Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 CORPORATE OWNERSHIP & CONTROL
КОРПОРАТИВНАЯ СОБСТВЕННОСТЬ И КОНТРОЛЬ
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Corporate Ownership & Control
Корпоративная собственность и контроль
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3
CORPORATE OWNERSHIP & CONTROL Volume 10, Issue 3, 2013, Continued - 3
CONTENTS
THE QUALITY OF WEB INVESTOR RELATIONS IN LISTED ITALIAN COMPANIES: MEMBERSHIP IN THE STAR SEGMENT – DOES IT MAKE A DIFFERENCE? 245 Antonio D’Amato, Claudia Cacia DEBT AND FINANCIAL PERFORMANCE OF SMES: THE MISSING ROLE OF DEBT MATURITY STRUCTURE 266 Hayam Wahba DYNAMICS OF THE CURRENCY EXCHANGE RATES AGAINST THE AUD: ANALYTICAL AND RISK MITIGATION PERSPECTIVES 278 Tasadduq Imam, Abdullahi D. Ahmed, Kevin Tickle INTERIM FINANCIAL REPORTING IN THE ASIA-PACIFIC REGION: A REVIEW OF REGULATOTY REQUIREMENTS 292 Nguyen Huu Cuong, Gerry Gallery, Tracy Artiach WHICH COMPANIES FIND IT EASIER TO OBTAIN BANK LOANS? EVIDENCE FROM CHINA 301 Wenjuan Ruan, Erwei Xiang DETERMINANTS OF ACCESS TO BANK FINANCE FOR SMALL AND MEDIUM-SIZED ENTERPRISES: THE CASE OF SRI LANKA 314 Pandula Gamage
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THE QUALITY OF WEB INVESTOR RELATIONS IN LISTED ITALIAN COMPANIES: MEMBERSHIP IN THE STAR SEGMENT – DOES IT MAKE A DIFFERENCE? Antonio D’Amato*, Claudia Cacia** Abstract The Internet has influenced corporate communication practices as concerns providing timely, comprehensive and accurate financial information. The paper investigates the quality of investor relation of listed Italian companies. In line with Borsa Italiana which defines STAR the companies with a strong vocation for communication, we aim to verify that such companies actually do communicate better than the others. In this perspective, we consider that the companies listed on the other MTA Telematic Stock Market- segments of the Italian Stock Exchange, could align the quality of financial disclosure to that of STAR companies as a result of imitative strategies. Our main findings reveal that in the Italian market herding does not characterize the behavior of companies as regards Web Investor Relations (W.I.R.) practices and quality. Keywords: Financial Communications, Web Investor Relation Index (WIRI), Italian Listed Companies, Star Segment, Voluntary Disclosure, Herd Behaviour JEL Classification: G30, G32, M10, M14, M41 *D epartment of M anagem ent and Information Technology, U niversity of Salerno, via Ponte D on M elillo, 84084 Fisciano (SA ) Tel: +39089963107 Fax: +39089963505 Email: andamato@ unisa.it **D epartment of M anagem ent and Information Technology, U niversity of Salerno
1. Introduction and research objectives Web communication has taken on a significant role in corporate communication strategies. The technical and functional characteristics of the Internet improve the communication process and increase the quantity and quality of information disclosed. In particular, the web has revolutionized communicating by breaking down the physical and temporal barriers that exist in the relationship between sender and recipient of the message. Therefore, in addition to the significant cost advantages that the web offers to businesses for implementing communication strategies, it radically improves the effectiveness of circulating information to the public: this helps to create a truly transparent and competitive economic environment (Berk, 2001). In this perspective, the use of the web to disseminate financial information represents one of the most important and interesting areas of web communication (Hindi & Rich, 2010). In particular, the literature has long emphasized that timely, comprehensive and accurate financial communication can bring significant benefits to businesses (Fishman & Hagerty, 1989, Lang & Lundholm, 1993, Schuster & O'Connell, 2006) and more generally to the economic and financial system (Chang et al., 2008). The potential of the web for radically improving the
quality and timeliness of dissemination of financial information has also been underlined (Berk, 2001). The web overcomes the traditional frequency of financial reporting activities, able as it is to transmit continuous information flows that in real time, stimulate investor decision making processes. Consequently, businesses are well aware of the potential of the web for the dissemination of financial information (Ashbaugh et al., 1999). The characteristics of the web in terms of visibility, low cost, etc.. have increased the focus on the propensity of firms to disclose voluntarily. The Web, in fact, increases the opportunities for companies to voluntarily communicate quantities of information, beyond the legal requirements. In this respects scholars and practitioners have shown dissatisfaction with traditional mandatory communication, deemed incapable of fully satisfying the information needs of investors and stakeholders in general (ACCA, 1999, Bozzolan et al., 2003; Chen & Jaggi, 2000; Eng and Mak, 2003; Ernst & Young et al., 1999; OECD 2001). Such dissatisfaction has led to the need for companies to provide voluntarily clear cut, timely and complete information about all aspects of their business. On the one hand, investors are interested both in financial and non financial information (Eccles, 2011). On the other, not only are
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 investors interested in the life of the company, but also other stakeholders (suppliers, employees, customers, etc.) express the need for different types of information such as financial or information on Corporate Social Responsibility (CSR) and so on (Hockerts & Moir, 2004). However, if as the literature shows, effective communication produces significant benefits for businesses, then companies should be willing on a voluntary rather than mandatory basis to provide investors and other stakeholders with all the relevant information for an accurate analysis of company dynamics. The willingness of companies to communicate effectively, by providing thorough, complete and accurate information, should also derive from the knowledge that in financial markets in particular, competition is nourished by the information available to the operators. For this reason, companies should be stimulated to provide information that is adequate in quality and in quantity to hold its own against competitors. In practice, it is necessary to overcome the logic of mandatory disclosure and affirm an approach for the adoption of best practices of voluntary disclosure. Based on these considerations, the paper analyzes the quality of web investor relations (WIR) in listed Italian companies with the aim to highlight whether some companies communicate better than others, or whether there is an alignment of all listed companies to the same level of communication quality. In this perspective, the literature shows that companies for various reasons tend to apply imitative strategies in voluntary disclosure (Brown et al., 2006; Cerbioni and Menini, 2011). In particular, scholars discussing on informational herding highlight the similarity or convergence in the way such firms communicate. The reasons for herd behavior may be various. First, the literature emphasizes that managers can be induced to disclose on the basis of information from other managers (Banerjee, 1992; Welch, 1992). Secondly, managers are induced to communicate in a similar manner to avoiding appearing different from others and the risk of being negatively evaluated by the public (Scharfstein and Stein, 1990; Trueman, 1994). The companies listed on the STAR segment are defined by Borsa Italiana as companies with a strong vocation for communicating. Therefore these companies should evidence a significantly higher level of communication quality compared to the others. On the other hand however, if the voluntary approach to financial disclosure is effectively shared and disseminated, no significant difference among all listed companies might be observed. First of all, if NON STAR companies are aware of the benefits and the strategic role of financial communication, they should put in place communication comparable, in quality and efficacy, to that of STAR companies. Consequently, NON STAR companies might present the same communication quality as STAR companies
for example as a means to compete in capital acquisition on the financial market. Therefore, our research has been built on the observation and comparison of communicative practices of companies listed on the STAR segment compared to the remaining companies listed on Italian Stock Market. Expected findings could help to shed light on the ability of listed Italian companies to improve their communicative action. From this point of view, our work could contribute to enriching the empirical literature on the communicative practices of listed Italian companies. The work also investigates whether the quality of WIR could positively influence market performance. From this point of view scholars have shown that greater disclosure enhances company market performance (Botosan & Plumlee, 2002; Gietzmann & Ireland, 2005; Richardson & Welker, 2001;). Our study is structured as follows. In the first part we review the literature on WIR. Then we outline our research hypotheses. In the third part we present the model to assess the quality of WIR and illustrate the methodology used to test the hypotheses. Finally, we show the results and discuss implications. 2. Literature Review This section of the paper reviews the literature on investor relations to delineate a theoretical framework as a foundation for the confirmation or otherwise, of the hypotheses on which this work is built 2.1. Disclosure, Investor Relations and Technological innovation The main objective of corporate disclosure is to help investors evaluate company performance and make profitable investment decisions (Charlotte, 2006). The aim of Investor Relations (IR) is to manage effectively the communication between a company and its investors. Success in investor relations requires the companies to extend the scope of investor relations from a mere obligatory disclosure towards more frequent, extensive, proactive and diversified two-way interaction (Laskin,2006). The overall goal is to create a mutually beneficial relationship between companies and investors based on a fair valuation of the company stock price. Therefore, to improve communication with investors, the information communicated by companies has to be extended beyond the mandatory financial information towards a broader, transparent, and socially responsible disclosure, which also focuses on non-financial information. As is well known, disclosure theory differentiates between mandatory and voluntary disclosure. Mandatory disclosure is oriented to protect and guarantee the minimum information requirements for stakeholders as a consequence of the inadequate
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 production and uneven distribution of corporate financial information. It refers to the information which must be available as an outcome of current statutory provisions, capital markets rules or regulations issued by accounting authorities. Mandatory disclosure is being practised by all listed firms in most countries with the main characteristics defined at national or regional level by organizations or government authorities (Adina & Lon,2008). Through mandatory disclosure it is possible to reduce information abuse by insiders (insider trading) and to achieve greater capital market efficiency through the effective representation of business dynamics (Leftwich, 1980; Watts & Zimmerman, 1990). From this point of view, Stigler (1961) laid the foundations of modern economics of information theory by studying the activities aimed at reducing the uncertainty of investor decisions and the extent of information present on the market (Akerlof, 1970). To this were added the studies devoted to the efficiency conditions of securities markets (Fama, 1970; Healy & Palepu, 2001) and to moral hazard and adverse selection problems (Akerlof, 1970). Theoretically, agency problems (Jensen & Meckling, 1976) could be solved by offering more information, or stipulating rules that require companies to disclose to the market specific information considered to be of general interest, or particularly relevant for investment decisions (mandatory disclosure). The existence of regulatory remits however, does not ensure the quality of corporate communication. Although the sanction mechanisms related to mandatory disclosure, acting as a deterrent to inadequate behaviour, render the information disclosed by companies more credible, regulatory requirements allow businesses wide margins of discretion. Thus the thoroughness of the information contained in published documents is strongly influenced by a firm's attitude to transparency. The latter implies the adoption of a voluntary disclosure approach, whose objective is to increase the quantity and quality of information available for the market (Leland & Pyle, 1977, Leuz & Verrecchia, 2000, Welker, 1995). Consequently, voluntary disclosure can be defined as an additional offer of information that is not required by law but which is an effective tool for companies, in order to obtain financial capital as well as to attract outside investors (Adina & Lon, 2008). Various studies suggest that voluntary disclosure reduces information asymmetry among informed and uninformed market participants (Brealey and Myers 2000; Diamond & Verrecchia, 1991; Frankel et al., 1999). In truth, disclosure whether it is mandatory or voluntary, does in fact diminish information asymmetry between shareholder and management and ensures effective resource allocation. The literature points out, in fact, that a higher level of communication is associated with better performance, both in relation to higher stock returns, and greater
ability to compete on the financial market for fund raising at affordable costs. Less information asymmetries, in fact, moderates the perception of risk by investors: therefore this reduces the cost of capital, and conversely increases the liquidity of shares and their price (Diamond & Verrecchia, 1991, Lang & Lundholm, 1993). Merton (1987) shows, in particular, that risk-adverse investors do not invest in securities the characteristics of which are unknown. Moreover, Harrison & Huang (2005) emphasize that an effective communication policy is a goal sought by insiders to ensure a high degree of liquidity of shares, as a condition to sell their shares easily. This is particularly true for small companies or those in which insiders have invested most of their wealth. Welker (1995) & Leuz, and Verrecchia (2000) highlights that company disclosure is positively linked to the increase of share trading volume and therefore to market liquidity. Glosten and Milgton (1985), Healy et al., (1999) and Froidevaux (2004) also stressed the same findings. Healy et al.(1999), Lang and Lundholm (1993, 1996) showed that wide disclosure can improve stock trading in the capital market. In short, companies should have an attitude oriented to transparency, encompassing the integration of mandatory and voluntary disclosure (Leland & Pyle, 1977). The cost for corporations of disclosing information to the investor is significant (Gray et al., 1995). IR managers are reluctant to disclose information if the advantages of such disclosure do not outweigh the cost of disclosing information (Kelly,1983; Maingot & Zeghal, 2008). Information has a cost both related to production and use, which impacts in different ways on the basis of different utility functions and diverse levels of risk aversion (Allegrini, 2003; Di Stefano, 1990; Quagli, 2001;). There are direct costs of disclosing, such as the preparation of the information for disclosure which is borne by the corporation and also the analysis of the disclosed information which is borne by the different users of the information (Manigot & Zehal, 2008). Another type of cost related to disclosure is the potential cost of litigation (Froidevaux, 2004) related to companies that prefer not to disclose information (Manigot & Zeghal, 2008). Therefore, a high level of disclosure could also reduce litigation risks. However the literature clearly shows that the resources investments to improve the quality and quantity of disclosure creates clear benefits for businesses. Several Authors highlight the benefits of transparent communication, in terms of: • higher level of information intermediation and of analyst coverage (Ashbaugh & Pincus, 1999; Bhushan, 1989; Bowen et al. 2002, Francis et al., 1998; Healy et. al., 1999); • higher level of investor interest (Dhaliwai, 1979); • higher level of stock liquidity (Diamond & Varecchia, 1991; Frost et al. 2002; Glosten & Milgrom,1985; Lang & Lundholm, 1996);
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lower cost of capital (Dhaliwai, 1979; Elliot & Jacobson, 1994; Lev, 1992); • lower agency costs and level of information asymmetry (Chow & Wong-Boren, 1987; Healy et al., 1999; Jensen & Meckling, 1976; Leuz & Verrecchia, 2000; Low, 1996); • higher level of business value as the cost of capital decreases (Amihud & Mendelson,1986; Botosan, 1997; Demsetz, 1968; Sengupta, 1998; Kothari & Short, 2003); • opportunities to operate market manipulation (Bushee & Leuz, 2003). Other empirical evidence shows the existence of a positive relation between communication quality and P/E multiple and a direct relation between IR activity and business credibility and stock price level (Eccles & Mavrinac, 1995). Understandably, for an efficient communication policy, the benefits arising from economic-financial disclosure should outweigh the costs associated with information dissemination. Therefore, economic-financial disclosure is an essential development tool for enterprises which in no circumstances, should renounce professional administration of this kind of communication. Investor relationship department and their investor relations activities have recently captured world-wide interest because of major corporate failings (Laskin, 2006). The spread of a transparency culture in financial communications has encouraged the trend towards standardization of IR practices. This has been reinforced by technological innovations (Higgins, 2000). The web enables companies to acquire a widespread and more complete range of information regarding the business context; at the same time, it accelerates the disclosure process and attracts a wider audience (Bollen et al. 2006). One of the prerogatives of the web is represented by its ability to overcome the time-space barriers that affect traditional media: therefore the web facilitates the real-time dissemination of information on corporate events (Cacia, 2011). The use of the Internet for the dissemination of economic and financial information has become an indispensable component for business in managing relationships with the market. The web enables the conveying in a virtual space of traditional financial information (ranging from summary data or balance sheets, to information strictly speaking, outside the spheres of accounting; data on corporate events, corporate governance, rules on insider trading, etc., to which can be added other information, including that deriving from the market (Oyelere et al., 2003). The web, through the elimination of the sluggishness and typical costs of traditional means of communication, enables the replication of the typical conditions of perfectly competitive markets in an online environment. However, in consideration of the persistence in virtual markets of information asymmetries due to the problem of visibility on the web, it follows that the
existence of a website is not equivalent to its visibility on the net (Cacia, 2011). In the light of such considerations, the choice to disclose information through the web acquires a strong sense of openness, transparency, willingness and commitment by businesses to be known in the market (Giusepponi, 2002). Transparency is a prerequisite for building positive relationships with stakeholders and represents an opportunity for firms to manage trust and consensus with customers and investors (Marcus & Wallace, 1997; Mutti, 1998); this also helps to increase corporate esteem and credibility on the market (Broomley, 2001; Rindova & Fombrun, 1999). In addition, the web facilitates the construction of a fluid and transparent relationship between business and stakeholders, offering the opportunity to communicate with the market community in a uniform way. Several authors in the literature have analyzed the tangible and intangible benefits associated with the transparency and use of new technologies in communication (Debreceny et al., 2002; Ettredge et al., 2001; Khadaroo, 2005; Hodge, 2005; Wickramasinghe & Lichtenstein, 2006). In addition to the above mentioned benefits related to the improvement of financial disclosure, it should be noted that the literature has highlighted specific benefits from using the Internet in disclosure strategies. In general, through the Internet, businesses are able to increase the information flow in four directions: quantitative, qualitative, spatial and temporal (FASB, 2000; Quagli 2004; Teodori, 2008). The Internet allows a more complete transmission of information to the financial community (quantitative dimension): information relating to previous years, financial performance, the information sources developed by specialized operators (analysts), news about competitors or more general information of the macro-economic framework. In a qualitative perspective multimedia technology enriches the content representation of corporate events in multimedia formats (audio, video, web cast). The web also allows the eliminating of information filters created by intermediaries and operates in favoring the quality of the information disclosed. Interactive relationships between firm and interlocutors allows the eliminating of a uni-directionality flow of communication and promote the selectivity of the information transmitted; the most interesting factor is related to the possibility of customizing the information disclosed. The Internet allows the differentiating of communication flows for different users, by establishing various degrees of intensity depending on the relationship between those who request information and the issuing company. From a viewpoint of space, the web offers the possibility to overcome geographical boundaries that separate the company from its public. Thus communication becomes global (Qualgli, 2001). The web allows a
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 reduction in time (timing dimension) and in the cost of information production and disclosure (Rowbottom et al., 2005). The possibility to offer any kind of information in “real time” promotes timeliness in the acquisition process of documents, data and news and also guarantees an almost immediate update (AA.VV., 2003). This means that the web satisfies the information needs expressed by many stakeholders and links the benefits of lower costs of disclosure, indepth knowledge of recipients as well as timeliness and completeness of the information transmitted (Lymer & Debreceny, 2003). However these benefits are associated with some drawbacks. The first problem is related to security, deriving from hacker socket or potential error in transferring data that could compromise integrity. Notwithstanding, the main source of problems in the communication process through the Internet is information reliability, the credibility of web content (Quagli, 2002). Accordingly, the company should indicate carefully the source of data to facilitate evaluation of information reliability. Another critical aspect is information traceability, namely the ability to trace changes in documents on site or their deletion. Finally, the possibility of manipulating digital information generates the loss of a sense of psychological security that characterizes the printbased document: “Users may not regard Internet reporting as an acceptable substitute for print-based annual reports” (Oyelere et al., 2003). 2.2. Web Investor Relations and Communication Quality The literature has highlighted the central role of IR as a link between a company and the financial community and as a tool to increase corporate visibility and to improve the relationship with management (Bushee & Miller, 2005). Marston (1996 p. ) describes IR as the link between a company and the financial community: “Investor relations is not just a neutral process concerned with the provision of information to assist users. It may also be concerned with managing information flows in the best interests of the organization”. This recent but fast-growing process has led to improved global competition, both on the supply side of goods and services, and demand-side of resources, especially financial resources. Therefore, such fierce competition has encouraged the training of individuals specialized in investments tracking (Higgins, 2000). In this context, the selection of investment opportunities is achieved through detailed economic and financial information. The company must be able to provide this information so that the best investment opportunities can be evaluated. From this perspective, there is a need to build a network with the financial market, based on a continuous and effective communication process, to support the growth and renewal of businesses and the information needs of the market. These relationships
should be activated by proper financial communication policies aimed at effective and timely communication to financial market operators. Through presenting new information, a company can influence market operators and among the various media, the Internet enhances information flows in terms of quantity, quality, space and time. According to Bollen et al. (2006: 275) “The main objective of the use of the Internet for IR activities is providing individual investors with comprehensive and timely information that previously was available only to a select group of interested parties, such as institutional investors and analysts”. Thus, the literature debate moves from corporate reporting to web IR. Deller (1999) for instance has analysed the Internet as a tool for IR activities. The Author’s analysis had the scope of developing a panel of WIR tools. In the same year, Hedlin identified the development phases of communication via the Internet. Other scholars have attempted to identify the attributes of web financial reporting (Debreceny, et al. 2001; Ettredge et al. 2001) and proposed a description of company financial information and the consequences resulting from their web inclusion. In a subsequent study Ettredge et al. (2002a) analyzed the forces having greater effects on business decisions concerning voluntary communication strategies. Other scholars have analysed the financial communication and IR activities in a different perspective regarding information asymmetries, cost reduction of financial resources, shares liquidity, performance, corporate governance and so on (Bharadwaj, 2000; Botosan, 2006; Bown and Caylor, 2004; Brennan and Tamarowski, 2000; Byrd, 1993; Chang, 2006; Deller, 1999; Diamond and Varecchia, 1991; Geerings et al., 2003; Lang and Lundholm, 2000). Among the studies aimed at determining the characteristics of IR and the quality of Internet communication, particularly important is that of Geerling, Bollen e Hassink (2003); the Authors inspired by the prior studies of Hedlin (1999), Deller (1999) and Beattie & Pratt (2003), have identified five stages in the development of IR policy on the web. Geerling et al. (2003) identified 29 items – revised subsequently by Bollen (2006) - for the evaluation of web IR quality. The items mark a milestone in the measurement and explanation of IR quality determinants. Many other studies have contributed to the definition of factors for assessing the quality of IR on the web (Debreceny et al. 1998; Deller et al., 1999; Hedlin, 1999; Rowbottom et al., 2005) through the development of indices and checklists (Barac, 2004; Deller et al., 1999; Ettredge et al., 2001; Geerings et al., 2003; Hedlin, 1999; Pirchegger & Wagenhofer, 1999; Quagli 2002; Strong, 2003; Teodori, 2008; Xiao et al., 2005). Other studies have identified the elements of voluntary disclosure with impact on perceived quality (Avallone & Veneziani, 2002;
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 Debreceny et al., 2002; Pervan, 2006; Vanstraeven, 2003). From this point of view the quality of a corporate web site depends on multiple variables; above all the content and the way in which it is presented and managed, also from a technical perspective (Buglione, 2003; Rosenfeld et al., 2002). Several Authors in the literature have analyzed communication quality as a determinant of corporate value and have proposed numerous indices to evaluate communication effectiveness. However this has not yet led to the identification of items unanimously adopted to evaluate corporate website, especially in reference to the IR section. Nevertheless, it is possible to identify a trend shifting towards the goal of transparency and quality of economic and financial communication and WIR activities. The main findings from the studies highlight two main aspects of financial communication via web: 1. the first concerns the definition of the generic features of a website: namely design, structure, functionality, accessibility, usability, interactivity (Borsa Italiana S.p.a, 2010; Boscarol, 2009; Consob, 2001;ISO 9241; Mich and Franch, 2000, Nielsen 2000; Polillo, 2005; Wilkinson et al., 1997); 2. the second refers to financial communication and to its informative content (IR section) (AIRA, 2000; AIAF, 2000; Borsa Italiana, 2002; Consob, 2002; European Commission, 2001; IASC,1999; IFAC, 2002; IOSCO, 2007; Investor Relations Society (IRS), 2006 SEC, 2008;). Ultimately, the literature while offering specific taxonomies that facilitate the process of understanding the fundamental elements for the construction of a website, tends to create confusion in the identification of the series of characteristics qualifying the quality of websites for IR. In any case the increased importance of the use of the Internet for IR has contributed to a substantial change in the shape and functionality of the sites, and of voluntary and mandatory content, by introducing numerous elements such as information relating to corporate governance, corporate social responsibility or specific characteristics of business and management (Cacia, 2011). In our opinion, to measure the quality of IR on the Internet it should take into account information both about the sites content – to examine the type and amount of information that companies make available to investors (point 1) – and how information is diffused (point 2), which is essential for the realization of an effective and efficient communication able to generate a competitive advantage for firms. Thus, in our view the concept of “quality” of web investor relations can be defined by the following characteristics: 1) the presence of information related to: the business, financial reporting, corporate governance and corporate social responsibility;
2) the website should have a set of technical characteristics to make web use effective for stakeholders. Such characteristics are accessibility, usability, good architectures, functionality, setup. 3) the information should be useful for stakeholder in terms of relevance, faithful representation (reliable), adequacy, comprehensiveness, comparability, timeliness and comprehensibility. To conclude the section, this paper aims to contribute to the existing literature, both by defining the concept of "quality" and explaining its determinants. To this aim, we develop an index for measuring the quality of WIR. 2.3 Theoretical framework: Herding theory Based on a review of the literature, in line with the purpose of the research, the Herding Theory was used to analyze the behavior of listed companies in Italian Stock Market segments. According to the literature, companies tend to align to other companies in voluntary disclosure strategies (Brown et al., 2006). Such phenomena is also termed herding (Chamley 2004, Hirshleifer and Teoh 2003) and is related to voluntary disclosure decisions (Brown et al., 2006). Herding refers to any similarity or convergence in corporate behavior as a result of corporate interaction (Hirshleifer and Teoh 2003). In communication, herding is the influence of one firm’s disclosure decisions on the disclosure decisions of other firms (Brown et al., 2006). The reasons for herding may depend on managers being induced to disclose on the basis of information from other managers (Banerjee, 1992; Welch, 1992); or, on managers being induced to communicate in a similar manner to others to avoid appearing different, thus avoiding the risk of being evaluated negatively by the public (Scharfstein & Stein, 1990; Trueman, 1994). Other studies have indicated that many technology markets are subject to positive network feedback rendering leading technology growth more predominant (Brynjolfsson & Kemerer, 1996; Gallaugher & Wang, 2002; Kauffman et al., 2000). Furthermore, empirical evidence of herd behavior and imitative strategies has been recently documented in stock analysts’ equity recommendations, television programming (Hong et al., 2000; Kennedy, 2002; Welch, 2000) and IT adoption (Kauffman et al., 2003). Kauffman et al. (2003) suggest "payoff externalities, informational cascades and managers’ career concerns as three interrelated explanations for the kinds of imitative decision making behaviors that are observed in IT adoption". They provide a new theoretical framework for understanding observed forms of herding in IT adoption and in the fundamentals of IT investment decisions. Other research has analyzed the role of herding in stock markets; for example, scholars suggest that herding has become the dominating force
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 of the US stock market since 2000 (Zhou & Sornette, 2006). The literature also stresses the role of competitors in corporate communication strategy (Hirshleifer & Teoh 2003). Sometimes externalities, cultural and social environment or belonging to the same sector can influence corporate behavior, leading to consistent practices amongst companies (Aerts et al., 2006). Many Authors highlight that corporate communication policy is strictly influenced by the level of correlation between the signals that two rival companies send out to the market (Jorgensen & Kirschenheiter, 2005; Varecchia, 1983). Therefore, herding is related to the same decisional problems that companies have to face. As concerns corporate communication, herding makes communication policies analogous among companies (Banerjee, 1992; Bikhchandani et al., 1992; Chamley, 2004). Many empirical studies support this point of view (Firth, 1996; Freeman & Tse, 1992). However studies on herding in communication are limited (Botosan & Harris, 2000; Brown et al., 2006; Pincus & Wasley, 1994). Some recent studies evidence a trend towards sectorial specialization (Quagli, 2005) that also involves information uniformity, especially when regulatory elements are low (Di Piazza & Eccles, 2002). Finally, Cerbioni and Menini (2001), in analyzing the communication policies of Italian companies, showed that variations in communication quality are governed by herding. Consistent with theories of herding, our study attempts to contribute to the literature by focusing on the dynamics of herd behavior in the Italian Stock market. We aim to contribute both to the voluntary disclosure and herding literature by providing previously undocumented evidence of herding in disclosure practices of listed Italian companies. 3. Hypotheses According to the definition of the Italian Stock Market (see Borsa Italiana web site) companies listed on the STAR segment “voluntarily adhere to and comply with the following strict requirements: 1. High transparency and high disclosure requirements; 2. High liquidity (35% minimum of free float); 3. Corporate Governance in line with international standards.” As regards the first point, it should be noted that Italian Stock Market Rules stipulate specific disclosure requirements on STAR companies. In particular, Article 2.2.3 requires that companies listed on the STAR segment have to make available interim management statements, half-yearly and annual reports together with the information referred to in Articles 114(1), 114(4) and 114(5) of the T.U.F. – Consolidated Law on Finance – (price sensitive information) on their company website. Such information should also be provided in English. In addition, companies listed on the STAR segment are
obliged to post on their website, the documents distributed during meetings with professional investors (Art. IA.2.10.8, Instructions accompanying the Rules). Despite the specific information requirements imposed on STAR companies by Italian Stock Market Rules, it should be noted that the Consolidated Italian Law on Finance and the regulation issued by CONSOB (Commissione Nazionale per le Società e la Borsa - Italian Securities and Exchange Commission) have set disclosure requirements on listed companies such that there are no appreciable differences between STAR and NON STAR companies regarding the mandatory disclosure that they have to produce. Of course disclosure requirements are only a minimal part of the wider corporate disclosure that a company should convey to investors. Therefore, assessment of the communication quality of companies must necessarily refer to a comprehensive and systematic series of information that can make clear to a large audience business conditions in terms of: 1. corporate governance; 2. financial performance; 3. sustainability policies and correlative results. However the search for a high level of transparency in information and a high vocation in communication is a goal all companies should strive for. The literature points out, in fact, that a superior level of communication is associated with better performance, both in relation to higher stock returns, and the ability to compete on the financial market for financing at affordable costs. Therefore, if we consider that IR management has a strategic impact (Rayder & Regester, 1989) because it can improve the value creation of a company, the research question posed concerns whether STAR companies compared to other companies listed on the Italian Stock Market differ as regards the quality of their communication. Taking into account that STAR companies should present a high level of transparency, the research question we pose is: can alignment of disclosure policies, practices and objectives be found in all the companies listed on the Italian Stock Market? Scholars pinpoint the existence of an imitative process that leads companies to align their disclosure practices (Aerts et al., 2006; Brown et al. 2006; Pincus and Wasley, 1994; Scharfstein and Stein, 1990). The international literature discusses reputational herding and informational herding (Brown et al. 2006) to highlight (as mentioned above) that companies can choose to align communication policies to those of other companies in order to achieve direct benefits or to avoid appearing different from those more attentive to the diffusion of information. Cerbioni and Menini (2011) point out that the more transparent companies serve as example for others. This research question is interesting: if NON STAR are characterized by similar communication
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 quality to that of STAR companies, this could confirm the existence of herding behaviour in communication practices of listed Italian companies. Therefore beyond the mandatory disclosure imposed by institutions, companies tend to boost the quality of communication and enhance the role of IR. Based on these preliminary observations, six hypotheses were tested concerning the quality of IR activities carried out by STAR and NON STAR companies and to particular aspects of the same: Hp 1: Companies listed on the STAR segment of Borsa Italiana have an overall WIR quality significantly higher than the others listed on the Italian Stock Market. In addition hypotheses that relate to specific content of the web communication to investors were also tested: Hp 2a: Companies listed on the STAR segment of Borsa Italiana show significantly higher quality in their corporate website (in terms of web site content, usability, accessibility, etc.) compared to that of the other companies listed on the Italian Stock Market. Hp 2b: Companies listed on the STAR segment of Borsa Italiana have a significantly higher index of corporate information quality compared to the other companies listed on the Italian Stock Market. Hp 2c: Companies listed on the STAR segment of Borsa Italiana have a significantly higher quality of voluntary corporate governance disclosure compared to the other companies listed on the Italian Stock Market. As concerns the quality of the mandatory corporate governance disclosure there is no difference between STAR and the other companies listed on the Italian Stock Market. HP 2d: Companies listed on the STAR segment of Borsa Italiana have a significantly higher quality of voluntary financial disclosure compared to the other companies listed on the Italian Stock Market. As concerns the quality of the mandatory financial disclosure there is no difference between STAR and the other companies listed on the Italian Stock Market. Hp 2e: Companies listed on the STAR segment of Borsa Italiana have an index of CSR communication quality significantly higher compared to the other companies listed on Italian Stock Market. The literature shows that businesses characterized by a high quality of financial disclosure
have better market performance. High quality disclosure, in fact, increases share liquidity, reduces the cost of equity and increases the market value of company shares (Byrd & Johnson, 1993; Brennan & Tamarowski, 2000; Botosan, 2006). In this perspective, the hypotheses to be tested is as follows: Hp 3: A positive relationship exists between the quality of WIR and market performance. 4. The research design: sample, variables and methods of analysis The empirical research focused on companies listed on the Italian Stock Market to ascertain whether the listing on the STAR segment constitutes a relevant factor in explaining the quality of financial information conveyed via the web. In particular, the research aims to verify whether alignment of WIR quality among companies actually exists. The core item of the study is a Quality Index, designed to measure the quality of disclosure practices of listed Italian companies. Among the best practice recommendations, checklists and guidelines issued by various organizations, institutions and academic contributions, to gauge the quality of web disclosure, we decided to base our research on the Web Investor Relations Index (WIRI) (Cacia, 2011). Compared to current disclosure evaluation tools literature, the WIRI has the advantage of providing a quantitative measure of investor relations quality. Furthermore, the WIRI contributes to reducing the subjectivity of the assessment, because it measures investor relations quality in terms of presence/absence (1/0) of defined characteristics. Our research is based on a sample of 134 listed companies on the Italian Stock Exchange. In the sample we included two different groups of listed companies: STAR and NON-STAR. Of these two groups of companies we measured through the WIRI, the quality of voluntary and mandatory disclosure, in order to verify whether STAR companies compared to others actually present a higher level of disclosure quality. The distinction between mandatory and voluntary disclosure was made on the basis of regulations and laws that regulate corporate information requirements. To test the research hypothesis a multivariate analysis was conducted. The first six hypotheses (HP. 1-2) were tested with the dependent variable represented by the quality index of web company information. The seventh hypothesis (Hp. 3) instead, was tested with the dependent variable represented by Tobin's Q. Membership of the STAR segment constituted the independent variable used in testing our hypotheses. In the various models estimated we included several control variables to avoid spurious effects in the relationship between the dependent and independent variable. Moreover, to further strengthen
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 the reliability (Denzin & Lincoln, 1994; Gibbert & Ruigrok, 2010) of the research, data collection and data analysis were explained in full. In particular, both the development and the operationalization of the WIRI index were discussed to strengthen the validity of the methodological approach adopted (Gibbert et al., 2008). Furthermore, to maintain a consistent approach (Steier & Miller, 2010), data collection was conducted by one of the authors and then crosschecked by another. 4.1. The sample In our sample we included all companies listed on the STAR segment and a corresponding number of companies listed on the other segments of the Italian Stock Market (MTA). We excluded those belonging to the financial industry because of the particular regulations to which such companies are subject. At present 74 are the STAR enterprises, 7 of which operate in the financial industry. Thus 67 companies were suitable for our analysis. Similarly, 67 firms were drawn randomly from the set of those listed on the other segment of the ordinary market, with the constraint that they did not operate in the financial sector. The total number of firms under investigation amounted to 134. For each company selected we collected the necessary data by analyzing their corporate website. Other useful information for our analysis was obtained from the Italian Stock Exchange and CONSOB website. 4.2. Dependent variables To measure the quality of a corporate IR website, and even IR activities, we used the research tool devised and developed by Cacia (2011) known as Web Investor Relations Index (WIRI). The WIRI assesses the quality of WEB investor relation through the analysis of three main areas: 1. Area I - Company information; 2. Area II – The use of the Internet for financial communication: a) Corporate Social
Responsibility; b) Financial Information; c) Corporate Governance; 3. Area III - Features and functionality of the website: Web site Content, Usability, Accessibility, Architecture, Maintenance and Reliability (Frequency), Functionality, Characterization. The first area – Company Information – refers to the analysis of a corporate website concerning the general information relative to the company and its business area. The second area - Internet use for financial communication - relates to typical information addressed to investors (financial information, corporate governance information, etc.) and information relating to Corporate Social Responsibility (CSR); The third area - Features and functionality of the website - refers to the technical and functional evaluation of the website, in line with the definitions of the literature and international best practices. The WIRI measures the quality of Web Investor Relations in terms of presence or absence of defined characteristics that the literature recognizes as important for high quality communication. In this respect the model is composed of 280 items, distributed within the above mentioned areas. The items were derived from the systematic consultation of both the literature dealing with investor relations and the main international guidelines setting out the characteristics and standards that companies should observe in financial communication (Hooks et al., 2002). The studies from which the items included in the WIRI derive, number 20. Each item is measured on a binary scale (absence/presence - 0/1) and a weight is assigned to each item. The weight is based on the representativeness (in terms of citations) that each item has in the studies taken as reference. Therefore, for example, if an item has been cited by three studies, then the weight assigned corresponds to 3/20. Thus, the WIRI, representative of the overall quality of online information, corresponds to the sum of the weighted values of each item (Tab.1).
Table 1. Areas, sub-areas and number of items listed in the WIRI Area Company Information
Typical information aimed at investors and analysts
Features and functionality of the website
Sub-area
No of Items
Company information Corporate governance Financial reporting and other financial communications to investor and analysts Corporate Social Responsibility Information Website Content, Usability, Accessibility, Architecture, Maintenance and Reliability (Frequency), Functionality, Characterization.
15 50
Total items
156 9
50
280
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 In our study we decided to use WIRI as a measure of the overall quality of web investor communications. However, to highlight the contribution of each of the five sub-areas (Tab. 1) to the quality of WIR we calculate separate sub indices. The decision to defining sub indices for each subarea, was related to the need to make a clear distinction between the assessment of financial and non-financial information and between mandatory and voluntary disclosure or to evaluate Website design. For example, Website design is a critical aspect to take into account because website information organized in a logical and easy-to-navigate layout is essential for providing general access to information content and offers the opportunity of evaluating the weak and strong areas of web communication. As concerns the distinction between voluntary and mandatory disclosure, the main disclosure requirements established by law and Market Authorities relative to financial information and to corporate governance information were taken into account. Therefore, for these two sub-areas of disclosure we separated the items related to the mandatory from those related to voluntary disclosure. By consulting the T.U.F., the regulations issued by the Italian Stock Exchange and the CONSOB, the disclosure requirements of listed Italian companies were identified and the corresponding items of our model that measure the quality of mandatory disclosure (Tab. 1) were matched. Consequently, the following partial indices are compiled: 1. Company Information Quality Index (CIQI) measuring the quality of company information section; 2. Corporate Social Responsibility Information Quality Index (CSRIQI) measuring the quality of Corporate Social Responsibility information. 3. Two indices were compiled to measure Financial Information Quality; the first, referred to mandatory disclosure (FIQIMandatory) and the other relative to voluntary disclosure (FIQIVoluntary). The indices measure the quality of mandatory and voluntary financial reporting and other financial communications to investors and analysts (annual report, stock information, press area, analyst area, etc.). 4. Corporate Governance Information Quality. As for financial information, likewise for the evaluation of corporate governance information two indices were identified to measure the quality of mandatory corporate governance (CGIQIMandatory) and voluntary disclosure (CGIQIVoluntary). . 5. Website Quality Index (WQI) which measures the quality of the website in terms of features and functionality (web site content, usability, accessibility, etc.).
6.
Each sub index was calculated as the sum of the weighted scores of each item included in each sub-area. Expressed in formulae, we have: n
SI = ∑ Itemi × pi
(i = 1, 2, 3….n)
i =1
where: SI = Sub Index of a specific sub-area Itemi = score of item i of a specific sub-area pi = weight of item i of a given sub-area Thus, the WIRI is equal to the sum of the quality score awarded in the five sub-areas. WIRI = CIQI + CRSIQI + FIQI(Mandatory and Voluntary) + CGIQI(Mandatory and Voluntary) + WQI As regards hypothesis 3, corporate performance was measured in terms of Tobin’s Q (Chen and Lee, 1995). Tobin’s q ratio defined as the capital market value of the firm divided by the replacement value of its assets, incorporates a market measure of firm value which is forward-looking, risk-adjusted, and less susceptible to change in accounting practices (Montgomery & Wernerfelt 1988). According to Bharadwaj et al (1999), Tobin's q ratio was chosen as a measure of firm performance as it is more adequate for examining IT related benefits. In this work we calculated Tobin’s Q following the approach of Chung and Pruitt (1994). The two Authors calculate Tobin’s Q as the ratio of Equity Market Value plus Net Debt on Total Assets. 4.3. Independent and control variables The independent variable was represented by company membership in the STAR segment of the Italian Stock Exchange. The variable was expressed by a dummy variable. Several control variables were included in the analysis and sum up those used in the literature for the analysis of the quality of financial communication and company performance (Bollen et al. 2006). In particular we considered: • firm size expressed using the natural logarithm of market capitalization; • industry. The industry was identified as the mostrelevant macro-industry used by the Italian Stock Market to rank companies. In particular, firms were classified within the following broad sectors: technology, consumer goods and consumer services, and, finally, industrial; • leverage expressed as the ratio between debt and equity (D/E); • ownership concentration measured by the level of free float (floating); • independent directors (%), as the percentage of independent directors seated on the board; • degree of internationalization measured as the percentage of revenue from foreign markets;
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 •
•
firm performance measured as stock return (calculated as the variation in price plus any dividends paid, divided by the original price of the stock - for the previous year); the status of holding companies. When companies move from simple ownership
structures to complicated ownership structures such as holdings, agency costs emerge (Holderness, 2007). Consequently, such status affects market valuation. 4.4. Methodology The underlying rationale of our research was to contribute to developing the field of web investor relations. At the same time, we aimed to provide guidance to other researchers framing research questions. A content analysis (Weber, 1985) was carried out to evaluate the WIR of the companies surveyed. The link to each corporate website was found on the site of the Stock Exchange - Borsa Italiana S.p.a. (aggregator) where the company stock was listed. In particular, company website analysis was conducted in two distinct phases: during the first stage, we identified and saved company web pages. The pages were memorized in the Multipurpose Internet Mail Extension HTML (MHTML) format with the .mht extension, which facilitates storage and data analysis. In the second the corporate websites were mapped and then evaluated using the research tool presented. The survey was conducted using all the technical measures necessary to ensure identical assessment processes of the corporate websites surveyed. In particular, analyses were all conducted on the same days of the week and during the same time slots, using the same computer work station. The analyses were carried out from March to May 2012. Data on control variables of the models were derived from Company Annual Reports and from information on the websites of the Italian Stock Exchange and CONSOB. Available data were processed using multivariate techniques. The model used for testing the first six hypotheses had the following specification:
Quality = β0 + β1 (Dummy-STAR) + β2 (Control Variables ) + βIndustry(Industry Dummy Variables) + ε The dependent variable “Quality” indicates, respectively, in each of the eight models WIRI, CIQI, CSRIQI, FIQI(Mandatory/Voluntary), CGIQI(Mandatory/Voluntary) and WQI. The control variables considered in the models include the following: company size, leverage, degree of internationalization, the degree of the ownership diffusion, percentage of independent directors, firm performance. To test the seventh hypothesis (HP. 3) the following model was estimated: Q-Tobin = β0 + β1 (WIRI) + β2 (Control Variables ) + βIndustry(Industry Dummy Variables) + ε The control variables considered in the models are the following: dummy variable for the companies belonging to the STAR segment of Borsa Italiana, company size, leverage, degree of internationalization, the degree of ownership diffusion, percentage of independent directors and status of holding company. The estimation of the models was preceded by verification of the assumptions underlying the multiple regression model, taking all appropriate measures to ensure the accuracy and consistency of results. In particular, the estimation of the models was not subject to heteroscedasticity and multicollinearity. The results of the analysis are presented and discussed in the following section. 5. Research Findings and Discussion The following tables contain the main results obtained from the analysis. Table 2 shows the most relevant descriptive statistics of the sample. However Table 3 shows the results of t tests on the main variables measured on the sample. As is easy to verify, on the basis of univariate analysis, the companies listed on the STAR segment differ in many respects from the others listed on the ordinary market.
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 Table 2. Descriptive statistics of the main variables measured on the sample Mean WIRI CIQI
Median
S.D.
Min.
Max.
42,4295
41,4500
10,55091
19,70
70,90
9,007
9,05
1,99612
3,30
14,95
CGIQIMandatory
1,9142
1,9
,32696
0,7
2,55
FIQIMandatory
5,8724
6,05
,33021
4
6,05
CGIQIVoluntary
3,9870
3,75
1,84238
,10
9,80
12,5980
12,25
5,18109
3,30
24,75
,4516
,0000
,71397
,00
2,15
2,7776
2,6
1,0539
0,8
4,90
Indipendent directors (%)
,3944
,3750
,15522
,00
,90
Free float(%)
,3616
,3310
,14956
,09
,79
Foreign revenue (%)
,4217
,4935
,35947
,00
1,00
Performance
,0028
-,0309
,33341
-,69
1,24
Firm size (ln)
5,1543
4,9568
1,78167
1,22
9,82
Q-Tobin
,1769
,1402
,57557
-1,13
1,96
Financial leverage (D/E)
,9379
,5521
1,45865
,00
9,35
FIQIVoluntary CSRIQI WQI
In particular, companies listed on the STAR segment, on average, differ from the second group in terms of size, financial leverage and projection on foreign markets. Furthermore, significant differences also exist with regard to the proportion of independent directors on the board. In particular, STAR companies compared with the other group are smaller in terms of
capitalization (t = -2,397, p Prob.(H E –> N M ) B4 : Is Prob.(LE –> LE) > Prob.(H E –> H E) R1−3 : Rank in terms of being in (LE, N M , H E) state
B4 : Is Prob.(LE –> LE) > Prob.(H E –> H E) R1−3 : Rank in terms of being in (LE, N M , H E) state B1 : Is Prob.(LE) > Prob.(H E) B2 : Is Prob.(N M –> LE) > Prob.(N M –> H E) B3 : Is Prob.(LE –> N M ) > Prob.(H E –> N M ) B4 : Is Prob.(LE –> LE) > Prob.(H E –> H E) R1−3 : Rank in terms of being in (LE, N M , H E) state B1 : Is Prob.(LE) > Prob.(H E) B2 : Is Prob.(N M –> LE) > Prob.(N M –> H E) B3 : Is Prob.(LE –> N M ) > Prob.(H E –> N M ) B4 : Is Prob.(LE –> LE) > Prob.(H E –> H E) R1−3 : Rank in terms of being in (LE, N M , H E) state B1 : Is Prob.(LE) > Prob.(H E) B2 : Is Prob.(N M –> LE) > Prob.(N M –> H E) B3 : Is Prob.(LE –> N M ) > Prob.(H E –> N M ) B4 : Is Prob.(LE –> LE) > Prob.(H E –> H E)
No H KD
Yes
SGD
No M YR
(3, 2, 2) No
(3, 2, 2) No
(3, 2, 2) No
Yes
No No Yes
No No Yes
Yes No TW D (3, 3, 1) No No No Yes CN Y (3, 2, 2) No No No Yes
K RW
I DR
(3, 2, 2) No
(3, 2, 2) No
Yes
Yes
Yes
Yes
No NZD (3, 1, 3) Yes
No
Yes Yes No
Figure 6. Dendogram based upon executing AHC on exchange rate characteristics for the currencies
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 Figure 7. Models relating TWI to the exchange rates of the currencies: (a) Model M1 considers all the currencies in a single stage; (b) Model M2 relates exchange rates for all the currencies to T WI in two stages
(a) Model: M1
(b) Model: M2 Figure 8. RMSE for the Models: M1 and M2 over 100 trials
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3
INTERIM FINANCIAL REPORTING IN THE ASIA-PACIFIC REGION: A REVIEW OF REGULATOTY REQUIREMENTS Nguyen Huu Cuong*, Gerry Gallery**, Tracy Artiach*** Abstract This paper addresses the question of how interim financial reporting regulation varies across the AsiaPacific region. Using a content analysis method, the study investigates the relevant regulations in eight selected countries in the Asia-Pacific region which differ in a number of country-level attributes. We find that the regulations in the region show considerable variation in terms of the form of regulatory enforcement, reporting lag, audit requirements, and reporting form. By providing the first in-depth review of the nature of differences in interim financial reporting in key countries in the Asia-Pacific region, the findings of this study will be of interest to investors, regulators and researchers in their quest for international “convergence” in financial reporting practices. Keywords: Interim Financial Reporting, Accounting Regulation, Asia-Pacific, Disclosure * Corresponding
author. U niversity: School of A ccountancy, Q ueensland U niversity of Technology, B risbane, Australia School of Accountancy, Q ueensland U niversity of Technology, B risbane, Australia *** U niversity: School of Accountancy, Q ueensland U niversity of Technology, B risbane, Australia ** U niversity:
1. Introduction Interim Financial Reporting (IFR) can play an important informative role in capital markets, provided the contents of the interim reports are accurate and timely. Interim reports issued by listed firms may differ because entities issue the reports in compliance with various sources of regulations. The paper aims to examine regulations governing IFR practices in the rapidly growing Asia-Pacific region. While there has been considerable effort on a global basis to harmonise and implement International Financial Reporting Standards (IFRSs), there has been no apparent effort to harmonise interim reporting rules. Further, there are no known global or regional comparative studies of IFR regulations in the extant literature. Also, the extant literature offers little guidance on the optimal level and form of IFR regulations and is not assisted by the general nature of international accounting standard on Interim Financial Reporting – IAS 34. In practice, IFR is regulated by a variety of statutory securities regulations, stock exchanges rules and by accounting standards that differ across countries. This leads to considerable diversity in disclosure practices. However, the nature and the extent variation has not been documented and highlighted in the disclosure literature. International Accounting Standard 34 Interim Financial Reporting (IAS 34), issued by International Accounting Standard Board (IASB), defines IFR as the disclosure of updated information for an interim period, thereby providing information to stakeholders in a timelier manner than annual financial reports:
“An interim financial report is a financial report that contains either a complete or condensed set of financial statements for a period shorter than an entity’s full financial year” (IAS 34 para. IN2). According to the objective of IAS 34, IFR plays an important information role in capital markets when the reports provide up-to-date information to users (IAS 34, para. Objective). It allows users to project the numbers for the upcoming annual reporting (Gordon, 1961) and may be more useful than audited, but less timely, annual financial reports (Ball & Brown, 1968). Nonetheless, questions as to the nature of IFR regulations have been raised that remain unanswered in the absence of empirical research. The paper is motivated by the fact that there has been significant effort on a global basis to establish one set of IFRSs; however, there has been little effort to harmonise interim reporting, leading to a continued diversity in IFR practices. Accounting standards on interim reports are loose and allow for substantial discretion on various aspects of IFR including the interim period, reporting lag, reporting form, audit requirements, and accounting methods. For example, IAS 34 (para. 1) does not mandate the frequency or timing of IFR disclosure. Similarly, domestic requirements are not well regulated. Prior research has suggested that IFR requirements may under-regulated in one country but over-regulated in others (e.g., Tan & Tower, 1997). As such, interim reporting regulations are likely to differ and consequently, interim reporting disclosure extent and quality may vary considerably across countries. This diversity is likely to influence the usefulness of reported
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 information because the lack comparability of IFR accounting numbers complicates cross-country analysis and investment decision-making. A lack of agreement on an appropriate interim reporting model also makes it difficult for domestic regulatory bodies to decide how and the extent to which interim reports should be regulated. To date, there has been little research that compares IFR worldwide or even on a regional basis. In addition, the accounting literature provides little guidance on the optimal form and extent of IFR and related regulations. The paper is organised as follows. Section 2 provides a summary of the main aspects of IFR under the International Accounting Standard. Section 3 presents an outline of the regulatory requirements for preparing and releasing interim financial reports in each of the eight selected countries of the study. Section 4 concludes by offering suggestions for future studies. 2. International Accounting Standard (IAS) for Interim Financial Reporting (IFR) – Key Features IAS 34 Interim Financial Reporting (IAS 34) was first issued by the IASB’s predecessor, the International Accounting Standard Committee, in February 1998 and adopted by the IASB in April 2001.1 The objective of the standard is to prescribe the form, the minimum content and the principles for recognition and measurement in the preparation and presentation of an interim financial report. The objective is justified on the basis that: “Timely and reliable interim financial information reporting improves the ability of investors, creditors, and others to understand an entity’s capacity to generate earnings and cash flows and its financial condition and liquidity.” (IAS 34 para. Objective) In contrast to many other international accounting standards, IAS 34 permits considerable discretion by entities in its application. Notably, it “does not mandate which entities should be required to publish interim financial reports, how frequently or how soon after the end of an interim period” (IAS 34 para. 1). Whilst frequency is not defined, IAS 34 encourages a publicly traded entity to produce interim reports at least for the period of the first half of its financial year, and to release it within 60 days after that period’s end (IAS 34 para. 1). An entity shall issue either a complete set of financial statements or a set of condensed ones (IAS 34 para. 4) by using the
1
The most recent updated version of IAS 34 was issued in January 2013, and is effective for annual periods begin on or after January 1, 2013. However, the version discussed in this paper was published in January 2011, which is applicable for the sample interim reports (financial year end 2012).
same accounting policies as are applied in annual financial reports (IAS 34 para. 28). 3. IFR Regulation in the Asia-Pacific Region Since many of the provisions in IAS 34 are substantially voluntary in nature, it is not surprising that IFR practices vary across countries, especially in the required disclosures, the length of an interim reporting period and the time permitted until release of the interim reports (reporting lag). Such variation across countries can be attributed to the influence of national securities regulations, stock exchanges listing rules2, and rules and guidelines of domestic accountancy bodies. Given the extent of discretion and regulations, five main aspects of IFR regulation are relevant to the study: i) regulation enforcement; ii) interim reporting period; iii) report form; iv) audit requirement; and v) the accounting measurement policy. Regulation enforcement refers to the extent to which interim reporting regulations are mandatory or voluntary. Interim reporting period refers to the regularity or required reporting interval of interim reports (either half-yearly or quarterly periodic reports). Report form is the content of the interim report and refers to the preparation of either a complete or condensed set of interim reports. Audit requirement is the extent to which regulation varies regarding the audit of the interim report with the alternatives being non-audit, audit committee (internal) review, audit review or full audit of the interim report. The final aspect, the accounting measurement policy is the domestic accounting standard setter’s policy on the recognition and measurement method for preparing the interim report with the two possible alternatives being either the integral or discrete (or independent) methods.3 However, because the discrete method is adopted for interim reports by all of the selected countries, the 2
The Stock exchanges examined in this study are the main boards for each selected sample country. Therefore, only listing and disclosure rules imposed by the main boards are analysed. 3 Under the integral view, which tends to be endorsed by the US GAAP, the interim report is considered as an integral part of the annual accounting period where annual operating expenses are to be estimated and allocated to the interim periods. Consequently, the results of subsequent interim periods must be adjusted to reflect prior estimation errors. Under the discrete view, which tends to be endorsed by IAS 34, each interim period is considered as a discrete accounting period. The same accounting methods are applied to recognise and measure disclosed items in both IFR and annual financial reporting. More specifically, the rules required to recognise interim expense are the same as those applied to annual expense recognition, and no special interim accruals or deferrals are permitted (Mackenzie, Coetsee, Njikizana & Chamboko, 2011).
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 comparison of the differences in regulations governing interim reports focuses on only the first four aspects identified above. The following sub-section provides a source of the relevant regulations governing interim reporting
with a summary of the reporting requirements for each country within the study and is summarised in Table 1.
Table 1. A summary of the variation in IFR regulations in eight Asia-Pacific countries Country
Sources of IFR regulation
IFR Mandatory Requirements
Australia
Corporations Act 2001 (as amended 2011) ASX Listing Rules AASB 134 (adopted IFRS Jan 1, 2005)
Half-yearly reports in a condensed or a full form within two months after the period’s end, requiring an audit review.
Japan
Financial Instruments and Exchange Act (Act No. 25 of 1948, as amended Act No. 99 of 2007) TSE Securities Listing Regulations ASBJ 12 Companies Ordinance (Cap 32 of 1950, as amended 2011) HKEx Main Board Listing Rules HKAS 34 (adopted IFRS Jan 1, 2004)
Quarterly reports in a condensed form within 45 days after the period’s end, requiring an audit review.
Hong Kong
Malaysia
Singapore
Securities Industry Act 1983 (as amended 2006) BMSB Main market listing requirements MFRS 134 Companies Act (Act 42 of 1967) Securities and Futures Act (Act 42 of 2001) SGX Listing Rules FRS 34
Half-yearly reports in a condensed form within three months after the period’s end, requiring an internal audit committee review.
Quarterly reports in a condensed form within two months after the period’s end, with no audit requirement stipulated. Quarterly reports (for listed firms that their market capitalisation exceeds $75 million) or half-yearly reports (for the other listed firms) in a condensed (or full) form within 45 days after the period’s end, with no audit requirement stipulated.
Philippines
Corporate Code (Batas Pambansa Bilang 68), PSE Listing and Disclosure Rules PAS 34
Quarterly reports in a condensed form within 45 days after the period’s end, with no audit requirement stipulated.
Thailand
Securities and Exchanges Act, B.E. 2535 (1992) (as amended 2008) SET Rule Books TAS 34
Quarterly reports in a full form within 45 days after the period’s end, requiring an audit review.
Vietnam
Law on Securities Ministry of Finance’s Circulars (on information disclosure) VAS 27
Quarterly reports in either a condensed or a full form within 20 days after the period’s end, with no audit requirement stipulated; AND Half-yearly reports in either a condensed or full form within 45 days after the period’s end, requiring an audit review. Note: All countries require the use of a discrete method. A full form means a complete set of financial statements as described in IAS 1 Presentation of Financial Statements; whereas a condensed form means a set of condensed financial statements, including, at the minimum, (i) a condensed financial position, (ii) a condensed statement or condensed statements of profit or loss and other comprehensive income, (iii) a condensed statement of changes in equity, (iv) a condensed statement of cash flows, and (v) selected explanatory notes. An audit review means a review engagement or a limited assurance engagement, which provides some assurance about the quality of information disclosed in interim reports but not providing as much assurance as an audit of annual reports.
3.1. IFR Regulations in Australia In Australia, IFR reporting requirements for listed firms are stipulated in the Corporation Act 2001, the Australian Securities Exchange (ASX) Listing Rules, and Accounting Standard AASB 134 Interim
Financial Reporting (AASB 134). The Corporation Act 2001 stipulates that a listed firm must prepare half-yearly financial reports in accordance with accounting standards (sec. 302 & 304). The reports must be audit reviewed (or audited) in accordance with auditing regulations (sec. 302). The ASX listing
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 rules affirm half-yearly disclosures required by the Corporations Act 2001 and require the reports to be lodged with Australia Securities and Investments Commission (ASIC) within two months of the accounting period’s end date (ASX listing rule 4.2A & 4.2B).4 Australia adopted IFRS for annual reporting periods beginning on or after January 1, 2005 (Australian Accounting Standards Board, 2011) and as such AASB 134 applies to interim periods beginning on or after 1 January 2005 (para. Aus 1.4). AASB 134 stipulates that listed entities must prepare their half-yearly reports in accordance with the Corporations Act 2001 (para. Aus 1.1). AASB 134 prescribes components, forms, and contents of the interim financial reports. A listed entity has the option of issuing either a condensed or a full set of interim financial statements including statements of financial position, comprehensive income, changes in equity, cash flows, and notes or other explanatory information (AASB 134, para. 5a-e). In addition, a listed entity is required to provide a financial position statement as at the beginning of the earliest comparative period when the entity applies an accounting policy retrospectively or makes a retrospective restatement of items in its financial statements, or when it reclassifies items in its financial statements (AASB 134, para. 5f). In summary, ASX listed entities are required to prepare half-yearly reports using the discrete method either in a condensed (or full) form, and to lodge the reports with ASIC within two months of the accounting period’s end. The reports are required to be audit reviewed (or audited). 3.2. IFR Regulations in Japan Regulations prescribing IFR practices in Japan include the Financial Instruments and Exchange Act (Act No. 25 of 1948), the Tokyo Stock Exchange (TSE) Listing Rules, and Accounting Standards Board of Japan Statement No.12 Accounting Standard for Quarterly Financial Reporting (ASBJ 12). The Financial Instruments and Exchange Act stipulates a listed company must provide audit-reviewed quarterly 4
Commitments test entities and mining exploration entities are required to prepare quarterly cash flow reports (ASX listing rule 4.7 & 5.1, app. 4C & 5B). Commitments test entities’ refers to entities listed on the ASX but do not satisfy the ASX’s profit test listing rule. The entities are listed under the assets test based on Quarterly report for entities admitted on the basis of commitments (ASX listing rule, app. 4C). In addition to quarterly cash flows, a mining exploration entity must lodge with the ASX a “quarterly activity report” on its exploration results (ASX listing rule 5.6, app. 5A). Mining exploration entities must lodge quarterly reports with the ASX immediately when the information is available and within one month after the quarter’s end (ASX listing rule 5.3).
reports for each three-month period of the financial year within 45 days after the period’s end (article 244-7 & 193-2). In conformity with the Financial Instruments and Exchange Act, TSE Listing Rules 308 and 438 affirm that a listed company must issue quarterly financial reports which are must be audit reviewed. Japan has not adopted IFRS for its public companies, but it has permitted specific public companies to early-adopt IFRS in 2010.5 ASBJ 12 specifies that a condensed quarterly financial report includes a balance sheet, a statement of income, a statement of cash flows, and notes to financial statements (Accounting Standards Board of Japan, 2007). A quarterly statement of changes in owners’ equity and other net assets is not required in a quarterly financial report. In summary, TSE listed entities are required to prepare quarterly financial reports using the discrete method in a condensed form and lodge the reports within 45 days of the period’s end. The quarterly reports are required to be audit reviewed. 3.3. IFR Regulations in Hong Kong Regulations managing IFR practices in Hong Kong comprise the Companies Ordinance (Act 42 of 1967), the Hong Kong Exchanges and Clearing Limited (HKEx) Listing Rules, and Hong Kong Accounting Standard 34 Interim Financial Reporting (HKAS 34). The Companies Ordinance requires listed companies to prepare IFR (sec. 79H). A listed company must deliver IFR in the English or Chinese language to the Registrar.6 The HKEx Listing Rules 13.48 mandates a listed issuer to prepare its half-yearly reports in respect of the first six months of its financial year and to make them available within three months after that period’s end.7 At a minimum, the set of interim reports must include a balance sheet, an income statement, a cash flows statement, a statement of changes in equity, comparative figures for the 5
Criteria for domestic Japanese to be eligible to voluntarily start using IFRS and announcement for IFRS adoption are available at IAS plus (Deloitte Global Services Limited, 2012a). However, in June 2011, the Minister of Financial Services indicated that mandatory adoption would not be required for the fiscal year ending March 31, 2015 and if mandatory adoption is decided a 5 – 7 preparation period would be provided. (Deloitte Global Services Limited, 2012a). 6 “The Registrar” refers the High Court or any Senior Deputy Registrar of the High Court, any Deputy Registrar of the High Court, and any Assistant Registrar of the High Court appointed by the Chief Justice for the purposes of this section. 7 Listing rules discussed here refer to the main board listing rules, which does not include listing rules required for firms listed on second board, known as Growth Enterprise Market.
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 statements, along with accounting policies and explanatory notes (HKEx, 2012, app. 16, sec. 37). Half-yearly reports must be reviewed by the listed firm’s audit committee and be available within three months from the firm’s period end date (rule 13.48; app. 16 - sec. 39). The HKEx also recommends a listed firm should prepare and disclose its quarterly financial statement within 45 days after the end of the relevant quarter (HKEx, 2012, app. 14, sec. C.1.6). A listed firm’s quarterly financial statements should be reviewed by its audit committee (HKEx, 2012, app. 14, sec. C.3.3). Hong Kong’s accounting standards were fully converged with IFRSs effective from January 1, 2005 (Hong Kong Institute of Certified Public Accountants, 2011b). Consequently, HKAS 34 is identical to IAS 34 (Hong Kong Institute of Certified Public Accountants, 2011a, app. D). In summary, HKEx listed entities are required to prepare half-yearly reports using the discrete method in a condensed form, and to lodge the reports within three months of the firms’ period end date. The reports are to be reviewed by the listed entities’ audit committees. Additionally, listed entities on the main board of HKEx are, in accordance with the HKEx’ recommendation, encouraged to voluntarily disclose quarterly reports within 45 days of the firms’ period end date. 3.4. IFR Regulations in Malaysia IFR practices in Malaysia are described in the Securities Industry Act 1983, the Bursa Malaysia Securities Berhad (BMSB) Listing Rules, and Malaysian Financial Reporting Standard 134 Interim Financial Reporting (MFRS 134). The Securities Industry Act 1983 stipulates that a listed firm must submit its IFR to the Securities Commission immediately after the end of period figures are available (sec. 99D). The BMSB Listing Rule 9.22-1 requires an issuer to provide its quarterly reports within two months of the firm’s quarter end date. The reports, at least, must contain certain items of a balance sheet, an income statement, a statement of cash flows, and a statement showing changes in equity and exploratory notes (rule 9.22-2 & app. 9B part A). No specific audit requirement is stipulated by the Malaysian regulations. Malaysia has planned for full convergence with IFRSs by January 1, 2012 (Deloitte Global Services Limited, 2012b). MFRS 134 – effective for annual accounting period on or after January 1, 2012 – is identical to IAS 34 (Malaysian Accounting Standards Board, 2011, pp. 938-939). Accordingly, MFRS 134 is in its nature therefore not mandatory to any entity. In summary, BMSB listed entities are required to prepare quarterly financial reports using the discrete method in a condensed form, and to lodge the reports within two months of the firms’ period end
date. No specific audit requirement for the interim reports is imposed by the Malaysian regulations. 3.5. IFR Regulations in Singapore IFR regulations in Singapore consist of the Companies Act (Act 42 of 1967), the Securities and Futures Act (Act 42 of 2001), the Singapore Exchange (SGX) Listing Rules, and Financial Reporting Standard 34 Interim Financial Reporting (FRS 34). The Companies Act does not provide details for preparing interim reports, but requires directors of any company incorporated in the country to provide financial statements that comply with financial reporting standards (sec. 201). Even though the Securities and Futures Act requires a borrowing entity to lodge its first six-month financial reports with the authority within three months after the period’s end (sec. 268), beyond initial listing, it has no stipulation about periodic disclosures by the listed entities. In contrast, the SGX Listing Rule 705 mandates a listed company with a market capitalisation exceeding S$75 million to provide IFR for each of the first three quarters of its financial year. The reports are required to be available immediately after the figures are available and no later than 45 days after the firm’s quarter end date. The rule further mandates listed companies, which are not mandatorily required to provide quarterly financial reports, to disclose first half-yearly financial reports in the same time frame as quarterly financial reports. Listed firms disclose the first three quarterly financial reports in any format as long as those reports are consistent through three quarters, whilst half-yearly financial reports are mandatorily presented in the form similar to the most recent audited annual reports (SGX Listing Rule app. 7.2). Because the Appendix 7.2 of the SGX listing rules describes specific items to be disclosed, the form of quarterly reports provided by firms listed on the SGX is regarded as a condensed form. No specific audit requirement is stipulated by the Singaporean regulations. In 2009, according to the Singapore Accounting Standards Council (SASC) (2012), Singapore had planned to fully converge financial reporting standards with IFRSs by 2012. However, on 2 March 2012, the SASC stated that full convergence will not be implemented in 2012, after they reviewed the plan (Deloitte Global Services Limited, 2012c). However, as of November 2008, the SASC has promulgated a set of accounting standards and interpretations that are nearly identical to the current set of IFRS (Deloitte Global Services Limited, 2012c). As for FRS 34, this standard is identical to IAS 34. Accordingly, FRS 34 is best regarded as a voluntary standard. According to FRS 34, “the Council on Corporate Disclosure and Governance encourages publicly traded entities to provide interim financial reports that conform to the recognition, measurement, and disclosure principles
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 set out in this Standard” (para. 1). A listed firm is also encouraged to provide IFR at least as of the end of the first half of their financial year, within 60 days after the period’s end (FRS 34, para. 1). In summary, SGX listed firms with market capitalisation exceeds S$75 million are required to disclose quarterly financial reports, whilst the other listed firms are required to provide half-yearly financial statements. All listed firms prepare interim reports in a condensed form by using the discrete method, and to lodge the reports within 45 days of the firms’ period end date. The Singaporean regulations do not impose any specific audit requirement for the interim reports. 3.6. IFR Regulations in the Philippines IFR practices in the Philippines are regulated by the Corporate Code of the Philippines (Batas Pambansa Bilang 68), the Philippine Stock Exchange (PSE) Listing and Disclosure Rules, and Philippine Accounting Standard 34 Interim Financial Reporting (PAS 34). The Corporate Code of the Philippines stipulates that every business entity (doing business in the Philippines) must provide its reports of specific period based upon the requirements of the Securities and Exchange Commission (sec. 141). The PSE Listing Rule 17.2 mandates a listed company to file with the exchange its three quarterly reports in a condensed form (i.e. form 17-Q of the Securities and Exchange Commission) within 45 days from end of the first three quarters of the fiscal year. A listed company is allowed to request an extension of five calendar days if it is not able to provide its quarterly reports by the deadline (PSE, 2009). The Philippine regulations do not impose any specific audit requirement for the quarterly reports. The Philippines has fully adopted IFRS from 2005 without modification (Deloitte Global Services Limited, 2012d). Accordingly, PAS 34 is identical to IAS 34 and is in its nature not mandatory to any entity. In summary, PSE listed entities are required to prepare quarterly financial reports using the discrete method in a condensed form, and to lodge the reports within 45 days of the fiscal quarter end date. No specific audit requirement for IFR is imposed by the Philippine regulations. 3.7. IFR Regulations in Thailand IFR regulations in Thailand are prescribed in the Securities and Exchange Act – B.E. 2535 (1992), the Stock Exchange of Thailand (SET) Listing Rules, and Thai Accounting Standard 34 Interim Financial Reporting (TAS 34). The Securities and Exchange Act sec. 56 mandates a listed firm to prepare quarterly financial reports and have them reviewed by an auditor. The SET listing rules oblige an issuer to produce its four quarterly financial reports and to
commission auditors to review the reports in conformity with the Securities and Exchange Act (Stock Exchange of Thailand, 2001, 2007, 2009). The reports must be submitted to the SET and the Securities and Exchange Commission within 45 days after the accounting period end date (Stock Exchange of Thailand, 2007, 2009). The due date of each quarterly report is clearly scheduled (approximately 45 days after each calendar quarter). Listed firms are required to lodge with the SET a translated English version of their quarterly reports in the full financial statements version (Stock Exchange of Thailand, 2007, 2009). Thailand has fully adopted IFRS for the 50 most actively trading listed companies in 2011 and planed to fully adopt IFRS for top 100 listed companies on the SET in 2013 (Deloitte Global Services Limited, 2012e). However, IAS 34 has been already fully implemented in Thailand from 2008 (Deloitte Touche Tohmatsu Jaiyos, 2008; PricewaterhouseCoopers, 2008). Consequently, TAS 34 is identical to IAS 34. In this sense, TAS 34 is in its nature not mandatory to any entity. In summary, SET listed entities are required to prepare quarterly reports using the discrete method in a full form, and to lodge the reports with the SET, and the Securities and Exchange Commission within 45 days of the period’s end. Interim reports require an audit review. 3.8. IFR Regulations in Vietnam IFR regulations for listed firms in Vietnamese include the Enterprise Law 2005, the Law on Accounting 2003, the Law on Securities 2006, and Vietnamese Accounting Standard 27 Interim Financial Reporting (VAS 27)8. The Enterprise Law requires that all accounting work in enterprises is in accordance with the Law on Accounting (article 9). According to the Law on Accounting, a business entity is obliged to comply with accounting standards when producing their financial reporting (article 29). The Law on Accounting’s guidelines (i.e. Decree 129/2004/NDCP) require state enterprises to prepare quarterly financial statements, and to file the reports with tax offices, statistical bodies, and business registration bodies within 20 days of the period’s end (article 15). Nevertheless, no specific requirement for interim reports is imposed on listed entities. The Law on Securities mandates a listed company to disclose quarterly financial reports within five days after the completion of that reporting (article 103). Pursuant to the Law on Securities, Circular No. 52/2012/TT-BTC instructs that a listed company must 8
In Vietnam, accounting standards are promulgated by the Ministry of Finance by various decisions. VAS 27 is prescribed in Decision 15/2005/QD-BTC. For more details about the legal system and legal enforcement in the country, we refer the readers to Nguyen (2011).
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 disclose its quarterly financial statements within 20 (or 45) days of the period’s end for single (or parent) listed entities (article 10.3). Apart from quarterly financial reports, a listed firm is also required to prepare half-yearly financial reports for the first six months of the financial year. The half-yearly reports must be audit reviewed and disclosed within five working days as from the auditor signed date, and no more than 45 (or 60) days after the period’s end for single (or parent) listed entities (article 10.2). To date, Vietnam has neither adopted IFRS nor announced a formal date for IFRS adoption. However, IAS 34 is in effect, fully implemented in Vietnam, even though the country has not adopted IFRS (PricewaterhouseCoopers, 2008). As specifically stated in paragraph 2, VAS 27 differs from IAS 34 in that VAS 27 is mandatory for entities that are required to publish their interim reports in accordance with the country’s laws and regulations. Reporting entities are encouraged to provide IFR in a form identical to annual reports (VAS 27, para. 6). In summary, listed entities in Vietnam are required to prepare both quarterly and half-yearly financial reports using the discrete method. This requirement distinguishes Vietnamese IFR regulation from the other countries reviewed above that mandate either quarterly or half-yearly financial reports, but not both. Firms are encouraged, but are not required to be present the reports in a full form. Additionally, only half-yearly financial reports require an audit review. For single listed entities, the permitted reporting lag for quarterly financial reports is 20 days and for half-yearly financial reports it is 45 days; whereas for parent listed entities the permitted reporting lag is 45 days and 60 days, respectively. 3.9. Summary of IFR Institutional Differences The above region review highlights a number of important IFR differences across the Asia-Pacific region. Mandatory quarterly reporting is required by five countries, namely Japan, Malaysia, the Philippines, Thailand, and Vietnam. In the three remaining countries, Australia, Hong Kong and Singapore half-year reporting is mandatory, but there is also voluntary quarterly reporting. Singapore is the exception for certain companies in that a mandatory requirement for disclosing quarterly financial information only applies to the high marketcapitalisation SGX-listed entities. Another exception applies to Australian mining exploration and commitments test entities which are required to lodge their quarterly cash flow statements to the ASX. The reporting time lag for disclosing mandatory quarterly reports ranges from 20 days (Vietnam) to 45 days (Japan, Singapore, the Philippines, and Thailand) and 60 days (Malaysia) from the quarter’s end. The reporting format varies from a full form (for Thailand) to a choice of a full form and a condensed
form of interim reporting (Vietnam), or a condensed form (Japan, Malaysia, Singapore, and the Philippines). An audit review of quarterly reporting is required in Japan and Thailand whilst no specific audit requirement is stipulated in the four remaining countries. Mandatory half-yearly reporting is required by Australia, Hong Kong, and Vietnam. For the four other countries, namely Japan, Malaysia, the Philippines, and Thailand, half-year reporting is voluntary. Whereas in Singapore, listed firms with a market capitalisation less than S$75 million are required to provide half-yearly reporting. The maximum reporting time lag for announcing the reports ranges widely from 45 days (Vietnam) to 90 days (Hong Kong) from the firms’ period end date. The format of mandatory half-yearly financial reports is likely to vary because Hong Kong prescribes the minimum components required to be disclosed; while Australia and Vietnam allow listed firms to provide half-yearly information either in a condensed or a full form. The mandatory half-yearly reports are required to be audit reviewed (Australia and Vietnam) or internal audit reviewed (Hong Kong). In summary, there are four aspects of crosscountry variations in IFR regulations: the form of regulation enforcement, reporting time lag, audit requirement, and reporting form. These are all likely to contribute to substantial disparity in IFR practices across the region. 4. Conclusion and Further Research This paper highlights the significant variations in regulations on interim reports in a range of major countries in the Asia-Pacific region. As a result of complying with the national regulations on IFR, listed firms incorporated in different countries are expected to disclose interim reports that vary in the interim reporting period, the form, the content and also auditing extent. Therefore, future research is needed to investigate IFR disclosure practices by listed firms in the region to comprehensive document the variations. Further, the extant literature identifies various country-level differences have influence on corporate regulatory practices and corporate reporting as well as disclosure decisions. The factors are likely to lead to cross-country variations in interim reporting regulations and levels of interim reporting compliance and disclosure, and as a consequence, the overall quality of interim reporting disclosure. Thus, there is a need for further study to examine this possible effect of country-level attributes, such as legal origin, enforcement, stage of economic development, and stage of IFRS adoption. References 1.
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40. Singapore Exchange. (2011). Rule Books - Mainboard Retrieved from Rules. http://rulebook.sgx.com/en/display/display_viewall.ht ml?rbid=3271&e. 41. Stock Exchange of Thailand. (2001). Regulations of the Stock Exchange of Thailand. Retrieved from http://www.set.or.th/dat/content/rule/en/BorJorPor010 0_EN.pdf. 42. Stock Exchange of Thailand. (2007). Disclosure Manual. Retrieved from http://www.set.or.th/en/regulations/supervision/files/d isclosure_manual_en_07.pdf. 43. Stock Exchange of Thailand. (2009). The Listed Companies Handbook. Bangkok. 44. Tan, S., & Tower, G. (1997). Comparing compliance: Too much regulation, or insufficient attention? Australian Accountant, 67(9), 56-59. 45. Tokyo Stock Exchange. (2012). Securities Listing Retrieved from Regulations. http://www.tse.or.jp/english/about/rules/b7gje600000 044tu-att/securities_lsiting_regulations.pdf.
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WHICH COMPANIES FIND IT EASIER TO OBTAIN BANK LOANS? EVIDENCE FROM CHINA Wenjuan Ruan*, Erwei Xiang** Abstract The study investigates the determinants of bank loan financing of Chinese listed companies from 1996 to 2009. The empirical results suggest that the channels through which companies obtain bank loans are different. Companies controlled by the state can more easily obtain loans from state-owned commercial banks and policy banks, while privately controlled companies have significantly larger access to loans from foreign banks. The empirical results also show that political connectedness and institutional development are the significant determinants of the bank loan financing of private companies. If companies locate in an area with higher level of institutional development, the proportion of their loans from state-owned banks is smaller than that of companies locate in areas with lower level of institutional development. Keywords: Bank Loan, Big Four, Foreign Banks, Political Connectedness, Institutional Development *Corresponding author. School of M anagement and G overnance, M urdoch U niversity, 90 South Street, M urdoch, W estern Australia 6150 Australia Tel: +61 8 9360 6028 Email: w .ruan@ murdoch.edu.au **B usiness School, N ankai U niversity, 94 W eijin R oad, N ankai, Tianjin 300071 P. R . China
1 Introduction In developing countries, the supply of financing resources is usually limited to meeting demand (Bai et al., 2006; Dinç, 2005). Bank loans have been the primary source of corporate debt in China. China’s financial system is dominated by a large banking sector controlled mainly by the four largest stateowned banks—the ‘Big Four’: the Bank of China, the Industrial and Commercial Bank of China, the China Construction Bank and the Agricultural Bank of China. These four banks control about three-quarters of China’s banking industry assets. The capital raised from the stock market has been growing rapidly since the inception of the Shanghai Stock Exchange and the Shenzhen Stock Exchange in the 1990s. However, the scale and importance of finance from the stock exchanges are still not comparable with other channels of financing, particularly from the banking sector, for the entire economy (Allen et al., 2005; Berger et al., 2009). In a predominantly state-owned bank lending environment (Firth et al., 2008), companies controlled by the government have the privilege of being able to acquire a bank loan from state-owned commercial banks. Cull and Xu (2000; 2003) investigate the efficiency of credit allocation by state banks. They find that while banks imposed tougher budget constraints on state-owned enterprises (SOEs) than did bureaucrats, those constraints softened as the 1990s progressed. Brandt and Li (2003) use the bank
loan data of Chinese corporations to examine empirically ‘bank discrimination problems’—a reference to state-owned banks that discriminated against private companies for non-profit reasons. Berger et al. (2009) test the efficiency of Chinese banks and categorise them by ownership type.9 Their results clearly suggest that foreign banks are the most efficient, followed by private domestic banks and non-Big Four majority state-owned institutions; the Big Four are measured as being the least profitefficient. Aside from bank discrimination and dispersive efficiency across different types of banks, privately controlled enterprises’ banking finance is another interesting phenomenon in China. On the one hand, with insufficient connections to government, most privately controlled companies depend on informal financing channels, such as private credit agencies, which are the most important non-banking finance channel during privately controlled companies’ establishment and growth periods (Allen et al, 2005; Brandt and Li, 2003; Firth et al., 2009). On the other 9
They define ‘majority state-owned banks’ as those banks whose state ownership is greater than 50 per cent of total ownership; ‘majority private domestic banks’ as those banks whose private domestic ownership is greater than 50 per cent of total ownership; ‘majority foreign banks’ as those banks whose foreign ownership is greater than 50 per cent of total ownership; and ‘no majority ownership banks’ as those banks without any majority ownership.
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 hand, a lot of privately controlled enterprises hold certain connectedness with the state, which provides a helping hand in their access of loan from state-owned banks. Privately controlled enterprises can be partially state owned in at least two ways. A former SOE can become a privately controlled company, for example through asset leasing, a merger, re-organisation, the introduction of foreign direct investment, bankruptcy recombination or management buy-out, but can still retain a certain level of state ownership. Secondly, privately controlled companies can become state owned by building a political link with the state (Firth et al., 2009) through inviting government investments. This study contributes to the research in the following ways. First, after comparing the bank loan resources and the amounts and proportions of bank loans between SOEs and privately controlled companies, the empirical results provide evidence to support Brandt and Li’s (2003) argument regarding bank discrimination. While Berger et al. (2009) rank the efficiency of different types of banks from the bank’s perspective, this empirical study investigates the allocation of bank loans from the debtor’s perspective. Results show that companies controlled by the state could easily obtain loans from stateowned commercial banks and policy banks, whereas privately controlled companies source significant larger bank loans from foreign banks. Second, while much of the literature suggests that political connections play a role in privately controlled companies’ access of bank financing, very little research has explored the direct relationship between political connection and detailed aspects of bank loan characteristics in China, such as which bank the loan is from and the amount/proportion of the loan that is obtained from the various types of bank. We investigate the influence of political connectedness and institutional development across provinces on the access to bank loans of China’s listed privately controlled companies. The empirical results show that, in China, political connectedness and institutional development across areas are important determinants of privately controlled companies’ access to bank loans from Big Four. However, the effect of political connectedness on loans from state-owned banks is found to be influenced by institutional development across areas. This study also focuses on listed companies. Chinese listed companies represent the most successful sector of the country’s economy in terms of corporate governance and they follow the fundamental rules of the market economy (Huang and Song, 2006). Being listed is also an important method through which Chinese companies can become corporatised and privatised. Moreover, local government officers in China often view the listing of companies as an indication of political achievement in an area. Therefore, this study considers that investigation of the bank loan issue and bank–listed company relationships may be a good way of
exploring the workings of government involvement in corporate financing. Further, it is considered that listed companies presented the best and largest sample in terms of offering reliable ownership data, especially data on the type of ownership control (Amit et al., 2009), which is crucial to this research. The remainder of this article is organised as follows. Section 2 reviews the institutional background of the Chinese capital market, particularly the evolution of the Chinese banking sector. Section 3 proposes the key determinants of bank loans and corresponding predictions, based on a review of the literature. Section 4 describes the data and variables and summarises the relevant statistics. Section 5 presents and interprets the empirical results of the study and according to a univariate comparison and multi-variable regressions. The article is concluded in Section 6. 2 Institutional Background of the Chinese Capital Market Since the implementation of China’s Reform and Opening Up Policy from 1978, the Chinese financial market has been transforming from a planned to a market-oriented system. There are two dimensions to this transformation: evolution of the banking sector and the emergence of stock markets. Evolution of the Banking Sector High economic growth in developing nations cannot continue indefinitely without significant banking system and legal/financial infrastructure reform (Berger et al., 2009). Four phases of change can be seen in the Chinese banking industry. The first occurred before the mid-1980s, when banks were administered by the Ministry of Finance to ensure that national production plans would be fulfilled. In 1983, the State Council designated the People’s Bank of China as the central bank. Around this time, the Big Four began to expand the scope of their services and were allowed to compete for depositors and lending services. However, the incentive for banks to compete with each other was quite limited. The second phase was from the mid-1980s to the mid-1990s. From 1987 to 1995, a number of regional banks opened, particularly smaller national banks (e.g. Everbright Bank, Hua Xia Bank and Min Sheng Bank) as well as several new types of non-bank financial intermediaries, such as urban credit cooperatives, trust and investment companies, finance companies associated with enterprise groups, financial leasing companies, securities companies and credit-rating companies. The 1995 Law of the People’s Republic of China on Commercial Banks officially termed the major state-owned banks ‘commercial banks’ and directed them towards commercial business based on market principles instead of policy lending.
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 The third phase occurred after the mid-1990s and extended until China’s entry into the World Trade Organization (WTO) in December 2001. In 1998, the People’s Bank of China permitted eight foreign licensee banks to obtain local currency funding. In 1999, the foreign banks were allowed to conduct local currency business in neighbouring regions. By the end of that year, 25 foreign banks had received permission to conduct local currency business with Chinese enterprises. The entrance of foreign ownership into the banking industry led to increased competition between financial enterprises. The fourth phase began in 2003 with the establishment of the China Banking Regulatory Commission (CBRC). One of the main responsibilities of the CBRC is to monitor the lending behaviour of commercial banks. With the launch of the Commercial Bank’s Accounting System for Financial Enterprises and Regulations on Information
Disclosure as well as the establishment of the CBRC, information disclosure systems for banking became increasingly mature. In 2004, the National Congress approved a constitutional amendment to protect private property rights by granting ‘private property’ a legal status equal to ‘public property’ (Firth et al., 2009). The four major banks thus began to compete for depositors and lending services and expanded their range of services to include private property. In late 2006, China began opening its banking sector to foreign competition, as mandated by the WTO. In the same year, the CBRC obliged all urban commercial banks to disclose their annual reports. Despite the reforms, the development of the banking industry remains unbalanced. For example, China’s banks continue to be plagued by substantial numbers of non-performing loans (Firth et al., 2008). Table 1 summarises the ratios of banks’ nonperforming loans to total loans from 2000 to 2010.
Table 1. Summary of banks’ year-end non-performing loans from 2000 to 2010 Bank name
2000
2001
8.78
3.96
2002
2003
2004
2005
2006
2007
2008
2009
2010
1.78
1.34
1.21
0.87
0.72
5.01
3.7
5.28
4.91
3.47
0.59
0.96
0.94
0.68
2.45
1.52
15.9
10.2
7.65
6.29
3.8
3.61
2.79
Policy banks China Development Bank Export-Import Bank of China Agricultural Development Bank of China Big Four (state-owned commercial banks) Bank of China China Construction Bank Industrial and Commercial Bank of China Agricultural Bank of China Joint stock commercial banks, urban commercial banks etc. Industrial Bank
28.78
27.51
22.49
16.29
5.12
4.62
4.04
3.12
2.65
1.52
1.1
20.27
19.35
15.17
9.12
3.92
3.84
3.29
2.6
2.21
1.5
1.14
34.43
29.78
25.69
21.24
18.99
4.69
3.79
2.74
2.29
1.54
1.08
30.07
30.66
26.73
26.17
23.43
23.5
4.32
2.91
2.03
3.13
2.49
2.5
2.33
1.53
1.15
0.83
0.54
0.42
5.8
4
2.85
2.4
1.58
7.37
4.14
China Guangfa Bank Bank of Communications Shanghai Pudong Development Bank Shenzhen Development Bank
35.15
23.58
19.65
13.31
2.91
2.37
2.01
2.06
1.92
1.36
1.12
10.7
7.57
3.38
1.92
2.45
1.97
1.83
1.46
1.21
0.8
0.51
21.76
14.84
10.29
8.49
11.41
9.33
7.98
5.62
0.68
0.68
0.58
4.39
2.8
2.04
1.29
1.31
1.28
1.23
1.22
1.2
0.84
0.69
13.62
10.25
5.99
3.15
2.87
2.58
2.12
1.54
1.11
0.82
0.68
Citic Industrial Bank
10.35
8.12
5.96
4.11
1.48
1.36
0.95
0.67
China Everbright Bank
13.13
9.34
9.57
7.58
4.49
2
1.25
0.75
5.97
4.23
3.96
3.04
2.73
2.25
1.82
1.5
1.18
4.07
2.91
2.34
2.29
1.88
1.35
4.93
81.06
1.06
0.77
0.47
0.36
6.11
4.05
2.16
1.93
1.51
0.56
China Minsheng Banking China Merchants Bank
Huaxia Bank
7.18
7.05
Shanghai Rural Commercial Bank Chongqing Commercial Bank Ningbo Yinzhou Rural Cooperative Bank Beijing City Commercial Bank Bank of Shanghai
20.03
8.27
6.77
8.75
6.06
4.91
4.22
2.06
1.55
1.02
0.69
5.97
4.99
3.92
3.48
2.41
2.23
1.59
1.12
Note: Data are organised according to raw data from the CSMAR database.
Table 1 shows two trends in the non-performing loan ratios of China’s banks. First, the non-
performing loan ratios of all banks have reduced substantially over the period 2000 to 2010. For
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 example, the non-performing loan ratio of the Industrial and Commercial Bank of China had decreased from 34.43 per cent in 2000 to 1.08 per cent by the end of 2010. With the exponential expansion of China’s banking industry in recent decades, the large decline in non-performing loans may have arisen from a real increase in their performance, but it is noted that government assistance, particularly in the form of the injection of assets into the Big Four banks, has probably also played an important role. Second, the most recent (2010) non-performing loan ratio data for policy and Big Four banks were still higher than those of most of the joint stock commercial banks and urban commercial banks. For example, in 2010, the non-performing loan ratio of the Agricultural Development Bank of China and Agricultural Bank of China was 2.79 per cent and 2.03 per cent, respectively, while the non-performing loan ratios of most joint stock commercial banks were less than 1 per cent. However, as Firth et al. (2008) have predicated, the unofficial ratios of nonperforming loans of Big Four and policy banks might be higher than the official ratios indicate because state-owned banks have an additional incentive to bailout poorly performing listed companies. Emergence of the Stock Market The Chinese securities market emerged with the establishment of the Shanghai Stock Exchange in 1990 and the Shenzhen Stock Exchange in 1991. During the first few years following this, most listed companies were SOEs; subsequently, many non-stateowned companies were also listed on the market. China’s companies are categorised according to their dominant ownership—for example, a ‘state-owned company’ is one that is ultimately controlled by the state and a ‘privately controlled company’ is ultimately controlled and run by civilians, rather than by the central or local government. One characteristic of the present Chinese market is the rapidly growing number of privately controlled companies. Listed companies from non-government background enterprises began to appear on the Shenzhen Stock Exchange from 1992. An average of only six privately controlled companies acquired listing qualifications each year between 1992 and 1997; however, after 1998, the listing of privately controlled companies accelerated. The proportion of privately controlled companies listed through initial public offerings was 6.97 per cent by the end of 2003 and this had increased to 15.38 per cent by the end of 2005. Until 2007, the total number of privately controlled listed companies was 410, representing 26.53 per cent of the 1,545 companies on the Shanghai and Shenzhen stock exchanges. These data provide evidence that privately controlled companies may represent the future trend and form of public
companies in China in the future as economic reform continues. 3 Literature Review and Development of Hypotheses Most of the literature to date has focused on bank loan decisions in developed countries, but the discussion of this issue has been emerging in developing countries over the past decade. In this section, we report our review of the main determinants of company bank loan financing in the context of China, where most banks are state-owned. Based on the review, we develop predictions of listed companies’ access to bank loans. Types of Ownership Control One feature of Chinese listed companies is that ownership is highly concentrated. Different types of ownership mean that there are correspondingly different company objectives and motivations, which influence the way that companies exercise their control rights over their financial decisions (Chen et al., 2009). In a country in which state-owned banks dominate the banking sector, one prominent feature is that financing resources are mostly controlled by the government and mainly reserved for SOEs. This has resulted in an environment in which private enterprises are regarded with scepticism and mistrust and are discriminated against (Brandt and Li, 2003); as such, financing has become a critical problem for private-sector development. With the support of stateowned banks, SOEs often obtain larger access to bank loans (Firth et al., 2009; Zheng and Zhu, 2009), while private-sector development has been hampered by limited access to external finance (Bai et al., 2006). Compared to state-owned banks, foreign banks do not have a lot of policy burden in their operation. They tend to lend to firms with better performance. Because of the tight restriction of getting listed on stock exchanges, the privately controlled companies must perform well to acquire the listing permission. Therefore, this research proposes that privately controlled firms can attain good working relationships with foreign banks and accordingly get larger loan from them. Thus, based on the assumption that the type of ownership control influences companies’ access to bank loans, we propose the following hypothesis: H1: SOEs have greater access to loans from state-owned banks than do privately controlled companies; privately controlled companies borrow more from foreign banks.
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 Political Connectedness of Privately Controlled Companies A considerable amount of research on political connection in enterprises has emerged in recent years, beginning with Fisman’s (2001) and Faccio’s (2006) work. Many emerging economies lack strong property rights protection and face an underdeveloped institutional environment, which forces companies to seek political connections in order to grow. As suggested by Faccio, Masulis and McConnell(2006), political connections may have a favourable effect on bank lending decisions. Dinç (2005) provided banklevel empirical evidence of political influence on banks across emerging countries through multinational research. The results suggest that the role of banks in financial systems cannot be fully understood without considering the political environment in which these financial systems operate. The Chinese economy is dominated by state ownership and there is ongoing ideological discrimination against private ownership in China. The best way to reduce ideological discrimination is through political connectedness because these help private companies access external financing resources such as bank loans by providing government guarantees (Faccio, 2006; Faccio et al., 2006). As access to bank loans is difficult and the public bond market is underdeveloped, finance always represents a developmental bottleneck to companies that have limited connectedness with the government. Some empirical research also reveals that without enough government connectedness, most privately controlled companies depend on informal financing channels, such as private credit agencies, during their establishment and growth periods (Allen et al., 2005; Brandt and Li, 2003; Firth et al., 2009). As such the following hypothesis is proposed:
good research laboratory for regional institutional efficiency since it has vast heterogeneity in institutional development across provinces (Amit et al., 2009). In line with the survey data on the investment climate in China conducted in 2003, Cull and Xu (2005) find that institutional developments, such as the extent of government intervention, are significant determinants of a company’s access to external finance in the form of bank loans. Bai et al. (2006) see the lack of formal protection of private property as the key reason for the private sector’s difficulty in accessing bank loans. By using manually collected ownership data from a sample of publicly listed companies in China, Amit et al. (2009) argue that family control may be an optimal reaction to institutional development across its various provinces. Li et al. (2009) use a sample of non-publicly traded Chinese companies to explore the role of ownership structure and institutional development in debt financing. They find that state ownership is positively associated with leverage and a company’s access to long-term loans and that this is influenced by institutional development. Bai et al. (2006) use a dataset from Chinese private enterprises to investigate the impact of political participation and philanthropic activities on access to bank loans. They conclude that institutional development influences the relationship between political participation and bank borrowing in Chinese companies. Further, Li et al. (2009) find that the effect of political connection on company performance is more important in regions with less developed markets and legal systems. Thus, the following hypotheses are proposed: H3a: If companies are located in an area with more institutional development, the proportion of their loans from state-owned banks is smaller than that of companies located in areas with less institutional development.
H2: Privately controlled companies with more political connectedness obtain greater access to loans from state-owned banks than do those with less political connectedness.
H3b: Across different provinces, the positive effect of political connectedness on loans from state-owned banks is reduced if there is concurrent institutional development.
Institutional Development across Areas An economy cannot properly develop without a competent institutional environment. The academic literature has long been interested in corporate finance issues influenced by institutional development. Qian and Strahan (2007), for example, conclude in their study that legal and institutional differences shape the ownership and terms of bank loans across the world. One of the distinct characteristics of China’s economy is the geographic variation in its institutional environment. Generally better regional institutional efficiency is associated with a better investment climate and higher productivity. Compared with developed countries with broad territories, such as the United States, Canada and Australia, China provides a
Other Important Determinants Company Performance To control and guard against risk, creditor institutions usually use information on earnings to reduce information asymmetry between creditor and debtor. Banks motivated to maximise their profits will likely use better information such as analysis of financial statements and credit scores in their lending decisions. Li et al. (2009) find that, under the current banking reforms, China’s banks have gradually begun to apply economic criteria to their lending decisions. Cull and
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 Xu (2000) demonstrate a link between bank loans and subsequent productivity, which suggests that banks are able to identify and lend to relatively productive enterprises. Additionally, according to the findings of Firth et al. (2009), Chinese banks extend loans to financially healthier and better-governed companies, which imply that they use commercial judgements in this segment of the market. However, all of these studies are from the perspective of the creditor and/or bank. In contrast, different findings are possible if research is conducted from the perspective of the debtor or company. For example, when the relationship between leverage and investment in Chinese listed companies is examined, Firth, et al. (2008) find that state-owned banks have an additional incentive to bailout poorly performing listed companies because a listed company that has experienced losses for two consecutive years may be de-listed if it cannot return to profitability. Thus, the relationship between company performance and bank loans remains unclear. Managerial Ownership Financing choice in alleviating agency conflict between manager and shareholder is well recognised in the literature. The contradictory issue mainly highlights the discretion of management who are expected to make financing decisions on behalf of shareholders that maximise value (Datta et al., 2005). To guard against this conflict of interest, management is usually offered stock ownership in the company to avoid the divergence of interests between managers and shareholders. A corporate board of directors has the power to make, or at least ratify, all important financial policies, so it is quite plausible that board members with appropriate stock ownership will have an incentive to effectively monitor and oversee important corporate decisions (Bhagat and Bolton, 2008). When the interests of shareholders and managers are better aligned, there is no real necessity to use a powerful tool such as a bank loan to monitor a manager’s behaviour. As such, in the analysis of company loan characteristics, managerial ownership should be controlled for. 4 Sample and variables
these raw data, information on each listed company’s yearly bank loan was manually sorted and summarised. If the bank loan was in a foreign denomination, the amount of the foreign currency was converted into Chinese yuan using the renminbi exchange mid-rate10 on the date that the loan was announced. If the foreign exchange rate on that date can not be found (usually because the date occurred on a weekend), the foreign exchange rate for the day before the announcement date was used. All the raw data related to corporate finance and governance was extracted from CSMAR. These data were necessarily supplemented by annual report data obtained from the websites of the Shanghai and Shenzhen stock exchanges as well as from the China Centre for Economic Research database. Companies with ‘ST’ and ‘PT’11 status, companies in the financial and insurance industry, and companies with an incomplete dataset were excluded from the sample. Companies with observed outliers, such as leverage ratios greater than one or Tobin’s Q ratios greater than 10, were also omitted. The final sample consists of an unbalanced panel dataset with 2,509 company-year observations over the sample period of 2002 to 2009. Variables Initially, this study investigated the value of each company’s loans from different types of banks, such as Big Four, joint stock commercial, policy and foreign banks. The percentage of bank loans from each type of bank was also investigated. The type of ownership control is defined in terms of the nature of the ultimate controlling shareholder. If the ultimate controller is the state for the whole period of observation (from 2001 to 2008), the company is defined as an ‘SOE’; if the controller is non-state owned (a natural or legal person belonging wholly to private owners) for the whole period of observation, this company was defined as a ‘privately controlled enterprise’. An interesting phenomenon in China is that some privately controlled companies have managed to retain a certain amount of state ownership (Firth et al., 2009). This study follows Firth et al. (2009), who use the percentage of state ownership, which is calculated as the shares held by the state divided by the total
Sample and data 10
All publicly traded Chinese companies on the Shanghai Stock Exchange and Shenzhen Stock Exchange were included in the sample. The raw data on bank loans were obtained from a sub-database of the China Stock Market and Accounting Research Database (CSMAR), the China Listed Firm’s Bank Loans Research Database (GTA_CBL). The GTA_CBL database has collected relevant information on bank loans, such as interest, maturity and creditors, for listed companies since 1996. From
The resource is from webpage of State Administration of Foreign Exchange: http://www.safe.gov.cn/ model_safe/tjsj/rmb_list.jsp?id=5&ID=110200000000000 000 11 Chinese listed firms have been classified by the CSRC as ‘special treatment’ (ST) or ‘particular transfer’ (PT) firms to protect investor’s benefits. If a listed firm has negative profits for two consecutive years, it will be designated an ST firm; if it continues to operate at a loss for a further year, it will be designated a PT firm. A PT firm will be delisted if it cannot become profitable again within another year (Bai, Liu& Song., 2002).
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 shares outstanding, to measure the level of political connectedness in privately controlled companies. Data on the extent of institutional development across regions in China are obtained from the National Economic Research Institute’s marketisation index (Fan et al., 2010). This index has been widely used by scholars to measure the development of regional institutions. This study, follows such researchers as Firth et al. (2009), Li et al. (2009), Bai et al. (2006) and Lin et al. (2010), in constructing the institutional profile from three dimensions—the marketisation index, government intervention and legal development across each province.12 Government intervention is measured by the extent of economic resource allocation according to the market—less intervention was considered better. Legal development is measured by the development of intermediary organisations and the environment of the legal system; more development is considered better. The marketisation index is a combination of all the other institutional profiles and higher marketisation index scores suggest greater institutional development. The summarised definitions of institutional development are shown in Table 2. This study investigates each company’s industry type to control for the effect of industry. The definition of a ‘protected industry’ is according to the industry category of the China Securities Regulatory Commission (CSRC): if a company’s industry is monopolistic; state protection industry; highly regulated industry, such as the electricity, telecommunications, petroleum, exploitation, agriculture, construction or civil engineering industries; or franchise industry, the value is set as ‘1’; otherwise it is ‘0’. Companies’ return on assets (ROA), the operating earnings divided by the average book value of total assets, is considered to be the variable of profitability. Following Morck et al. (1988) and Cho (1998), this study defines ‘managerial ownership’ as the ownership stake of all board members. Some company-specific control variables, such as the ‘leverage ratio’, defined as total liabilities divided by total assets, and ‘size’, which is defined as a logarithm of total assets are also adopted. Table 3 shows the characteristics and descriptive statistics for the sample. Panel A shows the sources of bank loans categorised according to bank type. Most of the companies could obtain loans from Big Four and joint stock commercial banks. Only 148 observations in the sample gained access to loans from policy banks and 43 observations gained loans from foreign banks. Regarding the loan amount, on average, the sample companies received 552 million yuan loans from Big Four banks and 1,846, 1,614 and
359 million yuan loans from joint stock commercial banks, policy banks and foreign banks, respectively. The mean value of the loan percentages from Big Four and joint stock commercial banks were 36 per cent and 59 per cent, respectively. However, only 4 per cent of loans were from policy banks and 0.7 per cent from foreign banks. Panel B of Table 3 presents a summary of other company-specific variables. An average of 24 per cent of ownership was governmental, while 27 per cent of the listed companies in our sample were in protected industries. Managerial ownership was 0.025 per cent, on average, with a maximum value of 71.64 per cent, demonstrating that there is a wide variance of managerial ownership across Chinese companies. 5 Empirical Results Univariate Test First, the mean and median of company characteristic variables are compared to test whether there are any significant differences between SOEs and privately controlled companies. There are 1,698 observations controlled by the state and 811 out of 2,509 observations are privately controlled. The loan amounts from Big Four, joint stock commercial, policy and foreign banks as well as the proportions of loans from the different banks are shown in Table 4. The mean amount borrowed by SOEs from Big Four banks is four times more than that borrowed by privately controlled companies. SOEs also borrow significantly larger amounts from policy banks (133 million yuan on average) than privately controlled companies (15 million yuan on average), Further, privately controlled companies obtain six times more loans from foreign banks than SOEs. These results support Hypothesis 1, suggesting that SOEs have greater access to loans from state-owned banks than privately controlled companies, while the latter borrow more from foreign banks.
12
China has a centralised legal system in which corporate law and security regulations are the same across all provinces; however, the implementation and development of law companies are different.
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 Table 2. Definitions of institution and profitability variables Variables
Measurement Institutional development
Marketisation
Summary of five categories of market development (marketisation) indexes: government and market, development of non-state sector, development of product market, banking sector marketisation and legal environment. The larger the marketisation index value, the better
Government intervention
The extent of economic resource allocation according to the market. The smaller the government intervention value, the better
Legal system
The development of intermediary organisations and the legal system environment. The larger the legal system value, the better
Note: The measurements of institutional development are from Fan et al. (2010).
Table 3. Sample characteristics and descriptive statistics Panel A: Descriptive statistics of bank loan source Observations
Minimum
Maximum
Mean
Median
Loan amount: million yuan Loans from Big Four banks Loans from joint stock commercial banks Loans from policy banks Loans from foreign banks
1,228
3
255,208
552
115
1,816
1.5
2,580,700
1,846
115
148 43
5 4
68,316 10,000
1,614 359
200 80
Mean value of loan percentage Loans from Big Four banks
Loans from joint stock commercial banks
Loans from policy banks
Loans from foreign banks
0.3558
0.5917
0.0400
0.0074
Panel B: Descriptive statistics of other sample characteristics Minimum
25%
50%
75%
Maximum
Mean
SD
0
0
17.90%
46.33%
84.95%
24.17%
24.81%
0
0
1
0.2742
0.4462
0.6300
6.1100
7.6600
9.5500
11.7100
7.8119
2.2389
GOV
–16.4000
7.2500
8.1000
9.2900
13.4500
7.9116
2.4385
LAW
1
4.4133
6.4100
9.5833
16.6100
7.1199
3.4930
ROA
–0.2850
0.0104
0.0309
0.0549
0.3739
0.0191
0.1891
0
0
0.01%
0.03%
71.64%
2.52%
11.82%
LEV
0.0091
0.4186
0.5452
0.6591
0.9740
0.5474
0.2615
Size
7.9328
9.0109
9.2959
9.6344
11.4921
9.3401
0.5103
State ownership (%) ProtectedIndustry Market
MANA (%)
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 Notes: ‘ProtectedIndustry’ refers to the dummy variable to measure if the industry is protected. According to the industry categories of the CSRC, an industry is protected if the company is monopolistic; state protected industry; or in a highly regulated industry, such as electricity, telecommunications, petroleum, exploitation, agriculture, construction, civil engineering. ‘Market’ refers to marketisation; ‘GOV’ refers to government intervention; ‘LAW’ refers to the level of legal system development. These profiles of institutional development are from Fan, Wang and Zhu (2010). ‘ROA’ refers to return on assets; ‘LEV’ refers to leverage ratio. ‘MANA’ refers to percentage of managerial ownership; ‘SD’ refers to standard deviation.
Table 4. Results of univariate test for bank loan sources for 2002 to 2009 Mean comparison
Median comparison
SOEs (1,698 obs.)
Private (811 obs.)
t
SOEs (1,698 obs.)
Private (811obs.)
Z
Loan amount from Big Four banks (million yuan) Loan amount from joint stock commercial banks (million yuan) Loan amount from policy banks (million yuan)
352
99
1.654*
0
0
1.826*
1,876
206
1.098
585
500
0.087
133
15
2.494**
0
0
2.082**
Loan amount from foreign banks (million yuan)
2
14
–1.407
0
0
1.992**
Notes: ** and * indicate significance at the 5% and 10% level, respectively. T-value from the t-test of differences in means. Z-value from the Mann–Whitney U test of differences in medians. ‘Private’ refers to privately controlled companies; ‘obs.’ refers to observations.
Modelling Bank Loan Resources in Privately Controlled Companies To investigate whether political connectedness in privately controlled companies aided them in obtaining loans from state-owned banks, we conduct multivariate analysis. We use companies’ access to
loans from Big Four banks as the repressor in a logistic model (Equation 1). The dependent variable ‘Big_Four’ was set as ‘1’ if a specific company in a specific year had a loan from one of the Big Four banks, otherwise it was ‘0’.
Big _ Fourit = α + β1 Politicalit + β 2 Institutionalit + β3 Politicalit * Institutionit + β 4 P erformanceit −1 + β5 ManaOwnershipit −1 + β 6 Leverageit + β 7 Sizeit −1 + β8 Pr otectedInduit
(1)
+γ ' ( Industrydummiesi ) + θ ' (Yeardummiesi ) + ε it In Equation 1 ‘Political’ (political connectedness) uses the proxy of the percentage of state ownership; ‘Institutional’ refers to three different aspects of institutional development—that is, marketisation (‘Market’), development of the legal system (‘LAW’) and government intervention (‘GOV’). ROA is used to measure company performance. ‘Industrydummies’ refers to dummy variables grouped according to the China Industry Classification Index and ‘Yeardummies’ refers to dummy variables grouped by year.
Table 5 reports the logistic regression of 811 observations of privately controlled companies accessing loans from Big Four banks with political connectedness, institutional and interactive variables, as well as company-specific control variables. All the coefficients of political connectedness are positive and statistically significant at the 5 or 10 per cent significance levels. This result supports Hypothesis 2 sufficiently, suggesting that political connectedness does have a positive effect on a privately controlled company’s access to loans from state-owned banks.
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 Table 5. Results of logistic regression on Big_Four from 2002 to 2009 Regression 1 Intercept Political
–0.7973 (0.612) 1.1449** (0.016)
Market Political*Market
Regression 2 0.5541* (0.082) 0.8068** (0.031) –0.0771** (0.037) 0.0018* (0.095)
Regression 3 –0.6908* (0.063) 0.6156* (0.052)
0.0431** (0.025) 0.0581 (0.800)
GOV Political*GOV LAW Political*LAW ROA MANA LEV Size ProtectedIndustry Year Obs. Pseudo R2
Regression 4 –1.1239 (0.478) 1.2968* (0.093)
0.0706 (0.846) –0.4268 (0.302) 0.0684 (0.102) 0.0708** (0.022) 0.0615 (0.612) Yes 811 0.0044
0.0343 (0.288) –0.2562 (0.508) 0.3637 (0.106) –0.0863** (0.030) 0.0042 (0.964) Yes 811 0.0110
0.0643 (0.360) –0.3566 (0.377) 0.0628 (0.127) 0.0975* (0.073) 0.0632 (0.723) Yes 811 0.0052
–0.0436** (0.047) –0.0539 * (0.086) 0.0424 (0.316) –0.2657 (0.416) 0.0528 (0.051) 0.1444 (0.023) 0.0481 (0.787) Yes 811 0.0097
Notes: Numbers in parentheses are P values; ***, ** and * indicate significance at the 1%, 5% and 10% level, respectively. The dependent variable is a dummy variable named ‘Big_Four’, which equals 1 if a specific company in a specific year only has a bank loan from a Big Four bank, otherwise 0. ‘Political’ refers to political connectedness. ‘ProtectedIndustry’ refers to the dummy variable to measure if the industry is protected. According to the industry categories of the CSRC, an industry is protected if the company is monopolistic; state protected industry; or in a highly regulated industry, such as electricity, telecommunications, petroleum, exploitation, agriculture, construction or civil engineering. ‘Market’ refers to marketisation; ‘GOV’ refers to government intervention; ‘PropertyRight’ refers to the level of property right protection; ‘LAW’ refers to the level of legal system development. These profiles of institutional development are from Fan, Wang and Zhu (2010). ‘ROA’ refers to return on assets; ‘LEV’ refers to leverage ratio. ‘MANA’ refers to the percentage of managerial ownership; ‘obs.’ refers to observations.
In regression 2, the influence of marketisation on accessing loans from Big Four banks is negative at the 5 per cent significance level. In regression 3, the influence of GOV on access to Big Four bank loans is significantly positive. In regression 4, the influence of LAW on the Big_Four (–0.0436) is significant at the 5 per cent level. This supports Hypothesis 3a, suggesting that institutional development across areas in China is an essential determinant of companies’ access to loans; this is also consistent with the findings of Li et al. (2008). However, when the level of institutional development is considered, the influence of political connectedness on Big_Four became smaller. For instance, in the second regression, when the influence
of political connectedness is joined by marketisation, the coefficient decreased to 0.0018. This supports Hypothesis 3b, suggesting that the positive effect of political connectedness on loans from state-owned banks is reduced if influenced by the institutional development across different provinces. The insignificant influence of company performance on the Big_Four dummy is evidence that even though the banking sector reform encouraged banks to lend to better-performing companies, political connectedness and marketisation, rather than company performance, still play important roles in privately controlled companies’ access to loans, which is consistent with Firth et al’s (2008) findings.
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 The results of this analysis also show that access to loans from Big Four banks is associated with greater leverage ratios and lower asset scales. Companies from protected industries have greater access to bank loans from Big Four banks than other companies. Endogeneity of the Type of Ownership Control In this study, state ownership is used as a measure of political connectedness. Thus, one question that may arise is whether companies with a high level of political connectedness will be ultimately controlled by the state at some point. According to the results in Table 4, SOEs intrinsically have greater access to loans from Big Four banks than privately controlled companies. Hence, to estimate the effects of political connectedness and type of ownership control on bank loans, either individually or together with institutional
development, the endogeneity of the type of ownership control must be controlled for. We use Heckman’s (1979) two-stage approach to estimate bank loan models. In this approach, the first stage is a probit model to predict the probability of a company being a state-controlled company. In the first stage, the dependent variable is ‘SOE’, which is set as ‘1’ if the company’s ultimate controller is the state, ‘0’ otherwise, and ‘Pr[SOE]’ is the predicted type of ownership control according to the probit model. In the second stage, the dependent variable is the Big_Four dummy variable, which is access to loans from Big Four banks. One of the independent variables, ‘Pr[SOE]’, in the second stage is from the probit model in the first stage. The second stage consisted of logistic regressions concerning the effects of both the predicted control type and institutional development on the access to loans from Big Four banks. The results are shown in Table 6.
Table 6. Results of two-stage approach on Big_Four from 2002 to 2009
Intercept
First Stage (SOE) 8.7245*** (0.000)
Pr[SOE] Market Pr[SOE]*Market GOV Pr[SOE]*GOV LAW Pr[SOE]*LAW Political ROA MANA LEV Size ProtectedIndustry Year Obs. Pseudo R2
–8.2410*** (0.000) 0.3804 (0.276) 10.6891*** (0.000) 0.2746 (0.329) –0.9087*** (0.000) –0.4580*** (0.001) Yes 2,509 0.3891
Second Stage (Big_Four) 1 2 3 2.5050*** 2.6474*** 2.3097** (0.009) (0.006) (0.015) 1.4238** –0.5331 –1.2113** (0.040) (0.415) (0.015) –0.1193*** (0.000) 0.0925 (0.157) –0.0291 (0.293) –0.0155 (0.811) –0.0721*** (0.000) 0.0683* (0.085) –0.5309 –0.3089 –0.5029 (0.173) (0.413) (0.193) 0.3403 0.3198 0.3094 (0.254) (0.283) (0.298) 0.1167 0.0742 0.0817 (0.778) (0.857) (0.843) 0.3552 0.3208 0.3224 (0.109) (0.144) (0.142) –0.1573* –0.2520*** –0.1793** (0.095) (0.007) (0.057) –0.0378 –0.0059 –0.0294 (0.687) (0.950) (0.753) Yes Yes Yes 2,509 2,509 2,509 0.0117 0.0061 0.0103
Notes: Numbers in parentheses are P values; ***, ** and * are signs for significance at the 1%, 5% and 10% level, respectively. ‘ProtectedIndustry’ refers to the dummy variable to measure if the industry is protected. According to the industry categories of the CSRC, an industry is protected if the company is monopolistic; state protected industry; or in a
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 highly regulated industry, such as electricity, telecommunications, petroleum, exploitation, agriculture, construction or civil engineering. ‘Market’ refers to marketisation; ‘GOV’ refers to government intervention; ‘LAW’ refers to the level of legal system development. These profiles of institutional development are from Fan, Wang and Zhu (2010). ‘ROA’ refers to return on assets; ‘LEV’ refers to leverage ratio. ‘MANA’ refers to the percentage of managerial ownership; ‘obs.’ refers to observations; ‘SOE’ refers to state-owned enterprise.
In the first stage, the probability that a company is controlled by the state is represented by the variable ‘Pr[SOE]’. Pr[SOE] is one of the main independent variables in the second-stage regressions, in which the overall Pr[SOE] coefficient for Big_Four is the sum of the Pr[SOE] coefficient and the interaction coefficient multiplied by the mean value of the interactive variable. This explains why the Pr[SOE] is positive in the regressions with the institution interactions. When the product of institution and the interaction coefficient is added to the Pr[SOE]coefficient, the sum is positive for every specification in our sample. For example, as presented in the results of regression 1 on the second stage in Table 6, the overall Pr[SOE] coefficient of the influence of Pr[SOE] on the access to loans from big four banks is: 1.424 + 0.093 * 7.812 = 2.151. The value ‘7.812’ is from Panel B of Table 3, the mean of market 7.8119. This example again proves Hypothesis 1, as it indicates that the type of ownership control influences companies’ access to loans, even if the endogeneity of ownership control is controlled. Compared with privately controlled companies, SOEs have greater access to loans from Big Four banks. According to the same rule as above, the overall marketisation coefficient is significant. This also proves Hypothesis 3 that obtaining a loan from a Big Four bank is more common for privately controlled companies when legal institutions are weaker and regional government is more interventionist. 6 Conclusions In China, banks play a vital role in the national economy as financial intermediaries. For the past few years, China’s banks have maintained a soaring momentum due to fast growth in the economy and lenient monetary policy. However, empirical research on the efficiency of Chinese banks is scarce. China is a country in which political factors explicitly and implicitly permeate corporate management and the national economy. The claim is that, in China, political connections and institutional development are as important determinants of access to bank loans as fundamental factors such as company performance. This study contributes to the current literature at least in the following ways. First, although the economic consequences of the type of ownership control are widely documented by the extant literature, whether this can be linked with bank discrimination has not been proven. This study provides evidence that suggests that access to loans by Chinese listed companies is highly dependent on type of ownership control. According to the results of
the univariate tests, SOEs have more access to loans from Big Four banks and obtain fewer loans from foreign banks than privately controlled companies. Even if the endogeneity of the type ownership control is controlled by employing two-stage regressions, the ultimate control type remains very important to listed companies’ access to loans in the state-owned banking system. Second, logistic regression analysis further supports the influence of political connectedness on a company’s access to loans from different types of banks. The empirical evidence strongly supports the fact that privately controlled companies with more political connectedness find it easier to access loans from the Big Four and joint stock commercial banks. This study thus echoes the conclusions of Dinç (2005), who find that political connectedness has an important influence on the behaviour of banks in emerging markets. Third, this research extends upon the conclusion that institutional development across areas influences companies’ external financing, such as the access to loans, when state-owned banks dominate the banking system. Due to the large population and differences in landscape, factors such as resources, culture and economic growth, different areas and provinces have different institutional development in China. Three variables are used to measure institutional development—the marketisation index, government intervention and development of the legal system. The empirical evidence shows that companies located in an area with more institutional development borrow fewer loans from state-owned banks than those located in an area with less institutional development. The positive effect of political connectedness on loans from state-owned banks is reduced if there is concurrent institutional development. References 1.
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DETERMINANTS OF ACCESS TO BANK FINANCE FOR SMALL AND MEDIUM-SIZED ENTERPRISES: THE CASE OF SRI LANKA Pandula Gamage* Abstract This paper examines what determines access to bank finance in small and medium-sized enterprises in Sri Lanka. The empirical evidence for this study is drawn from the Sri Lanka Enterprise Survey data set obtained from the World Bank. The logistic regression is used to analyse the data. This study found that access to bank finance is largely determined by location of the firm, availability of audited financial statements and the owner-manager’s perception ofaccess to finance. This paper can helppolicy makers make informed decisions to articulate policies, to develop training programmes, and to design support systems that can positively address the factors affecting access to bank finance forSMEs in Sri Lanka. Keywords: Bank Finance, SMEs, Access to Finance, Enterprise Surveys *College of B usiness and Centre for Strategic Economic Studies, V ictoria U niversity, PO B ox 14428, M elbourne, V ictoria 8001, Australia Tel: +61 3 99198017 Email: pandula.gamage@ vu.edu.au
1 Introduction Policy makers have, for a long time, voiced concerns about small and medium-sized entrerprises’ (SMEs) lack of access to finance. While much havebeen written about SME financing gaps, there is a lack of research investigating the determinants of access to bank finance by SMEs. Previous studies have been primarily concerned with the efficient provision of resources to the sector, and they frequently refer to the difficulty of SMEs in sourcing adequate finance. This focus on market efficiency and supply of finance to the sector has resulted in less attention to the determinants of capital structures (Mac anBhaird, 2010).Consequently, it is important that policy makers be well-informed about the determinants of bank finance. However, the review of the literature dealing with this area indicates that there is a significant gap in knowledge of the determinants of bank finance.This paper aims to fill this gap by investigating what factors determine the access to bank finance, employing the firm level data from Sri Lanka. An understanding of these factors could greatly improve our knowledge of the sector and could result in more appropriate support targeted atSMEs. The article proceeds as follows. The second section presents a brief summary of the literature concerned with factors affecting access to bank finance for SMEs. The third section describes the data set used and the statistical method employed. The results are then summarised and analysed in the fourth
section. Finally, section five draws the main conclusions, highlights policy implications, addresses the limitations of the study, and points to avenues for future research. 2 Access to bank finance and its determinants: a review of the literature This section provides a review of the literature in order to identify the independent and dependent variables used in the empirical analysis. Additionally, this review leads to the development of a model to estimate the probability of access to bank finance. 2.1 Ownership type Entrepreneurs choose ownership structures in large part to ensure adequate financing. Hence ownership structures in the firms can influence the ability to gain access to bank finance. For example, a sole proprietorship business is a high risk for borrowers as the repayment of the loan depends on one person. In contrast, other ownership types such as partnerships, listed firms, etc. have their repayment risks spread among several owners. Previous research foundthat listed firms and foreign-owned firms faced lesser financial constraints (Harrison and McMillan, 2003; Beck et al., 2006). Moreover, Storey (1994) found that corporate status at start-up appears to be associated with a greater likelihood of bank lending: ‘...from the bank’s point of view, a limited company status can offer benefits if it reflects the ‘seriousness’
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 of the business activity and also means that the owner’s personal collateral can be lodged with the bank in the event of failure (Storey, 1994, p.129). 2.2 Firm age As firms’ sources of finance change over time, firm age can be stated as another important determinant of access to bank finance. For instance, a firm may start as a family-owned business and use internal financing sources, such as personal savings and family finance. Subsequently, it might grow to obtain funds from its suppliers. When it has a well established legal identity, business track record and accounting systems, it may be able to obtain loans from banks. Previous studies (see Aryeeteyet al., (1994) and North et al.,(2010)) have found a positive correlation between firm age and access to bank finance. Being in the business for many years suggests that the firm is competitive in general and more transparent so that the information required by the lenders to evaluate and process applications is readily available. Moreover, new firms are not likely to meet the collateral requirements of the banks since they have not accumulated sufficient assets. Insufficient assets combined with the absence of information on financial recordsmakesit difficult forlenders to assess lending proposals submitted by new firms. Previous studies foundthat financing constraints wereparticularly severe for start-up enterprises and relatively young firms (three years old or less). For example, according to Aryeetey et al., (1994) who conducted a survey of 133 firms in various industries in Ghana, only 10 percent of startup firms could obtain bank loans and medium-sized enterprises and older firms were provided with credit three times more often than their smaller counterparts. North et al. (2010) reported that the main reasons for younger firms encountering problems in accessing finance werelack of credit history, insufficient security and poor business performance. 2.3 Industry sector Industry sector can be identified as a possible factor in the provision of bank loans to SMEs. A possible reason might be that lending banks may favour industry sectors that are growing. Likewise, some industry sectors have a much lower demand for loans than others, simply because they do not need loans. For example, the SMEs in the manufacturing sector require relatively large investments in assets such as land, factory building, plant and machinery, vehicles, while most of the service organisations and retail sector organisations in the SME sector need fewer investments in fixed assets. Using data from Mozambican manufacturing firms, Byiers et al. (2010) found that industry sector was an important determinant for having access to credit. For example, both metal-mechanic and wood-furniture sectors
hadsignificantly lower credit access than the food processing sector. Their interpretation was that banks attached a lower risk premium to the food processing sector compared to other two sectors. Usinga Business Environment and Enterprise Performance Survey III, which covered 9500 firms from 26 transition countries, Drakos and Giannakopoulos (2011) similarly reported that the likelihood of credit rationing for firms operating in the mining sector wasabout 14.9 percent higher. In contrast, they foundthat firms that operated in the real estate and hotel sectors respectively exhibited approximately 4.8 percent and 7.1 percent lower probability of being credit rationed. Moreover, some industries are more likely to depend on external financing than others. Firms in certain sectors require more credit to invest in equipment, machinery, buildings, labour and raw materials and, hence, may face proportionately greater constraints than firms in other industry sectors (Kumar and Francisco, 2005). According to Deakins et al. (2010), although no sectors wereexcluded by the banks, entrepreneurs in competitive sectors mightfind it difficult to raise finance, especially if they wereoperating in ways that didnot meet the banks’ own benchmarkings for the sector. Furthermore, North et al. (2010) reported that manufacturing SMEs in Scotland weretwice as likely to experience problems compared with SMEs in other sectors. A further reason why industry sector plays a role in lending is due to tangible assets across industry sectors. Some industry sectors such as manufacturing have a greater concentration of tangible assets, whilst some other sectors such as computer services are primarily composed of intangible assets. For example, Cressy and Olofsson (1997) stated that service SMEs, with lower level of collateralizable assets and greater risk associated with their activities, had greater difficulty to obtain debt. Additionally, Silva and Carreira (2010) argued that, for most services, the main input washuman and not physical capital and therefore service sector firms found it hard to use physical capital as collateral when resorting to external finance. 2.4 Location of the firm The location of the firm is another factor in accessing bank finance. Petersen and Rajan (1995, p.417) noted that banks located closer to borrowing firms enjoyed significantly lower transportation and monitoring costs, to such an extent that “if other banks are relatively far, close banks have considerable market power”. Due to this, small firms may end up paying high interest on bank loans or may have to adhere to restricted covenants such as collateral and other conditions. Additionally, the bank branch managers assigned in rural bank branches may have limited delegation of authority. As a result, there may be high amount of loan rejections or delays in approving loans requested by
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 rural firms, as the applications are processed, approved or turned down by officials in the head office, who have no personal knowledge of customers or projects based in rural locations. Finally, property value and marketability differ substantially between rural and urban locations. Consequently, banks may be reluctant to lend to small firms located in rural areas, as the assets offered as collateral by these firms may have less market value, and might be difficult to realise in case of default.O’Farrell (1990) suggested, on the basis of research in Nova Scotia in Canada, that banks weremore reluctant to lend to small firms in rural areas, because if these firms failed, it wasmore difficult to sell their assets. Kumar and Francisco (2004) also noted that there was a large variation in branch density across different regions in Brazil and argued that well branched regions hadeasier physical access and lower information asymmetry problems as a consequence of greater ratios of banks per firm and that firms located in these regions hadeasy access to credit. 2.5 Having audited financial statements Previous studies stated that the imperfect information of the borrowers was a great limitation for banks to grant loans (Jaffee and Russell (1976); Stiglitz and Weiss (1981)). Accordingly, banks often require audited financial statements before granting credit to mitigate this issue. Berry et al. (1993) found that lenders in the UK paid much more attention to accounting information in order to deal with the loan applications of small firms. Therefore, it might seem plausible that audited financial statements improve borrower’s credibility and therefore reduce risk for lenders. Meanwhile, Aga and Reilly (2011) conducted a study using firm level data from Ethiopia and foundthat a firm that maintainedaccounting records wassix percentage points more likely to have access to credit than firms that didnot have such accounting records. Likewise, Caneghem and Campenhout (2012) relied on a sample of 79,097 Belgian and Luxembourgian SMEs to test whether the amount and/or quality of financial statement information affects the financial structure of SMEs. Their findings showed that both the amount and quality of financial statement information are positively related to SME leverage. Similarly, Dharan1993) also pointed out that the auditor’s opinion wasassumed to convey the risk characteristics of the firm to the lenders without error. 2.6 Asset tangibility Usually, banks require a tangible fixed asset as security (collateral) for the loan and banks typically lend to a firm based on the value of fixed assets offered as security. However, small firms have fewer collateralizable assets than large firms. This may partly relate to the stage of growth of the firm. In the
earlier stages of the firm, it may have lower retained profits which may hinder it from purchasing fixed assets. Another reason for small firms to have a smaller proportion of fixed assets is the capital constraints they face. Because of the need to raise large amounts of capital, it is difficult for them to acquire a large number of fixed assets. The above reasoning implies that firms with tangible assets have relatively easier access to bank finance and lower costs of financing. Previous studies (see Storey, 1994; Berger and Udell, 1998; Michaelas et al., 1999) also suggest that bank financing depends on whether lending can be secured by collateral. Moreover, Sogorb-Mira (2005) found a positive effect of tangible assets on leverage for SMEs. Johnsen and McMahon (2005) also stated that other factors held constant, firms with more intangible assets need to borrow less because of collateral factor. 2.7 Sales growth Many studies that have attempted to construct the measures for firm performance in the SME sector which is, in itself, a difficult task - indicated that greater sales and profits wereassociated with greater access to credit (see Bigsten et al., 2000; Topalova, 2004). Therefore, the growth rate of sales can be considered as another factor affecting access to bank finance because growth over a period of time is likely to give a better indication of financing needs than sales of a single year.The European Commission (2003) also supported this view and stated poor business performance as one of the reasons for not receiving credit. In general, firms with increasing sales and sales turnover ratios are expected to have less credit constraints. According to Delmer et al. (2003), sales could be considered as an appropriate measure of growth. As they suggested, “if only one indicator is to be chosen as a measure of firm growth, the most preferred measure should be sales” (p.194). Barkham et al. (1996) also notedthat sales wasthe most commonly used measure of growth even by entrepreneurs themselves, because the data wererelatively easy to obtain. 2.8 Gender of the owner-manager The ability of female entrepreneurs to access bank financing has been in the research agenda of the small business discipline over the past 15 years. Carter et al. (2007) identified two main reasons for women’s lesser likelihood of using external debt finance, namely, structural dissimilarities between male and female owned firms and, gender discrimination in the supply and demand side factors. Several studies have tested gender-based discrimination in credit markets, but they arrived at conflicting conclusions. For instance, Hisrich and Brush (1986) suggested that women experienced difficulties in accessing bank
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 loans because of their gender. This mightbe due to that fact that loan officers wererisk averse and they negatively viewed female loan applicants because of perceived poor track record, lack of strategic planning and market plans. Watson (2002), in support of this argument, pointedout that because women-owned businesses generally started small and wereyounger as compared to men-owned ones, women who owned a businessfaced credibility problems with their bankers. Other researchers assumed that this wasdue to women’s propensity to operate with low personal equity or to their lack of skills. (See Carter et al. , 2007; Coleman, 2002). Despite the volume of research, there is no unequivocal support for the idea that there are gender- based differences in access to finance.
own and others’ experiences of applying for external finance. Based on a large sample of New Zealand SMEs, Hamilton and Fox (1998) argued that managerial perceptions played an important role in determining the capital structure of SMEs. Norton (1991) reached a similar conclusion when he stated that: “In small businesses and entrepreneurial firms, managerial beliefs and desires will play an especially important role in determining capital structure...(and) models must include management preferences, beliefs and expectations if we are to better understand capital structure policy” (p.174).
2.9 Experience of owner-managers
The data employed in this paper were extracted from the Sri Lanka Enterprise Survey data set carried out by the World Bank in 2011. The survey was conducted as part of the World Bank surveys based on standardised survey instrument, and a uniform sampling methodology that yielded a nationally representative sample of enterprises of Sri Lanka, including both manufacturing and service sector firms. To the best knowledge of the author, this is the only representative data set of this kind. The sample consisted of a total of 610 enterprises. Fifty-three percent (322 enterprises) of these enterprises weresmall (5-19 employees), 29 percent (179 enterprises) weremedium (between 2099 employees) and 18 percent (109 enterprises) of them belonged to the large category (100 or more employees). In accordance with the objective of this paper, large enterprises have been disregarded and only small and medium-sized enterprises were included in the analysis.
Entrepreneur experience is also viewed as an asset with regard to resource allocation decisions, including accessing financing facilities from banks (Politis, 2008). Lenders emphasise the importance of experience of the owner-manager at the time of lending assessment and they may look favourably to loan applicants with more experience in the business compared to an inexperienced applicant who carries a great risk to the bank. For example, Cowling et al. (2012) conducted a study using small business survey data in the UK and foundthat human capital playedan important role in accessing finance. In fact, they concluded that experienced managers were10 percent more likely to have their financing needs met compared to the inexperienced ones. 2.10 Perception of owner-manager Perceptions of business owners influence both growth motivation and behaviour of owner-managers. As Kwong et al. (2012, p.78) stated, “perception is important because it often comes before real action and such perceptions, even when false, can be as damaging as the presence of an actual barrier”. With regard to entrepreneurs’ perceptions on difficulties in accessing finance, Wyer et al. (2007) argued that it was important to recognise that individuals mightadjust their personal constructs and thus their perceptions, beliefs and expectations in the face of a new experience and mightchoose not to borrow based on the perceived difficulties in accessing finance. The entrepreneurs’ perception of access to finance might induce potential SME borrowers to voluntarily decide not to apply for bank loans despite having feasible projects which were credit worthy. In other words, even if the supply side is favourable, a perception that there are finance constraints can artificially suppress the demand side. This is the concept of ‘discouraged borrowers’ identified by Kon and Storey (2003) who revealed that finance gaps mightarise when entrepreneurs’ perceptions wereinfluenced by their
3. Methods 3.1 Data and sample description
3.2 Estimation method Logistic regression was used to measure the strength of association between pairs of variables, to determine the relationship between access to bank finance and SME characteristics. Logistic regression wasan appropriate choice in this research as the survey only providedinformation as to whether or not a business secured a bank loan, but didnot provide the actual amount of the loan. The dependent variable in the binary logistic regression wasa dummy variable which wasequal to one if the firm had access to credit and waszero otherwise. The independent variables were: ownership type, the age of the firm, sector, location of business, asset tangibility, firm performance, availability of audited financial statements, gender of the owner-manager, experience of the owner-manager and the owner-manager’s perception of their access to bank finance. The empirical specification of the model employed for the study is as follows:
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Where: Dependent variable is access to bank finance Ownership refers to the ownership type of the firm Age represents no of years of operation of the firm Sector represents the industry type Location refers to whether the head office waslocated in urban or rural area Audit refers to whether the firm’s financial statements wereaudited or not Tangibility represents the fixed assets ratio Salesgrowth represents growth rate in sales over a three-year period Gender denotes the gender of the owner-manager Experience refers to the years of prior experience of top manager Perception represents the entrepreneurs’ perception of access to finance;and ε1represents the error term assumed to be normally distributed with constant variance, which is supposed to capture the influence of all other variables affecting access to bank finance. 3.3 Dependent variables The most important variable is access to bank finance, i.e. the amount of bank finance rationed in the loan market. It should be measured by excess demand. However, the demand for bank finance is not directly observable. Because of this difficulty, most previous studies used a dummy variable for using bank finance or not, as a proxy variable for access to bank finance. However, there is a considerable difference between the actual use of bank finance and access to bank finance, so usage of finance is not sufficient to identify financially constrained firms. Therefore, this study adopted a different approach to measure access to bank finance. In order to provide evidence on who gotbank finance among SMEs, the author classified the firms into two categories based upon their response to the question whether they hada bank loan or overdraft. One possibility wasthat the firm didnot
need, or didnot apply for,a bank loan (voluntary exclusion). Firms in this category couldnot be considered as credit constrained. The second possibility wasthat the firm applied for a bank loan but was rejected by the bank. Finally, a firm might not apply for a loan at all because it wasdiscouraged to do so by the complexity of loan application procedures, high interest rates, lack of collateral, unfavourable loan conditions (for example, loan amount, maturity period) or simply consideredits chance of getting a bank loan wasminimal. In this paper, the second and third types of firms were classified as firms with “no access to bank finance”. 3.4 Independent variables Based on the existing literature discussed in section 2, the following independent variableswere identified and their descriptions are listed in Table 1.
Table 1. Description of independent variables Variable Ownership type
Age of the business Sector Location Having audited financial statements
Tangibility Sales growth Gender of owner-manager
Description Sole proprietorship = 1 Partnership = 2 Private, Public limited company or cooperative = 3 No. of years running the business Manufacturing = 1 Services = 0 If situated in a main business city = 1 If not situated in the main business city = 0 Yes = 1 No = 1 Tangible assets ratio (the ratio of property, plant and equipment to the total assets) Percentage growth rate of sales Male = 1 Female = 0
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Experience of owner-manger
Years of prior experience of owner-manager
Perception ofaccess to finance
No obstacle = 1 Minor obstacle = 2 Moderate obstacle = 3 Major obstacle = 4 Very severe obstacle = 5
4. Empirical results and discussion The direct logistic regression analysis was carried out by the logistic procedure in SPSS version 19. Table 2 shows the final model regression results including the logistic regression coefficient, Wald Test, level of
significance and odds ratios for the variables in the equation (Exp (B1). The value under (Exp (B1)) is the predicted change in odds for a unit increase in one independent variable, holding other variables constant.
Table 2. Logistic regression results Variables Ownership type Sole proprietorships Partnerships Firm age Location (Urban) Availability of audited statements (Yes) Sales growth Tangibility Owner-manager’s experience Owner-manager’s gender (Male) Perception ofaccess to finance No obstacle Minor obstacle Moderate obstacle Major obstacle Constant
B
S.E.
Wald
Sig.
Exp (B1)
1.354 1.409 1.239 1.360
.931 .769 .076 1.941 3.936 4.775 .388 2.924 .331 .002 12.934 .002 .000 .023 3.793
.628 .380 .782 .164 .047** .029** .533 .087 .565 .968 .024** .965 .995 .878 .051
.942 1.008 .827 .071
1.694
.112
.738
.567
-.675 .371 -.028 1.276 1.520 -.001 2.161 .018 -.047
.770 1.342 .020 .643 .695 .002 1.264 .031 1.171
-.060 .008 -.190 -2.648 -.567
.509 1.449 .973 3.583 4.571 .999 8.676 1.018 .954
Summary statistics Hosmer and Lemeshow (H-L) test -2 log likelihood
Walds’s
Cox and Snell R square Nagelkerke R square
6.407 84.631
p- value .602
.289 .447 85.1%
Correct predicted % **p< .05 ; one-tailed
Note: In running the logistic regression, the sector was used as the reference point and, therefore, is not shown in the table. For ownership type, the last category is private and public limited firms; for location, it is a rural location;for availability of audited statements, it is firms with no audited statements; for gender, it is female;for perceptions, the last reference point is ‘very severe obstacle’ category.
The full model containing all predictors was statistically significant, (15, N = 452) = 44.46, p< .001, indicating that the model was able to distinguish between the respondents who had access to bank finance and those who did not have access. In regard to testing the validity of the model, HosmerLemeshow test yielded a test statistic of 6.407 with a p- value of .602. Consequently, there is no evidence against the null hypothesis that there is no
difference between observed and model predicted values, implying that the model fits to the data reasonably well. However, the result of the HosmerLemeshow test can be misleading since it can be due only to the wide range of values of the original predictors. Therefore, Cox and Snell R2 and Nagelkerke R2 were also calculated and as can be seen from the above table, the overall fit is satisfactory, with Nagelkerke square of .447 and Cox and Snell R square of .289. The overall percentage
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Corporate O w nership & Control / V olum e 10, Issue 3, 2013, Continued - 3 prediction accuracy of the model is 85.1 percent. Given the aim of the model, this model is considered acceptable. According to the results, three independent variables hadsignificant impact on the probability of a firm having access to bank finance: the location of the firm, whether the firm has audited statements and the owner-manager’s perception of access to finance. As regards the estimated marginal effects of these variables on access to credit, the probability of accessing bank loans wasabout 3.6 times higher for the firms located in main business cities than for firms in rural areas, 4.6 times higher for firms with audited financial statements than for firms with no such statements. The rest of the variables identified in the study didnot appear to have any significant influence on the probability of having access to bank finance as indicated by the low odd ratio and insignificant pvalue. 5. Conclusion, policy implications and future research This paper attempted to explore the determinants of bank finance for SMEs in Sri Lanka. A priori reasoning, and an overview of the literature, suggested a number of factors that are likely to be associated with access to bank finance. The factors identified were: the ownership type, the age of the firm, sector and location of the business, asset tangibility, firm performance, availability of audited financial statements, gender of the owner-manager, experience of the owner-manager, and perception of the owner-manager of access to bank finance. The data utilised in this research were extracted from the Sri Lanka enterprise survey data set.To the best knowledge of the author, this is the only representative data set of this kind. In this paper, the determinants of access to bank finance by SMEs in Sri Lanka were analysed using the logistic regression model because the dependent variable, having access to bank finance, is a categorical variable with two discrete, non-overlapping and identifiable categories. According to the results, the access to bank finance is largely determined by location of the firm, availability of audited statements and the owner-manager’s perception of access to finance. The findings of the paper provide some insights to policy makers. First contribution of this study is to the loan evaluation process as whereby the processcan help distinguish credit worthy borrowers from the rest of the applicants. One of the findings of this study is that certain entrepreneurial characteristics, like the perceptions of owner-managers, have a high association with the access to bank finance. Hence, it is clear that assessing creditworthiness exclusively from a financial point of view is not suitable in the case of SMEs and loan officers should devote sufficient time to attempting to determine qualitative factors such as characteristics of the borrowers at the
time of evaluating loan applications. Second, it was found in this study that having audited financial statements increases the probability of getting access to bank finance. Hence, policy makers should look at this area in an effort to promote access to bank finance for SMEs and could support the education and training of small and medium business operators to develop their financial record keeping skills. While this paper has provided some insights into factors affecting access to bank finance for SMEs, the research admittedly has a number of limitations. The findings in this paper were based on managers’/owners’ self-reporting in the surveys. This produces certain constraints, such as a positive response bias. Therefore, it is also recommended to explore the relationships tested in this research by obtaining data from multiple sources such as interviewing bank lending officers and conducting case studies. In regard to the statistical analysis of the data, the present study applied logistic regression analysis to predict accessing bank finance by SMEs. While the method used for testing the hypotheses is technically sound, it may not be the only way in which to test the model. Future research may consider the potential advantages of statistical techniques such as structural equation modelling which allows the inclusion of interrelated dependence relationships. References 1.
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