in traditional financial reporting and corporate governance includes Chen and

Jaggi (2000) and Eng and Mak (2003). Chen and Jaggi (2000) find a positive association

between the proportion of independent non-executive directors and the comprehensiveness of

information in mandatory financial disclosures of Hong Kong companies. Eng and Mak (2003)

find that lower managerial ownership and significant government ownership are associated with

increased disclosure and that an increase in outside directors reduces the corporate disclosures of

firms listed on the Stock Exchange of Singapore.

More recently, in examining the factors that affect listed Chinese companies’ voluntary

adoption of IFR and their extent of disclosure, Xiao et al. (2004) find significant association

between Internet-based disclosure choices and the multiclass of ownership structure, such as

government agencies ownership, state-owned corporations ownership, and legal person

ownership. We extend prior corporate governance and IFR research by examining the impact of

firms’ corporate governance structures on the content and format of Internet financial disclosures

of U.S. companies. As previously noted, prior work has established an association between

corporate governance and voluntary disclosures. We extend this notion by examining a specific,

voluntary method of information disclosure – Internet financial reporting.

We develop a disclosure index based on prior literature and measure the extent of each

sample firm’s IFR by content, presentation format, required filings, voluntary disclosures, and

corporate governance disclosures. We measure corporate governance with shareholder rights,

ownership structure, and board composition and then investigate whether these factors influence

Internet financial disclosures. There has been an increasing call for firms to improve on their

4
corporate governance structure and financial disclosures.2 Therefore, in an additional analysis,

we include Internet-based corporate governance disclosures in the dependent variable and

examine the association between a firm’s corporate governance structure and its corporate

governance disclosures.

Results indicate that firms with weak shareholder rights and a higher percentage of

independent directors are more likely to engage in IFR. Interestingly, these firms are also more

likely to provide disclosure regarding their corporate governance structures on their corporate

web sites.

This study contributes to the existing IFR, corporate governance, and information

presentation literature in several ways. First, we are not aware of any prior studies that test the

impact of corporate governance mechanisms on IFR in the U.S or that examine specific Internet

corporate governance disclosures. The current study examines several corporate governance

mechanisms in a single model assuming different mechanisms may offset or interact with each

other. As corporate governance and disclosure are considered necessary measures to protect

shareholders, our results provide empirical evidence to policy makers and regulators for

implementing new corporate governance requirements and IFR guidelines.

Second, prior IFR studies have typically used sample firms for which analysts’ ratings of

overall disclosure quality were available from the CFA Institute, which limits the applicability of

the prior findings. We utilize a broad sample of publicly traded companies, which allows a

powerful analysis, as there is considerable variation in the measures of the explanatory and

dependent variables.

2
To reinstate and support investor confidence after recent financial scandals, government and regulatory agencies
are creating and enforcing new regulations for corporate governance. For example, the Sarbanes-Oxley Act of 2002
was designed to reestablish corporate accountability. Properly executed, it should provide an opportunity for an
improved control environment and more efficient and effective processes.

5
 Finally, we provide empirical evidence of the different modes of information presentation

format that are being used in Internet disclosures. Prior research has shown that the manner in

which information is presented to can influence the judgment and decision-making process and

decision outcomes (Clements and Wolfe 2000; Hodge 2001; Rose 2001; Dull et al. 2003; Rose et

al. 2004). This evidence is important motivation for future research on the effects of Internet

presentation formats and also to standard setters who must monitor the financial reporting

process and protect the interests of financial information users.

The remainder of the paper is organized as follows. Section 2 reviews prior research on

Internet financial reporting. Section 3 develops the hypotheses. Section 4 outlines sample

selection and variable definitions. Section 5 presents the results and analysis, and the final

section sets forth conclusions.

2. Prior Research

Research on IFR has produced valuable insights into the determinants of companies’

disclosure choices. For example, Ashbaugh et al. (1999) document IFR practices and provide

preliminary evidence on why some firms disseminate financial information on their corporate

web sites, while others do not. The results indicate that firms engaging in IFR are larger and

more profitable than those not engaging in IFR. Furthermore, firms responding to their survey

indicated that disseminating information to shareholders was an important reason for establishing

an Internet presence. Ashbaugh et al. (1999) was one of the first studies to examine the IFR

issue; however, it did not provide a theoretical rationale for its analysis.

Several recent studies have attempted to alleviate this problem by using theories on

voluntary disclosure (Ettredge et al. 2002; Debreceny et al. 2002; Xiao et al. 2004) to generate

hypotheses. Ettredge et al. (2002) classify IFR into required filings (i.e., disclosures that are

6
required by the SEC, such as Forms 10-K and 10-Q) and voluntary disclosures and investigate

whether Internet dissemination of both types of data can be explained by theories of incentives

for voluntary disclosure by traditional methods (e.g., Lang and Lundholm 1993). The results

show that the presence of required items on a company’s web site is associated with size and

information asymmetry while the presence of voluntary disclosures is associated with size,

information asymmetry, demand for external capital, and disclosure reputation.

Debreceny et al. (2002) study voluntary IFR in 22 countries to identify the firm and

environmental determinants of IFR. Instead of separating the Internet financial content into

required and voluntary items (in a manner similar to Ettredge et al. 2002), they examine both the

content and presentation methods of disclosure. The findings reveal that the presentation aspect

of IFR is more associated with the level of technology and disclosure environment than the

content of IFR. Xiao et al. (2004) measure IFR in multiple dimensions (i.e., content, presentation

methods, mandatory items, and voluntary items) and analyze the determinants of Internet-based

disclosures by Chinese listed companies. Their primary focus is on factors unique to the Chinese

context, such as the existence of state ownership dominance. They find that IFR is positively and

significantly associated with the proportion of legal person ownership, but not with ownership by

domestic private investors, foreign investors, or the state.

One characteristic of prior studies is the strong focus on quantitative aspects of the

determinants of IFR. A number of studies examine the relationship between IFR and factors such

as firm size, profitability, leverage, etc. (e.g., Craven and Marston 1999; Ettredge et al. 2002;

Debreceny et al. 2002; Oyelere et al. 2003). Only a few studies investigate qualitative

determinants of Internet-based disclosures such as ownership structure (Xiao et al. 2004) and

level of technology (Debreceny et al. 2002).

7
 Another characteristic of prior studies is the common use of analysts’ ratings obtained

from the CFA Institute (formerly AIMR). In order to explore the link between firms’

engagement in IFR and reputations for their corporate reporting practices, both Ashbaugh et al.

(1999) and Ettredge et al. (2002) use a sample of firms for which analysts’ ratings of overall

disclosure quality were available from the CFA Institute in its 1994/95 and 1995/96 An Annual

Review of Corporate Reporting Practices.3 For purposes of understanding IFR in today’s

environment, the applicability of their findings is limited by the use of 1994/95 and 1995/96

data.

3. Hypotheses

The primary objective of this paper is to investigate whether corporate governance

mechanisms affect a firm’s Internet financial reporting behavior, including both the content and

presentation format of Internet disclosures. Agency theory (Jensen and Meckling 1976) provides

a framework linking disclosure behavior to corporate governance. In theory, the impact of

corporate governance on voluntary disclosures may be complementary or substitutive (Ho and

Wong 2001). It is complementary when adoption of governance mechanisms strengthens the

internal control of the firm and makes it less likely for managers to withhold information for

their own benefits, leading to improvements in disclosure comprehensiveness and in the quality

of financial statements. On the other hand, it is substitutive when governance mechanisms reduce

information asymmetry and opportunistic behaviors in the firm, resulting in a decrease in the

need for more monitoring and voluntary disclosure.

We measure corporate governance by shareholder rights, ownership structure, and board

composition. Shareholder rights vary across firms. Some firms reserve little power for

3
An Annual Review of Corporate Reporting Practices was discontinued in 1995-96.

8
management and allow shareholders to quickly and easily replace directors (by either internal or

external takeover) while other firms reserve extensive power for management and place strong

restrictions on shareholders’ ability to replace directors. As shareholder rights decrease, the cost

of replacing management increases for shareholders. As a result, agency costs increase.

Consequently, we expect firms with weak shareholder rights to be more likely to engage in IFR

than those in firms with strong shareholder rights. Accordingly, we test the following hypothesis,

stated in alternative form:

H1: The level of a firm’s Internet-based disclosures is negatively related to its shareholder
rights.

We examine the impact of corporate ownership structure on IFR using measures of

managerial ownership and institutional ownership. Managerial ownership reconciles the

(potential) agency conflicts between managers and shareholders and thus reduces agency costs

(Jensen and Meckling 1976). Empirical studies find that managerial ownership overcomes the

problem of managerial myopia, with high managerial ownership associated with an increase in

innovation and productivity of firms and, in the long term, the value of these firms (Francis and

Smith 1995; Holthausen et al. 1995). Because managerial ownership serves to align the interests

of shareholders and managers, it reduces shareholders’ needs for monitoring. Eng and Mak

(2003) find managerial ownership to be negatively associated with voluntary disclosure.

Accordingly, we test the following hypothesis stated in alternative form:

H2: The level of a firm’s Internet-based disclosures is negatively related to its managerial
ownership.

9
 Institutional shareholders are often characterized in academic research as sophisticated

investors who have advantages in acquiring and processing information compared with other

investors (Bartov et al. 2000; Jiambalvo et al. 2002). Consequently, institutional investors can be

more effective as traders and monitors than can small, diffuse retail investors. Institutional

investors could actually prefer that information not be broadly disseminated because they are

concerned about either a decline in the quality of the information communicated or a loss of their

informational advantage (NIRI 2000). Recent studies indicate a negative relation between

institutional ownership and voluntary disclosure. For example, in examining the determinants of

a firm’s decision to provide shareholders access to conference calls, Bushee et al. (2003) find

that firms that provide open conference calls have a lower institutional ownership than firms that

do not provide open calls. Accordingly, we test the following hypothesis stated in alternative

form:

H3: The level of a firm’s Internet-based disclosures is negatively related to its institutional
ownership.

Board independence is an important element in monitoring the corporate financial

accounting process (Klein 2002) and affecting the reliability of financial reports (Anderson et al.

2004). A high percentage of independent directors on the board enhances the monitoring of

managerial opportunism and reduces management’s chance of withholding information.

Empirical evidence suggests that corporate disclosure increases with board independence.

Beasley (1996) finds that the proportion of independent directors on the board is positively

related to the board’s ability to influence disclosure decisions. Chen and Jaggi (2000) find

evidence of a positive relation between the proportion of independent directors and the

comprehensiveness of corporate disclosure in the Hong Kong context. Based on findings from

10
the largest 300 Chinese companies, Xiao et al. (2004) suggest that IFR format and disclosure of

information not required by the China Securities Regulatory Commission are positively

associated with the proportion of independent directors.

In contrast to the above findings, Eng and Mak (2003) find that increased presence of

outside directors is associated with reduced disclosure using a sample of Singapore firms,

suggesting that external directors in Singapore play a substitute-monitoring role to disclosure

rather than a complementary-monitoring role. The authors argue that the difference may be due

to greater representation of outside directors on the board of Singapore firms than firms in other

countries. Outside directors may be elected by block holders and have direct access to acquire

information, thus demand less disclosure. There is no evidence indicating that U.S. firms are in

similar settings to Singapore firms. Accordingly, we test the following hypothesis stated in

alternative form:

H4: The level of a firm’s Internet-based disclosures is positively related to its proportion of
independent directors on the board.

4. Sample and Variables

4.1 Sample

The initial sample of 3,488 firms traded in the NASDAQ National Market4 was obtained

from the 2003 COMPUSTAT dataset. We then match our initial sample with the 2002 Investor

Responsibility Research Center (IRRC) dataset, which leaves us with 583 companies. The IRRC

dataset provides a “Governance Index”, which provides a proxy for the balance of power

between shareholders and managers. The index is constructed from 24 distinct corporate-

4
The purpose of our study was to examine the corporate governance factors that encourage companies to voluntarily
use the Internet to broadly disseminate financial information, including corporate governance disclosures. Since the
NYSE requires companies to disclose specific corporate governance data on their corporate web sites (NYSE 2003),
NYSE filers were not considered in our analysis.

11
governance provisions grouped by the following: (1) tactics for delaying hostile bidders, (2)

voting rights, (3) director/officer protection, (4) other takeover defenses, and (5) state laws. For

every firm, one point is added to the Governance Index for each provision that reduces

shareholder rights. Thus, the Governance Index has a possible range from 1 to 24. Firms with

lower index have stronger shareholder rights and firms with higher index have weaker

shareholder rights.5

We eliminate financial institutions (SIC codes 6000-6999; n=37), firms with fiscal year-

ends other than December 31 (n=225), and firms with recent merger and acquisition events

(n=11). Five companies are further excluded because their proxy statements were unavailable.

The final sample consists of 305 companies.

4.2 Measurements of Internet financial reporting

FASB (2000, Chapter 2) describes IFR in terms of content and presentation. The

financial content on a firm’s web site usually contains voluntary disclosures, such as stock

quotes, press releases, financial history, etc., in addition to traditional required filings, such as

quarterly and annual financial reports. The presentation forms range from the equivalent format

of printed annual report to dynamic forms such as sound and video to enhance the display,

readability, and understandability of financial information. We adopt this framework and

develop a list of 36 items to measure a company’s Internet financial reporting in the form of

content (CONTENT) and presentation (FORMAT) based on Xiao et al. (2004), Ettredge et al.

(2002), and Debreceny et al. (2002).

Table 1 presents the measurement schemes for FORMAT and CONTENT. Data was

collected by examining the Investor Relations sections of each sample firm’s corporate website
5
See more detailed descriptions of the Governance Index construction in Gompers et al. (2003).

12
for the presence of each of the 36 IFR measurement items. A score of 1 (for present) and 0 (for

absent) was assigned to each disclosure item.

The REQ variable is the sum of the scores for the disclosure items within the required

filings category. Likewise, the VOL variable equals the sum of the scores for voluntary

disclosure items. Consistent with Ettredge et al. (2002), we include a link to EDGAR as a

separate characteristic of REQ because EDGAR includes many required filings such as proxy

statements that are not presented in either annual or quarterly reports. CG measures corporate

governance disclosures on each web site and is the sum of items 18~20, 35 and 36 from Table 1.

CONTENT examines the IFR disclosure content and equals the sum of variables of REQ and

VOL. FORMAT examines the IFR disclosure presentation formats and options provided on a

company’s web site that are not available in the traditional paper paradigm, including multiple

file formats, downloadable data features, hyperlinks, audio and/or video, and e-mail alerts.

TOTAL measures a company’s total disclosure across all 36 items. Table 2 summarizes all the

variables used in the hypotheses tests.

4.3 Explanatory variables

G is a proxy for the level of shareholder rights and is obtained from the IRRC dataset.6

MGMT and INSTITUTE measure the percentages of shares owned by the company’s

management and directors and by institutional shareholders, respectively.7 IDIRECT measures

6
The Governance Index (G) is calculated in the IRRC by adding one point to the index for each provision that
reduces shareholder rights (Gompers et al. 2003). For ease of interpretation, we transformed G as a dummy variable
where G is equal to 1 for firms with Governance Index less than 8 (the median of the continuous variable), and zero
otherwise. Thus, in our study, firms with a G equal to 1 are referred to as having “strong shareholder rights”; firms
with a G equal to 0 are referred to as having “weak shareholder rights.” Results using the continuous value of G are
statistically similar.
7
Fama and Jensen (1983) point out that high levels of managerial ownership can lead to management entrenchment.
Morck et al. (1988) show that firms with 5 to 20 percent managerial ownership perform better than firms either
below 5 percent or greater than 20 percent. Therefore, following Francis and Wilson (1988), we measure manager

13
the percentage of independent directors on the board.8 MGMT and IDIRECT were obtained from

the sample companies’ publicly disclosed reports for year 2003. INSTITUTE was obtained from

the Spectrum database.

We control variables that prior research has found to be relevant to voluntary disclosure

choices. The control variables included are firm size (SIZE), profitability (ROE), growth

opportunities (GROWTH), needs for new external equity capital (EQUITY), and auditor type

(BIG4). Empirical evidence shows a positive association between firm size and disclosure

(Chow and Wong-Boren 1987; Lang and Lundholm 1993). An explanation is that there may be a

fixed component to disclosure cost, so that the cost per unit of size is decreasing (Lang and

Lundholm 1993). Economies of scale suggest that larger firms are more likely to post financial

reports at web sites than smaller ones (Ashbaugh et al. 1999). We measure firm size (SIZE) by

the natural logarithm of the firm’s market value of equity on December 31, 2003. Firm

profitability is included in the control variables because managers of profitable firms have

greater incentives to disclose information to raise shareholder confidence and support

management compensation contracts (Malone et al. 1993; Wallace et al. 1994) than managers of

other firms. We measure profitability (ROE) with return on equity.

Traditional accounting measures do not fully capture the value of firms with high growth

prospects and high intangibles (Lev and Sougiannis 1999). Therefore, high growth firms attempt

to mitigate information asymmetry by making disclosures through additional mediums such as

IFR or conference calls (Frankel et al. 1999). Consistent with Frankel et al. (1999), we measure a

firm’s growth prospects (GROWTH) by the market-to-book ratio. We also include a measure of

ownership both as a continuous variable (MGMT) and as a nonlinear variable, MGMT2, coded one if outside the 5
to 20 percent range and zero if in the 5 to 20 percent range. MGMT and MGMT2 yield similar results in the
regression models.
8
We classify independent board members according to the definition in NASD Marketplace Rule 4200 (A)(15).

14
the firm’s needs for new external equity capital (EQUITY). Managers have incentives to disclose

favorable information prior to a security offering. They also might disclose negative information

if the market interprets not doing so even more unfavorably (Lang and Lundholm 1993; Frankel

et al. 1995). EQUITY is a dichotomous variable which equals one if the firm is a net issuer of

common equity in year 2003, and zero otherwise.

Finally, we control for the firm’s auditor type (BIG4). Xiao et al. (2004) find that the

extent of Internet corporate disclosure is greater among Chinese companies audited by the Big-5

(now Big-4) firms. We measure BIG4 using a dichotomous variable that equals one if auditor is

a Big-4 firm, and zero otherwise. All the data necessary to calculate our control variables were

obtained from COMPUSTAT database.

5. Results

Table 1 presents the measurement scheme of the IFR scale and provides the percent of

sample firms disclosing each of the items in the disclosure index. All of the 305 sample firms

had accessible corporate web sites although seven did not have an Investor Relations section on

their sites. The most popular presentation format is hyperlinked table of contents (97.7%). Other

frequently adopted presentation formats are audio files (81.3%) - which typically consisted of

web casts of earnings conference calls - and automatic Investor Relations information request

forms (74.0%). Only 2.3% of sample firms had video files on their web sites. The three most

common voluntary disclosure items are recent financial news releases (90.2%), information

about the firm’s stock transfer agent (73.4%), and same-day stock prices (72.8%). Very few

sample companies disclosed recent monthly financial data (0.7%), the advantages of holding the

firm’s stock (1.0%), and analyst ratings (2.0%). Seven of the eight required disclosure items

were found at half or more of the sites. In contrast, only nine of the 16 voluntary disclosure items

15
were found at more than 50% of the web sites. This trend, consistent with the findings in

Ettredge et al. (2002), suggests greater uniformity in the presentation of required disclosures,

relative to voluntary disclosures.

Table 3 provides the descriptive statistics for the full sample. The means scores for the 24

content items, 12 format items, five corporate governance disclosure items, eight required

disclosure items, and 16 voluntary disclosure items are 13.07, 6.30, 3.43, 5.84, and 7.23,

respectively. The level of overall Internet disclosures (TOTAL) in the sample ranges widely. Of

a possible TOTAL score of 36, the highest score is 31, and the lowest is 0. The mean (median) is

19.37 (20), indicating that the extent of IFR disclosure of our sample tends to be limited,

according to our IFR measurement scheme. The distribution of managerial ownership (MGMT)

is skewed to the right (mean = 15%; median = 9%). Institutional ownership (INSTITUTE) is

relatively high with a mean of 59%. On average, 72% of our sample firms’ boards of directors

consists of independent directors (IDIRECT). In addition, 78% of the sample firms were net

issuers of common equity in year 2003. Finally, 96% of the sample firms had a Big-4 auditor in

year 2003, suggesting a lack of variation in the variable BIG4.

Table 4 presents the correlation matrix between the independent and control variables.9

The independent variables with the highest correlation are MGMT and IDIRECT ( = -0.40).

When both MGMT and IDIRECT are included in the same model, their significant correlation

may impair the model’s ability to explain the variation in disclosures. Therefore, as a sensitivity

test, alternative models are analyzed excluding one of the two highly correlated variables at each

time and are presented for comparison purpose (see discussion in Section 5.1).

9
To assess the potential for multicollinearity, we regressed TOTAL on all independent and control variables. The
variance inflation factors (VIFs) are below 2 for all variables, suggesting that inter-correlation among explanatory
variables does not appear to be problematic and multicollinearity should not be a serious concern in this study.

16
 Table 5 reports the regression results. A separate OLS regression model was analyzed for

each of the six measures of IFR (FORMAT, CONTENT, REQ, VOL, CG, and TOTAL) and the

results of each regression are presented in columns A-F of Table 5, respectively. Hypothesis 1

predicts that IFR will be negatively related to a firm’s shareholder rights (G). The coefficients on

G are negatively and statistically significant for four of the six IFR measures (CONTENT, REQ,

VOL, and CG) providing support for H1. That is, firms with weaker shareholder right tend to

provide more Internet disclosures, including corporate governance items. A possible explanation

is provided by signaling theory, such that a lack of disclosures might send unfavorable signals to

investors especially for firms with weak shareholder rights. Therefore, firms with a low value of

G tend to provide more disclosures than those firms with a high value of G.

Hypothesis 2 predicts that IFR will be negatively related to a firm’s percentage of

managerial ownership. Five of the six coefficients of MGMT, as shown in Table 5, are in the

hypothesized direction; however, the coefficients are not statistically significant. Therefore, H2

is not supported.

Hypothesis 3 predicts that IFR will be negatively related to the percentage of institutional

ownership. Interestingly, the coefficient on INSTITUTE is only significant when examining the

format of Internet disclosures. Thus, companies with lower institutional ownership are more

likely to utilize the different presentation format options available using the Internet as a

disclosure medium.

Finally, hypothesis 4 posits that IFR measures will be positively related to the percentage

of independent members of the board of directors. The results in Table 5 provide strong support

for H4, since the coefficients on IDIRECT are positive and statistically significant for each of the

six IFR measures. Consistent with the finding in Chen and Jaggi (2000) that (traditional, paper-

17
based) comprehensive financial disclosures are positively associated with the proportion of

independent non-executive directors on the board, our results indicate that board independence is

positively related to corporate Internet disclosures.

SIZE was the only control variable that provided significant results for each of the IFR

measures. Consistent with prior IFR research (Ashbaugh et al. 1999; Debreceny et al. 2002;

Ettredge et al. 2002; Xiao et al. 2004), we find that larger firms are more likely to use the

Internet to provide financial disclosures.

5.1 Sensitivity Test

We conducted additional analyses to determine the robustness of our findings with

respect to IDIRECT. The alternative models exclude one of the two highly correlated variables,

MGMT and IDIRECT, at each time and are presented in columns G and H of Table 5. MGMT is

insignificant whereas IDIRECT is statistically significant in the full model (column F). However,

MGMT becomes statistically significant when excluding IDIRECT in the model (column H).

The significance of MGMT in the absence of IDIRECT is likely a result of omitted variable bias.

That is, MGMT picks up the effect of the important but omitted IDIRECT variable. Because

MGMT and IDIRECT each measures different aspects of corporate governance structure,

theoretically both variables belong in the full model regardless of significance. The inter-

correlation between these two variables did not provide any threat to the validity of our findings.

6. Conclusions

This study investigated whether a firm’s corporate governance mechanisms influence

Internet financial reporting behavior, including both the content and presentation format of

Internet disclosures. Internet financial reporting provides an efficient means for companies to

improve communications with investors, decrease costs associated with distributing hard-copy

18
information, and increase the frequency of information disclosures (Ashbaugh et al. 1999; FASB

2000). The Internet also provides more flexibility as to the type of information disclosed to

investors and the presentation format of the disclosures. The number of individual investors that

use the Internet to research investment opportunities and conduct stock trades online is

constantly growing (Spiro and Baig 1999), which makes IFR an important area of academic

research.

Currently, disclosure on the Internet is for the most part voluntary; consequently, there

are limited assurances as to the quality of the information reported on corporate web sites. As of

the date of this study, there are no accounting disclosure regulations specifically targeting

Internet financial reporting. The Financial Accounting Standards Board’s Business Reporting

Research Project (2000) noted concerns with the quality of web financial information: “with

increased timeliness there is the potential for decreased reliability” (FASB 2000, p.3) and

“information provided on the Internet does not have the same quality of predictable

completeness” (FASB 2000, p. viii). Regulators have also expressed concern over the format in

which information is displayed on the web: “a company may inadvertently give visitors the

impression that all information provided in other web sites to which the company’s web site is

linked is afforded the same level of accuracy and reliability” (FASB 2000, p.3).

This study extends prior IFR research by examining whether corporate governance

affects a firm’s Internet disclosure behavior. Results provide support for two of our four

hypotheses. We find that firms with weak shareholder rights are more likely to use the Internet

to disseminate information to existing and potential investors. Interestingly, firms with weak

shareholder rights are also more likely to provide specific information regarding corporate

governance on their web sites. A possible explanation is that managers provide additional

19
disclosures to shareholders in response to the increase in agency costs that result from the

existence of weak shareholder rights. In addition, we find that firms with a greater percentage of

independent directors are more likely to engage in IFR. This finding is an important extension of

recent research that has shown that corporate disclosure increases with board independence

(Beasley 1996; Chen and Jaggi 2000; Xiao et al. 2004). We find that board independence also

increases disclosure using a voluntary dissemination tool – the Internet. Importantly, we also find

a positive association between board independence and corporate governance disclosures. Our

results suggest that board independence is effective in increasing voluntary corporate disclosures.

As corporate governance and disclosure are considered necessary measures to protect

shareholders, our results provide empirical evidence to policy makers and regulators for

implementing new corporate governance requirements and IFR guidelines.

This study also provides empirical evidence on the presentation format methods used for

IFR. Studies have shown that the manner in which information is presented to investors affects

decision-making. For example, Hodge (2001) provided evidence of investors mistakenly

classifying unaudited information as audited when the information was hyperlinked to the

audited financial statements. Since 25.9% of our sample used hyperlinks to third-party web sites

and 48.2% used hyperlinks within the annual report, the effect of IFR presentation format

remains an important area for future research.

20
 Table 1
The Measurement Schemes of FORMAT and CONTENT

Disclosure Items % of Firms Disclosing

FORMAT
1 Annual report in multiple file formats 44.3
2 Financial data in processable format 36.7
3 Hyperlinked table of contents 97.7
4 Drop-down navigational menu 29.8
5 Hyperlinks inside the annual report 48.2
6 Hyperlinks to data on a third-party’s website 25.9
7 Audio files 81.3
8 Video files 2.3
9 Investor e-mail alerts 69.2
10 Automatic investor relations information request form 74.0
11 Dynamic graphic images 65.9
12 Internal search engines 54.8

CONTENT
Required disclosures:
13 Current year' s annual report (2003) 91.8
14 Last year's annual report (2002) 88.9
15 Recent quarterly report 59.3
16 Other SEC filings 61.6
17 Link to EDGAR or 10K Wizard 46.6
18 Charters for the audit committee 75.1
19 Charters for other Board committees 76.1
20 Code of conduct and ethics for directors, officers and employees 84.3

Voluntary disclosure:
21 Recent monthly financial data 0.7
22 Performance overview (e.g., highlights, fact-sheet, '
FAQ'
) 68.2
23 Earnings estimates 23.6
24 Calendar of events of interests to investors 70.2
25 Recent financial news releases 90.2
26 Listing of analysts following the firm 62.6
27 Analyst ratings 2.0
28 Text of speeches and presentations 14.8
29 Same-day stock prices 72.8
30 Historical stock prices 61.3
31 Information about the firm' s stock transfer agent 73.4
32 The advantages of holding the firm' s stock 1.0
33 Information regarding a dividend reinvestment plan 23.0
34 Dividend history 51.8
35 Corporate governance principles/guidelines 38.7
36 Members of the Board of Directors 69.2

A score of 1 (for present) and 0 (for absent) was assigned to each disclosure item.

21
 Table 2
Variable Definitions

Variable Definition

Dependent variables:
CONTENT Total score for content items; the sum of REQ and VOL
FORMAT Total score for presentation items
CG Total score for corporate governance disclosures (sum of
items 18~20, 35 and 36)
REQ Total score for required disclosures
VOL Total score for voluntary disclosures
TOTAL Total score for all 36 items

Independent variables:
G Corporate governance index from the IRRC dataset
MGMT Percentage of equity ownership by management and
directors
INSTITUTE Percentage of the company's outstanding common shares
held by institutions
IDIRECT Percentage of independent directors on the board

Control variables:
SIZE Natural logarithm of the firm's market value of equity
ROE Return on equity
GROWTH Ratio of market capitalization to book value of net assets
EQUITY Dummy variable; one if the firm is a net issuer of common
equity in year 2003, and zero otherwise
BIG4 Dummy variable; one if auditor is Big-4 firm, and zero
otherwise

22
 Table 3
Descriptive Statistics a

Variable Mean Std Dev Min Median Max

b
Dependent variables:
CONTENT 13.07 4.08 0 14 20
FORMAT 6.3 2.38 0 6 14
CG 3.43 1.55 0 4 5
REQ 5.84 1.57 0 6 8
VOL 7.23 3.19 0 8 13
TOTAL 19.37 5.88 0 20 31

Independent variables:
G 0.38 0.49 0 0 1
MGMT 0.15 0.16 0.01 0.09 0.96
INSTITUTE 0.59 0.21 0.02 0.6 0.99
IDIRECT 0.72 0.12 0.33 0.74 0.91

Control variables:
SIZE 6.68 1.36 3.13 6.68 12.24
ROE -0.10 0.96 -6.11 0.04 8.49
GROWTH 3.29 4.21 -20.48 2.79 25.83
EQUITY 0.78 0.41 0 1 1
BIG4 0.96 0.19 0 1 1

a
See Table 2 for Variable Definitions
b
The maximum possible scores for CONTENT, FORMAT, CG, REQ, VOL, and
TOTAL are 24, 12, 5, 8, 16, and 36, respectively. See Table 1 for the measurement
schemes.

23
 Table 4
Correlation Matrix

G MGMT INSTITUTE IDIRECT SIZE ROE GROWTH EQUITY

MGMT -0.08 1
(0.17)
INSTITUTE 0.01 -0.29 1
(0.80) (0.00)
IDIRECT 0.10 -0.40 0.23 1
(0.08) (0.00) (0.00)
SIZE 0.00 -0.09 0.31 -0.02 1
(0.93) (0.12) (0.00) (0.75)
ROE -0.08 0.03 0.37 -0.08 0.16 1
(0.16) (0.56) (0.00) (0.15) (0.00)
GROWTH 0.02 -0.07 0.00 0.02 0.06 -0.37 1
(0.79) (0.20) (0.94) (0.72) (0.32) (0.16)
EQUITY -0.01 -0.14 -0.01 0.11 -0.04 -0.16 0.10 1
(0.88) (0.01) (0.91) (0.05) (0.49) (0.00) (0.07)
BIG4 0.04 -0.04 0.09 -0.03 0.16 0.24 -0.04 -0.06
(0.46) (0.48) (0.12) (0.59) (0.01) (0.00) (0.49) (0.30)

Correlations greater than or equal to |0.40| are in bold, and probability > |r| under H0: Rho = 0 is in parenthesis.

G = Dummy variable; one if the firm’s corporate governance index from the IRRC dataset is less than 8 (median),
and zero otherwise.
MGMT = Percentage of equity ownership by management and directors
INSTITUTE = Percentage of the company’s outstanding common shares held by institutions
IDIRECT = Percentage of independent directors on the board
SIZE = Natural logarithm of the firm’s market value of equity
ROE= Return on equity
GROWTH = Ratio of market capitalization to book value of net assets
EQUITY = Dummy variable; one if the firm is a net issuer of common equity in year 2003, and zero otherwise
BIG4 = Dummy variable; one if auditor is Big-4 firm, and zero otherwise

24
 Table 5
OLS Regression Results
Coefficients (t-statistics)

A B C D E F G H
FORMAT CONTENT REQ VOL CG TOTAL TOTAL TOTAL
Constant 1.93 * 2.11 2.83 *** -0.72 0.85 4.04 3.53 12.83 ***
(1.37) (0.91) (3.12) (-0.39) (0.95) (1.20) (1.16) (5.01)
G 0.06 -0.84 ** -0.36 ** -0.48 * -0.43 *** -0.77 -0.8 -0.93 *
(0.23) (-1.85) (-2.03) (-1.33) (-2.42) (-1.17) (-1.22) (-1.38)
MGMT 0.12 -0.93 -0.58 -0.35 -0.46 -0.8 -3.69 **
(0.13) (-0.61) (-0.97) (-0.29) (-0.78) (-0.36) (-1.73)
INSTITUTE -1.02 * 0.12 -0.23 0.35 0.42 -0.9 -0.78 0.14
(-1.45) (0.10) (-0.52) (0.39) (0.94) (-0.54) (-0.47) (0.08)
IDIRECT 3.74 *** 7.66 *** 2.31 *** 5.35 *** 2.14 *** 11.41 *** 11.76 ***
(3.07) (3.83) (2.93) (3.37) (2.75) (3.91) (4.28)
SIZE 0.31 *** 0.57 *** 0.14 ** 0.43 *** 0.12 ** 0.88 *** 0.89 *** 0.8 ***
(2.93) (3.27) (2.04) (3.12) (1.78) (3.47) (3.49) (3.08)
ROE -0.02 -0.21 0.01 -0.23 -0.08 -0.23 -0.23 -0.33
(-0.11) (-0.82) (0.11) (-1.09) (-0.78) (-0.61) (-0.61) (-0.85)
GROWTH 0.02 0.04 -0.01 0.05 -0.04 ** 0.06 0.06 0.05
(0.58) (0.65) (-0.52) (1.08) (-1.67) (0.69) (0.71) (0.55)
EQUITY 0.29 0.59 0.44 ** 0.16 0.01 0.88 0.91 1.05 *
(0.87) (1.08) (2.03) (0.36) (0.06) (1.11) (1.16) (1.30)
BIG4 -0.16 1.49 0.5 0.99 0.35 1.32 1.35 1.1
(-0.22) (1.21) (1.04) (1.01) (0.74) (0.74) (0.75) (0.60)
F-value 2.21 ** 5.29 *** 3.63 *** 4.25 *** 3.64 *** 4.49 *** 5.05 *** 3.00 ***
2
Adj. R 0.03 0.11 0.07 0.09 0.07 0.09 0.1 0.05

*, **, *** Indicates significance at the 10%, 5%, and 1% levels, respectively, using a one-tailed test.

G = Dummy variable; one if the firm’s corporate governance index from the IRRC dataset is less than 8 (strong
shareholder rights), and zero otherwise.
MGMT = Percentage of equity ownership by management and directors
INSTITUTE = Percentage of the company’s outstanding common shares held by institutions
IDIRECT = Percentage of independent directors on the board
SIZE = Natural logarithm of the firm’s market value of equity
ROE= Return on equity
GROWTH = Ratio of market capitalization to book value of net assets
EQUITY = Dummy variable; one if the firm is a net issuer of common equity in year 2003, and zero otherwise
BIG4 = Dummy variable; one if auditor is Big-4 firm, and zero otherwise

25
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