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ACCOUNTING FOR FINANCIAL INSTRUMENTS: AN ANALYSIS OF THE

DETERMINANTS OF DISCLOSURE IN THE PORTUGUESE STOCK EXCHANGE*

Patrícia Teixeira Lopes University of Porto

Faculty of Economics

Lúcia Lima Rodrigues University of Minho

School of Management and Economics

Contact Author

Patrícia Teixeira Lopes University of Porto

Faculty of Economics

Rua Dr. Roberto Frias, 4200-464 Porto, Portugal

Telef.: 351 22 5571100; Fax: 351 22 5505050; e-mail: [email protected]

* It is gratefully acknowledged the financial support from Faculdade de Economia do Porto (Portugal) and

PRODEP. Comments and suggestions from participants at the 2005 EAA Conference and at the XV Spanish-

Portuguese Meeting of Scientific Management are also gratefully acknowledged. A special thank to Ann Tarca

and to three anonymous referees for helpful suggestions.

1

mailto:[email protected]

Abstract

This paper analyzes the determinants of disclosure level in the accounting for financial

instruments of Portuguese listed companies. We have constructed an index of disclosure

based on IAS 32 and 39 disclosure requirements and computed the index score for each

company. Consequently, this study also analyzes the characteristics of companies that are

closest to IAS before 2005. The analysis includes variables that capture intrinsic features of

Portuguese companies and institutional regulatory context, such as capital structure and

characteristics of the corporate governance structure, within contingency theory. We could not

find significant influence of corporate governance structure and of financing structure. We

conclude that disclosure degree is significantly related to size, type of auditor, listing status

and to the economic sector. This research reveals areas for improvement of the Portuguese

companies’ reporting practices and suggests areas for intervention of the Portuguese capital

markets regulator in the context of mandatory IAS after 2005.

JEL Code: M41 Accounting

Key words: Financial instruments accounting, Disclosure indices, Firm-specific

characteristics, International Accounting, IAS, Portugal

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I. INTRODUCTION

This research analyzes the determinants of disclosure practices in the accounting for financial

instruments by Portuguese listed companies. Considering the mandatory adoption of

International Accounting Standards after 2005 by listed companies, our ultimate objective is

to analyze the characteristics of companies that are closest to the disclosure requirements of

the International Accounting Standards (IAS)1 related to financial instruments – IAS 32 and

IAS 39.

There are several theories that help us to develop hypotheses on the determinants of

accounting practices: the positive accounting theory (Leftwich et al. (1981) and Watts and

Zimmerman (1978)), the signalling theory (Ross (1977)), and legitimacy and institutional

theory. These theories have been the background of several accounting studies on

determinants of accounting choice and disclosure in a wide range of countries. This paper is

based on the idea that those theories, originated in developed capital markets, may not apply

fully explain accounting and disclosure practices in Portugal, where there is a quite large

degree of family ownership and bank-oriented financing policies. Therefore, we include in the

analysis variables that capture intrinsic features of Portuguese companies context, such as

capital structure and characteristics of the corporate governance structure, within other

theoretical frameworks, namely, contingency theory.

Our main research questions are then:

Do theories on disclosure and accounting choice apply to the Portuguese listed

companies?

What are the factors that most influence disclosure practices in Portuguese companies?

What will 2005 really mean for Portuguese companies?

The remainder of the paper is organized as follows. Section II presents previous literature

related to the determinants of disclosure and compliance. Section III provides a brief

regulatory background. Section IV describes the development of the hypotheses. In Section

V, the research design is explained, which includes a description of the dependent and the

independent variables, the sample selection process and the sample characteristics. Section VI

gives the main statistical results while Section VII discusses the research results and draws

some conclusions. 1 In this paper, IAS stands for all the standards issued by IASB including International Financial Reporting Standards (IFRS).

3

II. PREVIOUS LITERATURE

Healy and Palepu (2001) describe the theoretical background to the demand for disclosure

(agency conflicts and information asymmetry) and review the empirical disclosure literature.

They divide it into four categories: the role of disclosure regulation in reducing information

and agency problems; the effectiveness of auditors and information intermediaries; factors

affecting decisions by managers on financial reporting and disclosures; and the economic

consequences of disclosures. The most relevant category to our study is the one that tries to

explain managers’ decisions, which has two main areas: (1) focusing on managers’

accounting decisions based on the positive theory of accounting and (2) focusing on

management disclosure decisions (voluntary disclosure literature, which is complementary to

the first one).

Accounting research on the determinants of disclosure practices and other accounting choices

based on company’s characteristics is a very extensive field. In this literature review, we

concentrate on studies that address IAS adoption or financial instruments accounting2. We

divide these studies in two types which differ between each other in the way that the adoption

of the standards (dependent variable) is measured. In one group of studies, the dependent

variable is a dummy variable that assumes the value 1 if the company claims to adopt IAS and

the value 0, otherwise. This type of studies does not take into account the fact that some

companies claim to comply with IAS but in fact fail to comply with many IAS requirements

(Cairns (1998), Cairns (1999)). As a consequence, it began to appear another type of studies

that quantifies the extent of compliance with a single (or a group of) standard(s) using

disclosure indices. This second type of studies examines annual reports of companies that

claim to comply with IAS in order to quantify actually the degree of compliance. This paper

2 There are several other studies that, in spite of having addressed the determinants of disclosure in general (not specifically related to IAS or financial instruments), bring insights to our research regarding the choice and measurement of explicative and dependent variables. We refer to some recent studies: Chen and Jaggi (2000)– Hong Kong; Eng and Mak (2003) - Singapore; Cooke (1989)- Sweden, Cooke (1993)- Japan; Hossain et al. (1994) – Malaysia; Wallace et al. (1994)– Spain; Wallace and Naser (1995)– Hong Kong; Gibbins et al. (1990); Frost and Pownall (1994); Gray et al. (1995)– US and UK; Meek and Roberts (1995)– US, UK and Continental Europe; Inchausti (1997) – Spain; Raffournier (1995) – Switzerland; Watson et al. (2002) – UK; Tai et al. (1990) – Hong Kong; Ahmed and Nicholls (1994); Akhtaruddin (2005) – Bangladesh; Ali et al. (2004) – South Asia (India, Pakistan, Bangladesh). Ahmed and Courtis (1999) paper is a very extensive literature review, which includes several early accounting studies on the determinants (company’s characteristics) of disclosure. It gives a thorough description of each study with respect to sample country, companies and time period, dependent variable(s), independent variables and results.

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is included into this second group of studies, once we develop a disclosure index based on the

requirements of IAS 32 and IAS 39.

The first group of studies includes Tarca (2004), Cuijpers and Buijink (2005), Ashbaugh

(2001), Murphy (1999), El-Gazzar et al. (1999) and Dumontier and Raffournier (1998). The

second group includes Chalmers and Godfrey (2004), Glaum and Street (2003), Street and

Bryant (2000), Street and Gray (2001), Abd-Elsalam and Weetman (2003) and Tower et al.

(1999).

Table 1 summarizes these studies, showing the type of statistical analysis conducted, the

explanatory variables adopted and the empirical results.

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Table 1: Recent empirical studies on the determinants of accounting choices based on firm’s characteristics Dependent variable Disclosure indices Dummy variable (adopter/non-adopter)

Chalmers and Godfrey

Glaum and Street

Abd-Elsalam and Weetman

Street and Gray

Street and Bryant

Tower et al.

Cuijpers and Buijink

Ashbaugh Murphy El-Gazzar et al.

Dumontier and Raffournier

Tarca

Type of analysis Univ./ Multiv

Univ/ Multiv

Multiv. Multiv Multiv. Multiv Multiv. (logistic

regression)

Multiv. (logistic

regression)

Manova + stepwise discriminant

analysis

Multiv (logistic

regression)

Univ/ Multiv Multiv (logistic

regression) Explanatory variables Size + 0 0 0 0 + 0 + + Industry Y Y/0 Y 0 0 0 0 Auditor type Y/0 Y Y/0 Y 0 Y/0 Listing status Y Y/0 Y Y Y + + Y Y Multinationality 0 Y + + + + Profitability 0 0 0 0 0 Relationship shareholders/ creditors (leverage, gearing, DE)

0 -/0 0 0 0 - 0

0 Relationship shareholders/managers (ownership structure, market value)

0/+ Y/0 0 + 0 +

Capital intensity 0/- Country of origin Y Y Y Y Y Reputation costs (firm/managers affiliation)

Y

Analysts following + Length of time to report -

Notes: Y statistically significant relationship; + positive relationship; - negative relationship; 0 no relationship

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III. REGULATORY BACKGROUND

In this section we describe briefly financial instruments accounting rules in Portugal,

highlighting the main differences relative to IAS 32 and IAS 393.

Regarding measurement criteria in non-financial companies, on-balance sheet financial

instruments should be measured at cost (or market value, if it is lower). Future contracts used

in trading operations are measured at fair value. The other off-balance sheet financial

instruments are not covered by specific accounting rules. This gap is covered by Accounting

Directive 18 (CNC (1996)), which establishes compliance with IAS whenever Portuguese

standards are not available. So, it may be expected that companies are already adopting some

IAS requirements in their accounting for financial instruments.

In financial companies, fair value should be applied to trading securities and to FRAs, futures,

options and swaps when used in trading operations. Changes in the fair value should be

registered in profits and losses in the period in which they occur. For operations that qualify

for hedge accounting, the profits and losses of the hedging instruments and the hedged

instruments are registered simultaneously, and the measurement criterion of the hedged

position prevails. Regarding disclosure, the list of requirements is already quite demanding,

particularly regarding derivatives adoption.

IV. THEORETICAL BACKGROUND AND HYPOTHESES DEVELOPMENT

Given the Portuguese regulatory background described above, and bearing in mind that the

European Union has been stating its goal of accounting harmonization within the member

states since 2000 (through the proposal of Regulation4 requiring all listed companies to

prepare their consolidated financial statements based on IAS), it is interesting to analyze

which companies were already anticipating IAS requirements especially with respect to

financial instruments’ disclosure items. The adoption of IAS means an increase in disclosure

requirements. Consequently, the theoretical background is provided by disclosure theories.

Verrecchia (2001) extensively reviews and categorises theoretical accounting literature on

3 We have followed the 2000 versions of IAS 32 and IAS 39 because these were the versions operating for financial statements in 2001 (the year of our empirical study). 4 Regulation 1606/2002.

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disclosure in order to develop a theory of disclosure by companies. He concludes that

asymmetry reduction is one potential starting point for a comprehensive theory of disclosure.

It has been shown empirically that disclosure is a complex function of several factors: it

depends on both company-specific factors (internal factors), and external factors, related to

the environmental context of the company, which include, culture, legal system, institutional

background, among others. There are several theories that explain disclosure practices by

companies: agency and political costs theories (Watts and Zimmerman (1978), Watts and

Zimmerman (1990)), signalling theory (Ross (1977), Morris (1987)), legitimacy and

institutional theory (Guthrie and Parker (1990), Carpenter and Feroz (1992), Carpenter and

Feroz (2001), Mezias (1990)), proprietary costs theory (Verrecchia (1983), Dye (1985),

Darrough and Stoughton (1990) and Wagenhofer (1990)) and contingency theory (Gray

(1988), Fechner and Kilgore (1994), Doupnik and Salter (1995)).

The argument for this paper is that the agency, the political costs and the signalling theories,

widely applied to developed capital markets, may not fully explain accounting and disclosure

practices in Portugal where there is high concentration of capital in families and bank-

oriented financing policies.

Nobes (1998) describes a model of international differences in financial reporting based on

the different purposes of reporting in each country. The purpose of financial reporting is

determined by the financial system of the country. Disclosure items are determined by the

relative importance of outsiders (financers who do not belong to the board of directors,

including individual shareholders) compared with insiders (financers such as governments,

families and banks). In countries where outsiders are important, there is a demand for more

disclosure. Models that incorporate cultural and other environmental factors have been

empirically tested by several researchers in either multi-country studies (Zarzeski (1996),

Hussein (1996), Jaggi and Low (2000), Salter (1998), Williams (2004), Archambault and

Archambault (2003)) or single-country studies (Chen and Jaggi (2000), Haniffa and Cooke

(2002), Akhtaruddin (2005)). Chen and Jaggi (2000) study the influence of specific corporate

governance factors present in East Asian companies (proportion of independent directors in

the corporate board and family ownership) on disclosures comprehensiveness by companies.

Haniffa and Cooke (2002) include in their study corporate governance, cultural and company-

specific factors as determinants of disclosure, arguing that (p. 317) “disclosure practice does

not develop in a vacuum, but rather reflects the underlying environmental influences that

affect managers and companies in different countries.”.

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The hypotheses and the independent variables

Based on the theoretical considerations and on the previous empirical research described

above, we have developed several hypotheses that relate company-specific characteristics to

disclosure practices in Portugal. All hypotheses are stated in alternative form indicating the

expected sign of the relationship.

Size

There are several arguments that can be used to link size to disclosure. As Watts and

Zimmerman (1990) argue, political costs are higher in larger companies. Consequently, larger

companies are more likely to show higher levels of disclosure since it improves confidence

and reduces political costs. Secondly, larger companies are supposed to have superior

information systems. Consequently, additional disclosure is supposedly less costly in larger

companies than in smaller ones. Moreover, proprietary costs related to competitive

disadvantages of additional disclosure (Verrecchia (1983)) are smaller as company size

increases.

H1: Larger companies are expected to have higher levels of disclosure than smaller

companies

Industry

The relationship between industry and disclosure can be explained by the political costs

theory. Watts and Zimmerman (1990) argue that industry membership (being related to size)

is related to political costs. Proprietary costs also vary according to industry.

Additionally, companies in the same industry have interests in producing the same level of

disclosure as other companies in the same industry in order to avoid being negatively

appreciated by the market (competitive pressures). This argument is in line with the signalling

theory.

Legitimacy and institutional theory also support this hypothesis because some industries have

higher institutional pressures than others.

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These theoretical considerations do not define the direction of the relationship between

disclosure and industry clearly. Therefore, our hypothesis does not indicate an expected sign

for the relation.

H2: Disclosure practices are predicted to be related to the industry in which the

company operates

Auditor Type

Chalmers and Godfrey (2004) argue that to maintain their reputation and avoid reputation

costs, high profile auditing companies are more likely to demand high levels of disclosure of

their clients. Dumontier and Raffournier (1998) observe that, in their own interest and for the

sake of their reputation, auditors want their clients to comply with complex accounting

standards.

This is also linked to the fact that major international auditing companies have greater

knowledge about IAS and so the costs of implementing and auditing them in their clients is

lower than for smaller auditing companies.

Auditing is argued to be a way of reducing agency costs (Jensen and Meckling (1976) and

Watts and Zimmerman (1983)) and so companies that have high agency costs tend to contract

high quality auditing companies.

H3: The degree of disclosure is predicted to be higher in companies audited by the Big 5

auditors than in companies with non-Big 5 auditors

Listing Status

The relationship between the company listing status and disclosure practices is based on the

agency cost and the signalling arguments. Companies listed on multiple or foreign stock

exchanges have greater agency problems. Higher disclosure reduces shareholders’ monitoring

costs. Additionally, in general, foreign investors are unfamiliar with national standards and so

internationally listed companies tend to comply with international standards so that their

accounts are understood by the majority of potential investors5.

Companies expect that compliance with IAS and high disclosure levels are interpreted as

good signals by the market and so could be a means of obtaining cheaper capital. This

5 Many stock exchanges around the world allow foreign companies to prepare their financial statements according to IAS (see IASB site).

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argument is even stronger if the company wants to raise its capital in foreign markets (capital-

need hypothesis, Cooke (1989)).

H4: The degree of disclosure is predicted to be higher in companies listed on foreign

exchanges than in companies listed on only one (its national) stock exchange

Multinationality

This hypothesis is linked to the last one. The more internationalised a company is the more it

has to show its stakeholders (customers, suppliers, government) that it is a good company.

Even a company that is not listed internationally may have an interest in showing good levels

of disclosure if it has international operations.

Cooke (1989) also argues that companies operating in more than one geographical area tend

to have better managerial control systems because of the greater complexity of their

operations. Better and more sophisticated management control and reporting systems produce

an amount of additional information which can be easily disclosed without additional costs of

preparation. So, they are expected to have higher levels of disclosure.

H5: The disclosure degree is predicted to increase with the internationalisation degree of

the company

Capital Structure

Shareholder/creditor relationship

As higher leverage levels suggest higher agency costs (potential wealth transfers from

debtholders to shareholders and managers), compliance with IAS and good disclosure levels

can be used to reduce agency costs and information asymmetries. There are authors, however,

that support a negative relation between leverage and disclosure (Zarzeski (1996), Abd-

Elsalam and Weetman (2003)). The argument is based on signalling factors and relies on the

fact that companies with high leverage ratios belong to bank-oriented financial systems where

capital markets are not seen as a primary capital source, and information about companies is

more private than public. This argument, however, does not take into account public debt.

These arguments show the inability of leverage alone to be a good proxy for the capital

structure of a company in terms of its relation to disclosure degree, because, in fact debt may

be inside debt or outside debt. Tarca et al. (2005), based on Nobes (1998), argue that

companies with relatively more outsider debt are more likely to use IAS. They defined

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outsider debt as the amount of long term debt that is sourced from the public capital market.

Based on theoretical considerations and on previous empirical studies, we argue that the

degree of disclosure is related to leverage, without specifying a direction for the relationship.

H6: The degree of disclosure is predicted to be related to leverage

Importance of shareholders

The greater the importance of equity the greater the information needs of shareholders and the

monitoring costs. The argument is the same as the one for the agency costs reduction, given

above. However, there is the same problem regarding outside versus inside equity. In fact,

equity may be inside in which case, shareholders have access to inside information meaning

that disclosure is less important. Tarca et al. (2005) defines outside equity as the proportion of

equity held by outsiders to the company, determined based on information about shareholder

structure. Based on the theoretical considerations and on previous empirical studies, we argue

that:

H7: The degree of disclosure is predicted to be higher the more the company relies on

equity markets

Corporate governance

In order to complement the importance of inside finance versus outside finance, we introduce

in the analysis another aspect of the companies’ management which may determine disclosure

level. Both agency and contingency theories conduct us to think that corporate governance

structure of the company may be related to reporting practices, specifically to disclosure

practices. The premise of agency theory is that independent directors are needed on the boards

to monitor and control the actions of the other executive managers (Haniffa and Cooke

(2002)). So, board composition may be an interesting variable to consider because it will

reflect the role of independent directors. It can be expected more disclosure for companies

with higher proportion of independent directors, once they are outside to the company and

will force management to disclose. On the other hand, if the board has a high proportion of

non-independent directors, it can be expected less disclosure, once they have access to inside

information. Portuguese companies are widely seen as being family managed with scarce

separation between those who own and those who manage capital and as a consequence

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turned on to inside or major stakeholders (the families or the main capital, either debt or

equity, providers). As such, if the board includes representatives of shareholders, these capital

owners do not have to rely extensively on public disclosure since they have access to internal

information.

H8: The degree of disclosure is predicted to be higher the greater the proportion of

independent directors on the board

V. RESEARCH DESIGN

This study has three main broad research questions:

Do theories on disclosure and accounting choice apply to the Portuguese listed

companies?

Which factors most influence disclosure practices in Portuguese companies?

What will 2005 really mean for Portuguese companies?

Based on these broad questions, our immediate research goals are:

- to identify the most important factors associated with the level of financial instruments

disclosures and,

- to identify the characteristics of companies that are closest to IAS 32 and IAS 39

requirements.

Next, we describe how we constructed and measured the dependent variable, the proxies for

the independent variables, the sample collecting process and the sample’s main

characteristics.

The dependent variable

Aiming at identifying disclosure practices concerning financial instruments, we applied the

content analysis technique to listed companies’ annual reports, which were comprehensively

analyzed. This analysis is based on a list of categories that covered all the items that assist us

to identify the existence and content of disclosures required by IAS 32 and IAS 39.

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Based on the list of categories used in the content analysis of annual reports, we constructed a

disclosure index. This index has eleven main categories of information, which are then

subdivided into 54 items. The main categories are designated as follows:

(1) Accounting policies (7 items)

(2) Fair values and market values (9 items)

(3) Securitisation and repurchase agreements (5 items)

(4) Derivatives: Accounting policies (5 items)

(5) Derivatives: Risks (4 items)

(6) Derivatives: Hedging (10 items)

(7) Derivatives: Fair value (4 items)

(8) Interest rate risk (2 items)

(9) Credit risk (3 items)

(10) Collateral (2 items)

(11) Other (3 items)

The detailed components of this index are described in Appendix I.

The construction of the index followed the literature on related areas. The index has three

main characteristics. It is (1) dichotomous, (2) unweighted, and (3) adjusted for non-

applicable items. These characteristics are now analyzed more carefully and our choices

considered, based on the literature.

Dichotomous

A score of one is assigned to an item if it is disclosed (disclosure index) and a score of zero

otherwise.

The total score for a company is:

∑=

=m

iidT

1

where di is 1 if item i is disclosed and 0 otherwise; m is the maximum number of items (54).

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Unweighted

The total score is calculated as the unweighted sum of the score in each item. The implied

assumption is that each item is equally important for all user groups. We are conscious that

this assumption may not reflect reality, but we think that the resulting bias is smaller than the

one that would result from attributing subjective weights to each item. The majority of

disclosure studies adopts unweighted indices: Cooke (1989), Cooke (1993), Meek and

Roberts (1995), Raffournier (1995), Inchausti (1997) and Chalmers and Godfrey (2004).

Several disclosure literature supports unweighted indices. Robbins and Austin (1986) found

that (p. 412-413) “the independent variables which were significantly associated with the

simple index of disclosure (consists only of the extent of disclosure) quality were also

significantly associated with the compound index (the product of the extent and relative

importance of financial disclosure index)”. Spero (1979), as cited by Hodgdon (2004), argues

that attaching weights to disclosure items is irrelevant because companies that tend to be more

forthcoming with less important information also tend to be more forthcoming with more

important information. Firth (1980) and Adhikari and Tondkar (1992) found the same results

for weighted and unweighted indices.

Adjusted for non-applicable items

In assigning the score for each item, the applicability of the item to each company was taken

into account. That is, we considered that a company should not be penalized if an item is not

relevant. This procedure observed maximum caution6. We read the entire annual report and if

there is no mention of a specific item, we assume that it was not relevant. So a maximum

score for each company is calculated as follows:

∑=

=n

iidM

1

where di is the disclosure item, and n is the number of items applicable to that company (n is

smaller than 54).

6 We are aware of the subjectivity that can be introduced by this procedure. Regarding the type of instruments and transactions, which are quite new and unknown for some of the sample companies, we believe that by not adjusting for non-applicable items we would introduce a bigger result bias. This situation is the opposite of what we find on Chalmers and Godfrey (2004). There, companies not using derivatives and making no disclosure were considered as non-disclosing companies. The reason is that it is assumed that the majority of companies would be using derivative instruments based on a previous survey.

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Then an adjusted index is calculated as T/M. This adjustment procedure for non-applicable

items is found in most of the empirical studies reviewed (Cooke (1989), Cooke (1993), Meek

and Roberts (1995), Raffournier (1995), Inchausti (1997)).

The Independent Variables

According to our hypotheses, the determinants of disclosure to be tested are size, industry,

auditor type, listing status, multinationality, capital structure and corporate governance

characteristics.

Size can be measured in several different ways. We consider two measures of size: total assets

(Tassets) and sales (Tsales), measured in million euros. These measures of size are frequently

used in many studies.

From prior research and theoretical considerations, there is no consistent approach to

subdivide the companies by industry. According to the expectation from accounting

regulation, we adopt the classification that separates companies between finance and non-

finance companies using a dummy variable (ind1).

Auditor type is a dummy variable that takes the value 1 if the company is audited by a Big 5

company and 0 otherwise. In 2001, the Big five auditors were Arthur Andersen,

PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young and KPMG.

Listing status is another dummy variable that assumes the value 1 if the company is listed in

the country of origin stock exchange and 0 otherwise. That is, for a company that is listed or

cross-listed in foreign stock exchanges this variable takes the value 0.

The degree of multinationality is measured by the percentage of foreign sales (foreign sales

divided by total sales).

Regarding capital structure, we identified, a priori, three relevant variables: leverage,

importance of equity and ownership diffusion. The degree of leverage is measured by the

debt to equity ratio. Considering the problem that debt can be outside or inside, meaning that

the premises of agency theory would lead to more disclosure in case of public debt, it would

be important to distinguish between inside and outside debt (Tarca et al. (2005)).

Unfortunately, we were unable to distinguish between public and private debt based on

information disclosed by companies, meaning that in order to make this differentiation we

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would have to exclude a big number of observations from our already small number of

companies.

The importance of equity is measured by the ratio market value to total assets. Equity

investors are usually outsiders to a company. But this is not always true, especially in

Portugal which is seen as a country where companies, even public companies, are family

owned and the capital is concentrated in a small number of shareholders. If a shareholder

owns a large stake in a company, the dependence on public disclosure is likely to be smaller,

because he can directly monitor management. Therefore, it is interesting to analyse stock

concentration ownership especially in the context of the Portuguese companies. The article

448º of Commercial Law (Código das Sociedades Comerciais) obliges companies to disclose

the name of the shareholders that hold more than 1/10, 1/3 and 1/2 of the capital. The article

6º of Regulation nº 11/2000 (CMVM (2000)), revised by Regulation nº 4/2004 (CMVM

(2004)), of the Portuguese securities market regulator (CMVM – Comissão do Mercado de

Valores Mobiliários) obliges the disclosure of the qualified holdings (5%, 10% or 20% of the

capital as set forth in the Portuguese Securities Code). This means that even if companies

disclosed both information as it is required by law, it is not possible to construct a variable

coherent for every company such as the proportion of shares owned by the five largest

shareholders or percentage of shares held by institutional shareholders just because companies

only disclose some of their shareholders. What we can get is the top two or three or five or

other number of shareholders, and in some cases nothing is disclosed. We tried to overcome

this problem, asking for this information to the Portuguese stock exchange (Euronext Lisbon),

which sent us a database for the year 2000 (the latest year for which they collected this

information). We could use the information for the year 2000, in spite all other data are for

2001, with the bias known a priori that would be introduced, but still this database revealed to

be very incomplete and did not have the five biggest shareholders for all quoted companies7.

In order to include this variable in the econometric analysis, several observations would have

to be deleted due to lack of information on the variable. This procedure would bring many

problems once it would reduce considerably the sample size introducing problems to

hypothesis testing. Consequently, although the perceived importance of this variable mainly

among Portuguese companies, we decided not to include this variable on the econometric

analysis. Nevertheless, a descriptive analysis of the ownership diffusion of Portuguese

7 Among the 55 quoted companies, this database allows us to obtain the top five shareholders for 27 companies, the top four shareholders for 7 companies, the top three shareholders for 6 companies and the top two shareholders for ten companies.

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companies based on the publicly available data is presented on the section of the sample

description below.

For purposes of including the characteristics of corporate governance structure as a

determinant of disclosure, and driven by agency and contingency theories, we defined a

variable for the proportion of independent directors on the board of directors of the

companies.

In Portugal, the regulation of corporate governance practices and disclosure is under the

responsibility of the Portuguese securities market regulator (CMVM). In 1999, CMVM

approved the first “Recommendations on Corporate Governance”. These comprised a set of

non-mandatory rules that should be accomplished by companies. Regarding managing boards,

it is encouraged that (CMVM (1999), Recommendation nº15) “the board of directors should

be comprised in such a way as to ensure that the management of the company is not only

geared towards the protection of the interests of majority stakeholders. It is therefore

recommended that independent members exercise significant influence on collective decision-

making and that they contribute to the development of the strategies of the company, thereby

acting in the interests of the company as a whole.”. This set of Recommendations however

did not produce fair disclosures for investors. This was recognized by CMVM itself, which

published a first mandatory set of rules – Regulation nº 7/2001 (CMVM (2001a)). In the

Introduction to this Regulation, CMVM recognizes that the disclosure of the extent to which

the Recommendations on Corporate Governance were observed is being complied

increasingly by companies, but “…it is not unusual to find that disclosure is uneven and

insufficient”. Regulation Nº 07/2001 obliges listed companies to disclose annual information

on various aspects of corporate governance in an appendix or chapter of their annual

management report. This is the reason why the construction of our variable of percentage of

independent directors is based on the corporate governance reports (or chapters of the annual

reports) of the year 2002. The variable obtained is not exempted from limitations. In fact, as

seen by the definition of independent director presented above, this is a concept defined by

each company. This means that we register what companies disclose in their reports as

independent directors in the board. Once there was not a definition of independence imposed

18

by law and applied to every company, there could be differences in the definition among

companies8.

Besides the proportion of independent directors in the total directors of the board, we define

two alternative measures for corporate governance characteristics of Portuguese companies. A

first measure is a dummy variable that takes the value of 1 if the company complies with

Recommendation 9 (CMVM (2001b)) and zero, otherwise. This recommendation encourages

the inclusion in the board of one or more independent directors regarding major shareholders

and that the company defines clearly the concept of independence. The other proxy is the

percentage of compliance with all the CMVM’s “Recommendations on Corporate

Governance” (CMVM (2001b)). These two measures are based on the answers by listed

companies to the 4th survey on the practices regarding corporate governance produced by

CMVM (CMVM (2002)).

Next table sums up the hypotheses, the proxies for measuring the independent variables and

the predicted relationship with the dependent variable.

8 CMVM felt, afterwards, the need for defining a clear and objective concept for independent director and in its Regulation nº 11/2003 (CMVM (2003b)), article 1, it defines that “administrators associated with specific interest groups in the company shall not be considered independent officers, namely: a) Members of the board of directors who are also members of the board of directors of the controlling company, as set forth in the Portuguese Securities Code; b) Members of the board of directors who are holders of qualified holdings in an amount equal to or larger than 10% of the share capital or of the voting rights in the company, or an identical percentage in a controlling company, as set forth in the Portuguese Securities Code; c) Members of the board of directors who hold management position or have contractual ties with a competing company; d) Members of the board of directors who receive compensation from the company, or from any parent company or affiliates within the same group other than in the form of compensation for their role as corporate officers; e) Members of the board of directors who are spouses, family or direct kin through third lineage, including those persons referred to in the paragraphs above. 3 – In addition to checking the circumstances described above, the board must ensure, in a well founded manner, the independence of the directors in light of other pertinent circumstances.”.

19

Table 2: Hypotheses, variables’ proxies and expected relationship Hypothesis Variables

proxies Expected relationship

Firm-specific variables Size Total assets Tassets Positive association with the

disclosure degree Natural log

of total assets Lassets

Positive association with the disclosure degree

Total sales Tsales Positive association with the disclosure degree

Natural log of total sales

Lsales Positive association with the disclosure degree

Industry 1 dummy variable

ind1: Financial (1 = yes; 0 = no)

No prediction

Auditor type 1 dummy variable

d_aud: Big 5 / Non Big 5 (1 = yes; 0 = no)


Listing status 1 dummy variable

d_list: Country of origin/Foreign country (listed on one foreign stock exchange or multilisting) (1= yes; 0=no)

Negative association with the disclosure degree

Multinationality Sales foreign countries/ Total sales

Mult Positive association with the disclosure degree

Capital (Finance) Structure: Shareholders/

creditors Debt/Equity DE No prediction

Ownership diffusion (not included in model for econometric analysis)

Percentage of shares owned by the top five shareholders

Own_conc Negative association with the disclosure degree

Shareholders Market value/ Total assets

MV Positive association with the disclosure degree

Corporate governance: Board composition Proportion of

independent directors

Ind_dir Positive association with the disclosure degree

Compliance with CMVM

recommendation regarding independent

directors

1 Dummy variable

D_ind_dir: 1 =complies; 0 = does not comply


Compliance with all CMVM corporate

governance recommendations

Degree of compliance (in percentage)

Corp_gov Positive association with the disclosure degree

20

Sample selection and characteristics

Our sample is based on the companies listed on Euronext Lisbon on the 31st December 20019.

At the end of 2001, there were 56 quoted companies in Portugal. One company did not

publish an annual report in 2001 and so it was excluded from the analysis. Hence, the final

sample is comprised of 55 companies, of which 29% are from the industrial sector and 20%

from the financial sector. Appendix II contains a list of the sample companies and respective

economic sector.

Table 3: Sample sectoral distribution Economic sector N

Basic materials 7 12.7%Consumer, cyclical 9 16.4%Consumer, non-cyclical 4 7.3%Financial 11 20.0%Industrial 16 29.1%Technology 4 7.3%Telecommunications 3 5.5%Utilities 1 1.8%

Total 55 100.0%

In terms of listing type, the big majority of companies (90%) is quoted in the Portuguese

stock exchange exclusively. Additionally, there are five companies that are cross-listed in the

USA. Regarding the auditor company, the majority (76%) is audited by a big five company.

The source for companies’ listings and auditor company data is the companies’ annual reports

complemented by the companies’ websites.

Table 4: Sample descriptive statistics Panel A: Continuous variables

N Minimum Maximum Mean Std. DeviationTotal Assets 55 22.05 358137.51 10833.29 48944.85Total Sales 55 5.80 34885.49 1720.26 4890.21Sales foreign countries/Total sales 55 .00 93.46 24.55 29.64Total liabilities 55 37.91 96.33 72.55 15.06

Panel B: Dummy variables N % Listing status Listed, origin country stock exchange 50 90.91% Listed, (one) foreign stock exchange 0 0.00% Multilisting, including USA 5 9.09% Multilisting, not-including USA 0 0.00% Auditor status Big five 42 76.36% Non Big five 13 23.64%

9 We chose the year 2001 because it is the year that IAS 39 became effective and it is the last year for which annual reports had been published when we started the research.

21

Regarding capital structure, we analyze companies’ debt to equity ratio, market capitalization

to total assets ratio and ownership diffusion. The source for the two first variables is the

annual reports and, for the ownership diffusion variable, a public database provided by

Euronext Lisbon (CR –ROM of quoted companies for the year 2000).

Table 5: Capital structure of Portuguese companies Panel A: Leverage and Importance of equity

N Min Max Mean Std.

Deviation

Liabilities /Equity (D/E) (%) 55 61.07 2628.39 492.92 550.53

Market value /Assets (%) 55 3.36 219.49 37.12 39.95

Panel B: Ownership diffusion – percentage of shares held by top shareholders

N Average Max Min St. dev.

Top five shareholders 27 59.33% 95.65% 18.09% 0.220484

Top four shareholders 7 64.98% 96.68% 25.89% 0.213024

Top three shareholders 6 75.41% 91.90% 55.91% 0.124249

Top two shareholders 10 70.82% 99.20% 42.94% 0.167491

Regarding corporate governance variables, we computed the percentage of independent

directors within the board of directors, based on the 2002 corporate governance reports

published by companies. When companies did not disclose this information, all directors were

classified as non-independent. This procedure may create a bias but it is considered preferable

to the alternative procedure of eliminating the observations.

Analysing the proportion of independent directors as referred by each company (Table 6,

panel A), we conclude that in almost 50% of companies, less than a half of the directors are

independent. Almost 30% of companies claim to have between 90 to 100% of independent

directors in their Board. As referred above, in the year 2002, the definition of independence

was not set forth by any regulation; it was the company that defined what it considered to be

independent directors and the disclosure was based on this self-constructed concept of

independence. This means that it might have happened that companies considered as

independent, directors that in fact were not, in the light of the subsequent regulations on

corporate governance. We, in fact, are convinced that this is not merely a possibility. CMVM

itself found that the situation regarding independence of directors should be changed and

regulated. As a consequence, CMVM decided subsequently to include definitions of

22

independence and specifically defined who cannot be considered an independent director

(Regulation nº 11/2003 (CMVM (2003) and Regulation nº 10/2005 (CMVM (2005)).

Indeed, in the CMVM 4th Survey of the Corporate Governance Practices (CMVM (2002)),

par.3.9, it can be read that “this recommendation (the existence of one or more independent

directors) is the one with lower degree of compliance… this is due, mainly, to the fact that it

has been introduced an additional question associated with this recommendation – the

existence of a clear definition of independence in the company. In fact, if this question was

not included, 80,4% of the companies would comply with this recommendation…”10. Thus,

the results for this variable cannot be interpreted without caution.

Trying to go a deep further on the analysis of the corporate governance structure of

Portuguese companies and in order to mitigate the disadvantages of the previous measure, we

consider additional measures based on alternative sources of information. We use two

additional proxies for the structure of Portuguese companies’ corporate governance. The first

is a dummy variable that takes the value of one if the company complies with CMVM’s

recommendation regarding the existence of at least one independent director and the existence

of a definition of independence. The source for this variable is CMVM and data for the

variable are obtained through a survey to quoted companies. The second is a continuous

variable that measures the degree of compliance with the overall recommendations on

corporate governance, as published in CMVM 4th survey on corporate governance practices

(CMVM (2002)).

Analyzing compliance with Recommendations on Corporate governance, we conclude that

Portuguese companies have still a big way to go through as regards to good practices on

corporate governance. Regarding the recommendation related to independent directors (Table

6, panel B), which includes both the need of having at least one independent director on the

Board and the existence of a definition of independence, the majority of companies (53%) do

not comply with it. Analyzing the average degree of compliance with all recommendations

(Table 6, panel C), it is slightly above 50%, meaning that in average almost half of the

recommendations are not complied by Portuguese companies. Individually considered, we

conclude that no company complies with all recommendations (the maximum value for the

compliance degree is 92%).

10 Authors’ translation.

23

Table 6: Corporate governance Panel A: Proportion of independent directors on the board

Proportion of independent directors N %

Accumulated Distribution

>=90 e <=100 15 27.27% 100.00% >=80 e <90 1 1.82% 72.73% >=70 e <80 1 1.82% 70.91% >=60 e <70 6 10.91% 69.09% >=50 e <60 4 7.27% 58.18% >=40 e <50 4 7.27% 50.91% >=30 e <40 3 5.45% 43.64% >=20 e <30 4 7.27% 38.18% >=10 e <20 4 7.27% 30.91% <10% 13 23.64% 23.64% 55 100%

Panel B: Degree of compliance with the CMVM’s Recommendations regarding independent directors

Number of companies

Yes 22 (46.81%) No 25 (53.19%)

Total 47 Source: Data granted by CMVM

Panel C: Degree of compliance with the CMVM’s Recommendations on Corporate Governance

Degree of compliance

Max 92.30% Min 18.20%

Average 57.13% St. Dev 18.40%

Total obs 47 Source: CMVM (2002)

VI. RESULTS

Descriptive statistics

Table 7 reports the overall means and standard deviations for the dependent variable – the

adjusted disclosure index (Idisc_a) and for each of its categories. The range of scores for the

disclosure index varied from 16% to 64% with a mean of 44%. The category for which we

registered highest disclosure degree is “Accounting policies”. The disclosure degree within

this category, which comprises the disclosure of the accounting policies for each class of

financial instruments, shows a mean of 80% among all companies. On the opposite side, the

categories that show lowest levels of disclosure are “Fair and market values” and “Credit

risk”. The first includes the disclosure of measurement method and significant assumptions.

24

The average disclosure degree within this category is only about 5%. The category for credit

risk comprises the disclosure of the main counterparties, maximum amount of credit risk

exposure and significant concentration of credit risk. This category shows an average

disclosure degree of 6%.

Table 7: Dependent variable

Minimum Maximum Mean Std Deviation Disclosure index 0.16 0.641 0.44 0.09

Categories (1) Accounting policies .000 1.000 .804 .120 (2) Fair values and market values .000 .500 .054 .129

(3) Securitisation .400 .800 .600 .126 (4) Derivatives – Accounting policies .000 1.000 .590 .334

(5) Derivatives – Risks .000 1.000 .535 .323 (6) Derivatives - Hedging .000 1.000 .401 .250 (7) Derivatives – Fair value .000 .500 .171 .221 (8) Interest rate risk .000 1.000 .345 .270 (9) Credit risk .000 1.000 .067 .207 (10) Collateral .000 1.000 .491 .402 (11) Other .000 1.000 .494 .101

Next table shows the mean of the index of disclosure by economic sector, by type of auditor

and by listing status. Companies from the technology sector show the highest level of

disclosure and, as expected, in average cross-listed companies and companies audited by the

big five group show higher levels of disclosure.

Table 8: Dependent variable means by economic sector, auditor type and listing status Disclosure index

Economic sector Mean Std.

Deviation Basic materials .435 .038Consumer, cyclical .422 .071Consumer, non-cyclical .465 .101

Financial .446 .156Industrial .440 .081Technology .471 .048Telecommunications .394 .071

Disclosure index

Auditor Type Mean Std.

Deviation Non- big five auditor .399 .085Big five auditor .451 .091

Listing Status One or more foreign stock exchange .537 .056

Portuguese stock exchange .429 .089

25

Simple regressions

OLS simple regressions were estimated to check for univariate relationships between the

disclosure index and each explicative variable. The results obtained are shown in Table 9. For

each explanatory variable, regression coefficients and t-statistics are reported. When there is a

hypothesized direction for a variable one-tailed t-test is applied, otherwise two-tailed tests are

used. In every regression, we analyze the presence of heteroscedasticity with the White’s

general test (White (1980)). When this test indicated the presence of heteroscedasticity, the

White’s heteroscedasticity consistent variances and standard errors were used.

Table 9: OLS simple regressions (White Heteroskedasticity-Consistent Standard Errors and Covariance, when necessary)

Hypothesis Variable Coefficient t-Statistic

H1 Tassets 4.61E-07 4.100543*

Lassets 0.012256 1.731635**

Tsales 5.09E-06 2.050536**

Lsales 0.015320 2.288001**

H2 Ind1 0.008909 0.285146

H3 D_aud 0.052654 1.845112**

H4 D_list -0.107740 -2.633464*

H5 Mult 0.000274 0.647

H6 Tliab 0.000648 0.777255

Fliab 1,093E-04 0.157

DE 0.003690 1.010319

H7 MV -.000196 -.622468

H8 Ind_dir 0.023527 0.724669

D_ind_dir(a) 0.036396 1.316085

Corp_gov(a) 0.082069 1.51533

Note: White Heteroskedasticity-Consistent Standard Errors and Covariance, when necessary * significant at 1%; ** significant at 5%; *** significant at 10%. One-tailed tests.

(a) these equations are estimated with the number of observations available for these variables (47 observations)

Three hypotheses are statistically validated. The first is H1 which relates the company size to

disclosure level. All measures of size are statistically significant and the sign of the

coefficient is positive as predicted. There is also a significant relationship between being

audited by a big-five company and the level of disclosure, confirming H3. Being listed in

more than one stock exchange (cross-listing) influences the level of disclosure as predicted by

26

H4. Companies that are listed only in the Portuguese exchange disclose less than companies

with multilisting status. Being a financial or a non-financial company is not related to the

level of disclosures. Additionally, the degree of multinationality does not relate to disclosure.

None of the variables related to capital structure proves to be related to disclosure. Moreover,

in spite of the expectations, the variables adopted for the corporate governance structure,

individually considered, do not show a statistically significant relationship with disclosure.

Now, we proceed to the multivariate analysis in order to test all hypotheses together.

Multiple regressions

Within multiple analysis, which jointly tests hypotheses formulated above, we enter all

independent variables at once in the models. The different measures for size are highly

correlated (the correlations between variables are shown on the Appendix III), which means

that they cannot be included at once in the model. In order to circumvent this problem, we

used the same procedure as Cooke (1989). We run a regression for each measure of size (total

assets, total sales, the natural logarithm of assets and the natural logarithm of sales)11.

Regarding corporate governance variables, initially we included the proportion of

independent directors. In a second stage, the proportion of independent directors was

substituted for an alternative measure using a dummy variable. Finally, we tested another

alternative measure for corporate governance - the degree of compliance with all CMVM’s

recommendations.

Some literature on determinants of disclosure indices points out a non-linear relationship

between the dependent and the independent variables (Parviainen et al. (2001) and Cooke

(1998)). In prior empirical studies, researchers have often performed transformations to the

variables in order to allow for non-linear relationships (Lang and Lundholm (1993), Wallace

et al. (1994), Ali et al. (2004), Haniffa and Cooke (2002), Abd-Elsalam and Weetman (2003),

Hodgdon (2004)). According to this past evidence, we test several alternative functional

forms for the relationship between the disclosure level and the independent variables. The

logarithmic transformation is commonly applied in empirical research to address alternative

functional forms between the dependent and the independent variables. Accordingly, we

performed the logarithmic transformation of the dependent variable (log-lin) and estimate 11 In related literature, we found other alternative procedures such as select the most relevant measure based on their explanatory power in univariate analysis (Dumontier and Raffournier (1998)) or in a pre-run stepwise regression (Giner (1997), Street and Bryant (2000), Raffournier (1995)) or, still, create a composite variable using factor analysis (Dumontier and Raffournier (1998)).

27

these alternative models. Additionally, quadratic terms of some independent variables are

included in the regressions to test for alternative functional form specifications and to capture

decreasing or increasing marginal effects (Hodgdon (2004)). The estimation of these models

(not reported) does not evidence improvements compared with linear results. On the contrary,

we obtain lower R2s and the models show problems in their overall significance (F-statistic).

The estimation results for the linear models with total assets as proxy for size are reported in

the Table 1012. Four independent variables proved to be statistically significant: total assets,

economic sector, auditor type and listing status.

Hypothesis 1, which states that size is positively related with levels of disclosure, is

supported by the results. This finding is consistent with Chalmers and Godfrey (2004) who

also find a statistically positive relationship between size and financial instruments’

disclosures. However, this result is inconsistent with studies that analyze compliance with

disclosure requirements of several IAS at a time, which found no significance for company

size (Hodgdon (2004), Glaum and Street (2003), Street and Gray (2001), Street and Bryant

(2000) and Tower et al. (1999)).

We find support for Hypothesis 2, which states that the disclosure level is related to the type

of industry. Our results show that belonging to financial sector is negatively related to the

disclosure level. This result is consistent with the study of Karim and Ahmed (2005) which

also tests the effect of financial/non –financial sector on disclosure compliance with IAS.

Other studies do not follow this classification. Chalmers and Godfrey (2004) separate mining

and oil companies from the others. Several studies separate manufacturing from non-

manufacturing industries (Abd-Elsalam and Weetman (2003) and Street and Bryant (2000))

and others use more than two industry classes.

Hypothesis 3, which states that disclosure degree is higher for companies audited by the

denominated group of the Big five is also supported. This finding is consistent with Hodgdon

(2004), Glaum and Street (2003) and Street and Gray (2001) who find positive significant

relationship between IAS compliance and type of auditor. Chalmers and Godfrey (2004) and

Abd-Elsalam and Weetman (2003) find mixed results regarding this variable.

The coefficient of listing status is statistically significant in all models, providing support for

Hypothesis 4, which states that the degree of disclosure is higher in companies listed on

12 After an analysis of the alternative models adequacy, based in broad features of the estimation results, such as the R2 value, the estimated t ratios and the signs of the estimated coefficients in relation to their prior expectations, models with tassets (reported in table 10) show better results than the others (not reported).

28

foreign exchanges than in companies listed on only one (its national) stock exchange. This

finding is widely evidenced in literature on compliance with disclosure requirements of IAS,

namely in Hodgdon (2004), Glaum and Street (2003), Abd-Elsalam and Weetman (2003),

Street and Gray (2001) and Street and Bryant (2000).

Hypothesis 5, which states that the degree of disclosure is higher in more internationalized

companies, is not supported by our models. This finding is consistent with Street and Gray

(2001) who find that the degree of multinationality is not a significant determinant of the

extent of compliance with IAS required disclosures.

The results do not show significant influence of capital structure on disclosure. Hypothesis 6

(degree of leverage, measured by the debt to equity ratio) is not supported. Previous studies

on compliance with IAS do not find statistically significant relationships either, except the

study of Abd-Elsalam and Weetman (2003) who find, in some cases, a significant and

negative relationship. Regarding equity financing, the importance of shareholders, measured

by the ratio of market capitalization and total assets, does not prove to be a significant

determinant of disclosure, either. Abd-Elsalam and Weetman (2003) find mixed results for

this factor – no significance for non-familiar IAS and significance for familiar IAS.

In spite of expectations, our data do not show evidence on the influence of corporate

governance on disclosure by Portuguese companies. Neither the proportion of independent

directors, nor the degree of compliance with the overall corporate governance

recommendations of CMVM show to be related to disclosure. The other alternative measure

for the importance of independent directors obtained from the survey conducted by CMVM

does not show improvements in the results, either.

In sum, our results support Hypotheses 1, 2, 3 and 4, that is we find size, belonging to the

financial sector, auditor type and listing status effects on the degree of financial instruments

related disclosure by companies. The results do not support the influence of the

internationality degree (H5), of the capital structure (H6 and H7) and of the corporate

governance structure (H8) on disclosure.

29

Table 10: Regression results (Dependent variable: idisc_a)

Independent variable

Model 1 Coefficient (t-statistic)



TASSETS 2.24E-07 (1.601922)***

2.98E-07 (1.964425)**

3.27E-07 (2.202875)**

IND1 -0.094637 (-1.452701)

-0.138512 (-1.700795)++

-0.135906 (-1.654129)++

D_AUD 0.041394 (1.165508)

0.054789 (1.446672)***

0.067667 (1.549685)***

D_LIST -0.085970 (-2.126436)**

-0.082827 (-2.083458)**

-0.099605 (-2.135163)**

MULT -7.80E-05 (-0.194589)

-0.000305 (-0.753093)

-0.000308 (-0.717547)

DE 0.006236 (1.115077)

0.008090 (1.432250)

0.008260 (1.402708)

MV -0.000184 (-0.394449)

-0.000273 (-0.547384)

-0.000295 (-0.561823)

IND_DIR -0.004799 (-0.168400)

D_IND_DIR 0.013069 (0.469624)

CORP_GOV -0.069853 (-0.830426)

Included obs 55 47 47 Adj R2 0.10537 0.126359 0.135941

Note: White Heteroskedasticity-Consistent Standard Errors and Covariance significant at 1%; ** significant at 5%; *** significant at 10%. One-tailed tests.

++ significant at 10%. Two-tailed tests.

VII. DISCUSSION AND CONCLUSIONS

The Portuguese Accounting Directive 18 (CNC (1996)) establishes compliance with IAS

whenever Portuguese standards are not available. There is lack of accounting standards for

financial instruments, namely regarding derivatives, in Portugal. Consequently, it may be

expected that companies have been adopting IAS requirements in their accounting for

financial instruments. Bearing in mind the mandatory adoption of IAS after 2005, it is

interesting to analyze the characteristics of the companies that were already anticipating IAS

requirements especially with respect to financial instruments’ disclosure items before 2005. In

order to attain this objective, we construct an index of disclosure issues, which comprises 54

items relating to financial instruments. The components of the index are based on IAS 32 and

IAS 39 disclosures.

Besides the determinants factors derived from the agency, the political costs and the

signalling theories, we introduce the analysis of capital finance structure and corporate

governance features of Portuguese companies within the context of contingency theory.

30

Portuguese companies have typically high degree of family ownership and bank-oriented

financing policies. Additionally, corporate governance practices only recently (in 2001 the

first Recommendations - non mandatory - on corporate governance were published by

CMVM) have been regulated and this regulation has been changing almost every year, in

order to attain better practices of corporate governance.

In spite of several difficulties with data availability and consistency among companies, we

conduct the analysis and conclude that disclosure degree is significantly related to size, type

of auditor, listing status and to the economic sector (financial/non-financial). Once the

disclosure index is based on IAS 32 and IAS 39 disclosure requirements, the results also show

that larger companies, companies listed on more than one exchange market and audited by

international auditing companies are closer to the IAS requirements. Against initial

expectations, we cannot prove the influence of corporate governance practices, including the

board composition on the amount of disclosure among Portuguese companies. Similarly, the

results do not show a significant influence of the type of capital financing structure. In fact

our measures of leverage degree and of importance of capital market’s financing do not show

statistically significant relations with disclosure level. These results, however, cannot be

interpreted without caution. In fact, as we described above, we found difficulties on data

availability regarding the structure of shareholders which did not allow us to proceed with a

deep analysis of the effect of family ownership in disclosure practices. Moreover, within

corporate governance characteristics, we also found several inconsistencies on disclosure by

companies, namely regarding the definition of independent director. The fact that, till 2003,

there was not a clear definition of independence by the Portuguese capital markets regulator,

conducted to a situation in which companies could disclose a number of independent directors

that in fact are not independent at the light of current regulation. Our measures for the

proportion of independent directors do not show significant relations with disclosure level.

This research brings important insights on the characteristics of Portuguese companies, its

corporate governance and capital ownership structures, and on the reporting practices within

the context of capital markets oriented accounting standards and much more demanding in

terms of disclosure requirements. As such, from this research, it emerged several areas for

improvement and that call for the intervention of the Portuguese capital markets regulator.

Regarding corporate governance, the Portuguese capital markets regulator has been

introducing several improvements on the regulation of the issue. Additionally, CMVM has

been publishing studies on the compliance degree with corporate governance

31

recommendations/regulations every year, disclosing the name of companies that comply or

not. These procedures are bringing improvements on corporate governance practices.

Regarding the adoption of IAS, there is not an enforcement program in action in Portugal.

The supervision of listed companies financial reporting is of the responsibility of CMVM.

This function assumes much more importance within the context of mandatory adoption of

IAS. In fact, the change to IAS means a complete change in the attitude toward financial

reporting. We show that, before 2005, many companies were not applying IAS 32 and IAS 39

as supplementary accounting standards, not complying with the Portuguese accounting

directive 18. This is an indicator that there will be several problems of compliance with

IAS/IFRS after 2005. Effective enforcement mechanisms are urgent. CMVM has been

publishing the name of companies that have certified auditor’s reports. This is an initial step,

but it is not enough within the enforcement of IAS. Similarly to what is done with corporate

governance practices, the market supervisor must develop analyzes of compliance with IAS

based on annual reports published by companies and implement actions towards non-

complying companies.

Finally, we would like to address some limitations inherent to this study. First, there is the

problem of the sample size. This problem, which is intrinsic to Portuguese capital market size,

restricts our hypotheses testing by means of linear regression models. Another limitation

results from the index construction process. We were very careful with the scoring process,

but errors may have occurred. Furthermore, annual reports are not the only means by which

companies disclose financial instruments. But, with no doubt, they are the most important

one. Lastly, this study covers the annual reports for a single year, before IAS/IFRS are

mandatory. Additional research that includes other years, namely after 2005, will allow

interesting analyzes of evolution of disclosure practices and compliance by companies within

new accounting frameworks. In spite of these limitations, we are convinced that this research

revealed very interesting relations of the disclosure practices and several characteristics of

Portuguese companies, showing the applicability of relevant theoretical frameworks in

contexts not studied before.

32

Appendix I–Components of the disclosure index

Disclosure Index

Score (if disclosed)

Accounting Policies

Held for trading securities 1

Held-to-maturity securities 1

Loans and receivables originated by the enterprise 1

Available-for-sale financial assets 1

Held-for-trading liabilities 1

Other financial liabilities 1

Trade date vs Settlement date 1

Fair values and market values

Measurement method 1

Significant assumptions 1

Fair value changes in Available-for-sale financial assets 1

Amount recognised in equity 1

Amount removed from equity 1

Unability of reliability in measurement

Financial assets description 1

Their carrying amount 1

Explanation of the reason 1

Range of estimates within which the fair value is likely to lie 1

Securitisation and repurchase agreements

Accounting policy 1

Nature and extent 1

Collateral 1

Whether the financial assets have been derecognised 1

Information about the key assumptions used in calculating the fair value of new and retained interests 1

Derivatives – Accounting policies

Risk management policy, including hedging policy 1

Objectives of holding or issuing derivatives 1

Accounting policies and methods adopted 1

Monitoring and controlling policy 1

Financial controls 1

Derivatives – Risks

33

Segregation by risk categories 1

Principal, stated value, face value, notional value 1

Maturity 1

Weighted average/effective interest rate 1

Derivatives – Hedging

Hedging description 1

Accounting method 1

Financial instruments designated as hedging instruments 1

Fair values 1

Nature of the risks being hedged 1

Future transactions hedging

The period in which forecasted transactions are expected to occur 1

The period they are expected to enter in income 1

Cash-flow hedging

The amount recognised in equity 1

The amount removed from equity and recognised in income 1

The amount removed from equity and added to initial measurement of the acquisition cost 1

Derivatives – Fair value

Fair value 1

Method adopted 1

Significant assumptions 1

Average fair value during the year 1

Interest rate risk

Future changes in interest rates 1

Maturity dates 1

Credit risk

Counterparties identification 1

Maximum amount of credit risk exposure 1

Significant concentration of credit risk 1

Collateral

Terms and conditions 1

Carrying amount and fair value 1

Other

Impairment losses 1

Total interest income and total interest expense (separately) 1

In AFS, realized and unrealized gains/losses (separately) 1

Total Score 54

34

Appendix II – Sample companies in alphabetic order

Company Name Economic Sector Company Name Economic Sector Barbosa & Almeida Industrial ITI Consumer, cyclical

BANIF Financial Jerónimo Martins Consumer, non-cyclical

BCA Financial LISGRAFICA Consumer, cyclical

BCP Financial Mota-Engil Industrial

BES Financial Mundicenter Financial

BPI Financial NOVABASE Technology

BRISA Industrial Soc. Comercial Orey Antunes

Industrial

BSCH Financial Papelaria Fernandes Consumer, cyclical

Banco Totta & Açores Financial PARAREDE Technology

Corticeira Amorim Industrial PORTUCEL Produtora de Pasta e Papel

Basic materials

Companhia de Celulose do Caima

Industrial PT Multimédia Consumer, cyclical

CENTRAL - Banco de Investimento

Financial REDITUS Technology

CIMPOR Industrial Salvador Caetano Industrial

CIN Basic materials Soares da Costa Industrial

CIRES Basic materials SAG GEST Consumer, cyclical

COFINA Basic materials SEMAPA Industrial

COMPTA Technology SOMAGUE Industrial

Modelo Continente Consumer, non-cyclical SONAE Indústria Industrial

EDP Utilities SONAE SGPS Consumer, non-cyclical

EFACEC Industrial SONAE.COM Telecommunications

Estoril - Sol Consumer, cyclical SUMOLIS Consumer, non-cyclical

F.Ramada Basic materials Teixeira Duarte Industrial

FINIBANCO Financial Portugal Telecom Telecommunications

FISIPE Basic materials TERTIR Industrial

Grão-Pará Industrial Vista Alegre Atlantis Consumer, cyclical

IBERSOL Consumer, cyclical Vodafone Telecel Telecommunications

IMOLEASING Financial

IMPRESA Consumer, cyclical

INAPA Basic materials

35

Appendix III - Correlations

Tassets Lassets Tsales Lsales Ind1 D_aud D_list Mult De Mv Ind_dir

D_ind_

dir

Corp_g

ov Idisc_a

Tas sets .0001

Lassets 0.558 1.000

Tsales 0.966 0.650 1.000

Lsales 0.473 0.896 0.612 1.000

Ind1 0.421 0.560 0.372 0.297 1.000

D_aud 0.096 0.349 0.144 0.407 0.121 1.000

D_list -0.551 -0.601 -0.578 -0.521 -0.358 -0.179 1.000

Mult 0.168 0.048 0.192 0.164 -0.182 0.091 -0.084 1.000

De 0.286 0.624 0.275 0.422 0.851 0.109 -0.279 -0.170 1.000

Mv -0.130 -0.214 -0.119 -0.073 -0.306 0.211 0.019 -0.129 -0.372 1.000

Ind_dir -0.002 0.311 0.076 0.246 0.161 0.307 -0.241 0.186 0.061 -0.148 1.000

D_ind_dir 0.185 0.148 0.135 0.075 0.302 0.175 -0.230 -0.055 0.272 -0.189 0.106 1.000

Corp_gov 0.352 0.559 0.408 0.563 0.261 0.410 -0.479 0.094 0.227 0.036 0.159 0.330 1.000

Idisc_a 0.251 0.281 0.271 0.273 0.118 0.267 -0.350 0.010 0.237 -0.108 0.071 0.195 0.161 1.000

36

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