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Ownership Concentration in Privatized Firms: The Role of Disclosure Standards, Auditor Choice, and Auditing Infrastructure

Omrane Guedhami Faculty of Business Administration, Memorial University of Newfoundland, St. John’s, NL A1B 3X5, Canada

guedhami@mun.ca

Jeffrey A. Pittman* Faculty of Business Administration, Memorial University of Newfoundland, St. John’s, NL A1B 3X5, Canada

jpittman@mun.ca

Abstract

We rely on a unique data set to estimate the impact of disclosure standards and auditor-related characteristics on ownership concentration in 190 privatized firms from 31 countries. Accounting transparency can help alleviate the agency conflict between minority investors and controlling shareholders, which is evident in the extent of ownership concentration, since the expropriation of corporate resources by insiders hinges on these private benefits remaining hidden. After controlling for other country-level and firm-level determinants, we find weak (no) evidence that extensive disclosure standards (auditor choice) reduce ownership concentration. In contrast, we provide strong, robust evidence that ownership concentration is lower in countries with securities laws that specify a lower burden of proof in civil and criminal litigation against auditors, consistent with Ball’s (2001) predictions. Collectively, our research implies that minority investors worldwide value legal institutions that discipline auditors in the event of financial reporting failure over both the presence of a Big Five auditor and better disclosure standards.

April 2005 JEL classification: G32, G34, M41, M42

Key words: Ownership concentration; disclosure; audit infrastructure; corporate governance * Contact author. We thank Najah Attig, Narjess Boubakri, Steve Fortin, and Oumar Sy for insightful comments on an earlier draft of this paper. We also appreciate generous financial support from the Social Sciences and Humanities Research Council.

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Ownership Concentration in Privatized Firms: The Role of Disclosure Standards, Auditor Choice, and Auditing Infrastructure

Abstract

We rely on a unique data set to estimate the impact of disclosure standards and auditor-related characteristics on ownership concentration in 190 privatized firms from 31 countries. Accounting transparency can help alleviate the agency conflict between minority investors and controlling shareholders, which is evident in the extent of ownership concentration, since the expropriation of corporate resources by insiders hinges on these private benefits remaining hidden. After controlling for other country-level and firm-level determinants, we find weak (no) evidence that extensive disclosure standards (auditor choice) reduce ownership concentration. In contrast, we provide strong, robust evidence that ownership concentration is lower in countries with securities laws that specify a lower burden of proof in civil and criminal litigation against auditors, consistent with Ball’s (2001) predictions. Collectively, our research implies that minority investors value legal institutions that discipline auditors in the event of financial reporting failure over both the presence of a Big Five auditor and better disclosure standards.

JEL classification: G32, G34, M41, M42

Key words: Ownership concentration; disclosure; audit infrastructure; corporate governance

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1. Introduction

In this paper, we provide new evidence from 190 firms in 31 countries on the role of

disclosure standards and auditor-related characteristics in reducing information asymmetry

between corporate insiders and minority shareholders. We mainly contribute to extant research

by examining the importance of legal institutions that discipline auditors to ownership

concentration. Ball (2001, p. 128) argues that isolated reforms intended to improve financial

reporting quality such as requiring a country’s firms to follow international accounting

standards will be futile without concurrent changes to its securities laws that hold auditors

more responsible for materially misleading financial statements (his italics):

If forced to nominate a single place from which to start changing a country’s system of public financial reporting and disclosure, I would advocate liberalizing the rules governing stockholder and lender litigation. The risk of litigation motivates managers and auditors alike to increase transparency and, in particular, to disclose bad decisions and report losses in a timely fashion. Many other institutional features⎯including the accounting standards actually implemented by managers and the quality of financial reporting and disclosure actually achieved⎯are determined endogenously by the incentives that managers and auditors encounter. An effective system of private litigation does more to improve actual practice than fiat that is exogenously imposed by governments.

There is extensive empirical evidence on the prevalence of ownership concentration

around the world. Shleifer and Vishny (1997) contend that concentrated ownership in firms

outside the U.S. is a natural response to poor legal protection of minority shareholders from

expropriation by managers. Large shareholders, whose wealth depends heavily on firm

performance, are eager to monitor management and have enough power to ensure that their

resources are not diverted (Jensen and Meckling, 1976; Shleifer and Vishny, 1986).

Consequently, concentrated ownership plays an important role in corporate governance,

especially in countries with poor investor protection; i.e., countries that accommodate more

managerial expropriation.

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However, more contemporary research suggests that although concentrated ownership

mitigates managerial expropriation, it engenders a new form of agency problem, the potential

expropriation of minority shareholders and other stakeholders by controlling shareholders.1

These dominant shareholders usually exert full control over managers and frequently hold

control power in excess of their cash flow rights, providing them with strong incentives to

extract private benefits at the expense of minority shareholders (La Porta, Lopez-de-Silanes, and

Shleifer, 1999; hereafter LLS, 1999). According to Shleifer and Vishny (1997, p. 758), “large

investors represent their own interests, which need not coincide with the interests of other

investors in the firm, or with the interests of employees and managers. In the process of using

his control rights to maximize his own welfare, the large investor can therefore redistribute

wealth⎯in both efficient and inefficient ways⎯from others.” Consistent with this view, recent

studies on the value of voting rights of large bock trades (Dyck and Zingales, 2004) and dual-

class firms (Nenova, 2003) report significant control premiums, indicating high private benefits

of control. Other empirical research finds that the extraction of private benefits, mainly shaped

by the legal environment, can be costly to controlling shareholders and firms in terms of raising

equity finance and firm value (LLSV, 2002; Claessens et al., 2002; Durnev and Kim, 2005). In

this paper, we investigate whether alternate governance mechanisms, namely disclosure

standards and auditor-related characteristics, improve contracting by moderating agency

problems that lead to concentrated ownership in less protective legal environments.

We conduct our analysis in the specific context of privatization in non-U.S countries.

Privatization constitutes a discrete event that often results in a drastic change in firms’

ownership structure, providing an opportune testing ground in which to understand corporate

governance.2 Bushman and Smith (2003) explain that regime shifts within a country, including

1 Among others, Ball (2001) explains that despite its economic importance, international accounting research seldom examines expropriation. 2 See Megginson and Netter (2001) for a comprehensive review of the privatization literature.

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the privatization of state-owned enterprises, suit exploring the link between financial

accounting quality and economic outcomes. More generally, in their recent literature review,

Denis and McConnell (2003) identify privatization as an interesting setting in which to conduct

international corporate governance research.

Our study builds on Boubakri, Cosset, and Guedhami (2005), who examine the

relationships among ownership concentration, legal protection, and firm performance after

privatization. The authors report high levels of private ownership concentration for a sample of

209 firms from 39 countries. Consistent with Shleifer and Vishny’s (1997) conjecture, they

provide evidence that strong investor protection is associated with lower ownership

concentration.3 In a contemporaneous study, Atanasov (2005) finds that in the absence of legal

institutions that protect minority shareholders and constrain majority owners, privatization in

Bulgaria leads to concentrated ownership and significant control premiums being paid by

controlling shareholders who extract more than 85 percent of firm value as private benefits.

Importantly, the large private benefits of control that accompany high ownership concentration

are an artifact of poor external corporate governance according to this and prior research; e.g.,

LLSV (1998), Bebchuk (1999), LLS (1999), and Dyck and Zingales (2004).

We quantify minority shareholders’ reluctance to invest in companies with greater

private benefits of control with the extent of ownership concentration in privatized firms. After

controlling for country-level and other firm-level determinants, we fail to find that the presence

of a Big Five auditor affects ownership concentration.4 Although this result is sensitive to

model specification, we provide weak evidence that enhancing disclosure standards reduces

3 Boubakri et al. (2005) also caution that despite the role of ownership concentration in less protective countries, it marginalizes other mechanisms of corporate governance, especially impeding reforms intended to improve capital markets. LLS (1999, p. 512) voice similar concerns: “… the controlling shareholders generally do not appear to support legal reform that would enhance minority rights; in fact, they typically lobby against it.” 4 For expositional simplicity, we refer to the set of Big Five auditors and their predecessors as the Big Five auditors in this paper. Our 1980-2001 sample period precedes the demise of Arthur Andersen.

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ownership concentration. In comparison, we report strong, robust evidence that countries’

auditing infrastructure moderates the agency conflict between outside investors and controlling

shareholders, consistent with Ball’s (2001) predictions. Specifically, we document that

ownership concentration is lower in jurisdictions with securities laws that set a lower burden of

proof in civil and criminal cases against auditors. Economically, our results imply that

ownership concentration will subside by 35 percent and 31 percent, respectively, with a one

standard deviation reduction in the variables representing the burden of proof in civil and

criminal litigation.5 Moreover, we find in multivariate regressions that these provisions that

subject auditors to more severe private and public enforcement dominate other legal and extra-

legal institutional factors in explaining ownership concentration.

Collectively, we interpret our research as implying that minority investors value legal

institutions that discipline auditors in the event of financial reporting failure over both auditor

choice and better disclosure standards.6 In documenting the sobering impact of civil and

criminal litigation on auditors’ incentives to constrain insiders’ discretion over the financial

reporting process, our evidence complements recent international research that finds that

institutions that affect managers’ incentives matter more than formal disclosure standards to

accounting quality; e.g., Ball et al. (2003) and Francis et al. (2003). Our results also reinforce

evidence in LLSV (1997, 2000) and DeFond and Hung (2004) that a strong surrounding

enforcement infrastructure is more important than extensive investor protection laws to good

corporate governance.

In contrast to Dyck and Zingales (2004) and Haw et al. (2004), we find that the severity

of tax enforcement does not influence ownership concentration, our proxy for the amount of

5 In calibrating the economic importance of these coefficient estimates, we note that the mean (median) private ownership concentration in our sample is 40 (36) percent three years after privatization. 6 LLS (2005) report cross-country evidence that extensive disclosure requirements, but not standards of proof in civil and criminal litigation, lower ownership concentration.

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insiders’ private control benefits. Instead, our research suggests that governance reforms meant

to alleviate the agency conflict between controlling shareholders and outside investors should

focus on lowering the burden of proof in both civil and criminal cases against firms’ auditors

and, to a lesser extent, requiring more disclosure. Fortunately, these policy prescriptions are

relatively straightforward for governments to implement to improve their securities markets.

In fact, such feasible reforms should enhance the quality of financial reporting, leading to the

positive externality of higher tax compliance since preventing diversion of corporate resources

benefits tax authorities as well as outside investors.

The remainder of the paper proceeds as follows. Section 2 develops our testable

hypotheses. Section 3 describes the sample and reports summary descriptive statistics on the

regression variables. Section 4 discusses the empirical findings. Section 5 concludes.

2. Motivation

Countries can intervene in their capital markets by enacting securities laws that facilitate

private contracting. Absent these specific legal provisions, litigation is governed by contract

and tort law, which can result in considerable uncertainty for investors since issues like intent

and negligence have to be settled in court (Easterbrook and Fischel, 1984). The concern is that

private tort and contract litigation may be too expensive and unpredictable to deter firms from

making materially deficient disclosures (LLS, 2005). We isolate several cross-country legal

factors that may influence the role of auditors as information intermediaries in the financial

reporting process. In particular, we examine two mechanisms available to governments to

improve civil litigation by standardizing private contracting: prescribing disclosure standards

and specifying liability standards for auditors. In addition, we investigate whether firms’

auditor choice and the extent of public enforcement in the form of criminal sanctions that can be

imposed on auditors matter to ownership concentration.

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Accounting transparency has an important economic role to play in investor protection

given that the extraction of corporate resources by controlling shareholders hinges on these

private benefits being difficult to detect (Dyck and Zingales, 2004). Hung (2000) and Ball (2001)

argue that strong shareholder protection should constrain insiders’ opportunism in financial

reporting. Consistent with controlling shareholders having stronger motives to conceal firm

performance when they are diverting more corporate resources, Leuz et al. (2003) find that

earnings management is more pervasive in economies with weak investor protection. Legal

institutions also affect the value relevance of reported earnings and accruals to investors (Ball et

al., 2000; and Ali and Hwang, 2000). This research implies that more disclosure will lead to

firms becoming better known to outsiders, thereby moderating the amount of private benefits

that controlling shareholders enjoy to the detriment of the remaining shareholders.

Accordingly, high-quality disclosure should lower the likelihood that controlling shareholders

can extract private benefits without incurring legal penalties or damaging their reputations. We

predict that ownership concentration will subside in privatized firms located in countries that

mandate more disclosure, which reduces insiders’ hiding incentives by helping minority

shareholders identify any diversionary practices (all hypotheses are stated in alternate form):

H1: Ownership concentration will be lower in countries that require more disclosure.

We also examine the link between auditor-related characteristics and ownership

concentration in privatized firms. There is extensive theory (e.g., Easley and O’Hara, 2004; and

Leuz and Verrecchia, 2004) and evidence (e.g., Sengupta, 1998; and Francis et al., 2005) that

more precise financial reporting lowers firms’ cost of capital. Mansi et al. (2004) and Pittman

and Fortin (2004) find that lenders demand higher yields on debt issues made by U.S. firms

without Big Five auditors to compensate for the greater uncertainty about these securities.

However, international research on the influence of auditor choice until recently has been

scarce. Khurana and Raman (2004) document that, unlike in the U.S., investors in Australia,

Canada, and the U.K. do not reward firms retaining a Big Five auditor with lower financing

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costs. In contrast, Fan and Wong (2005) attribute evidence that Asian firms suffering more

serious agency problems are more apt to choose a Big Five auditor to their superior external

monitoring.

We respond to DeFond and Francis’s (2005) call for research on the role of auditor choice

in firms outside the U.S. by estimating the impact of retaining a Big Five auditor on ownership

concentration in privatized firms from 31 countries. Given the importance of accounting

transparency to minority shareholders eager to prevent the diversion of corporate resources to

controlling shareholders, our setting suits examining whether monitoring by a Big Five auditor

is valuable.7 Hiring a high-quality auditor to enhance the credibility of its financial reporting

may enable firms to persuade smaller investors that controlling shareholders will have less

opportunity to siphon firm value by, for example, manipulating transfer prices or hiding

related-party transactions (Volpin, 2002; and Dyck and Zingales, 2004). The absence of a Big

Five auditor may render privatized firms’ disclosures less informative, leading to higher

ownership concentration as potential investors protect themselves against insiders’ greater

discretion over financial reporting. Market participants may perceive that a Big Five auditor

will ensure that managers responsible for preparing the financial statements have less flexibility

in their choice of accounting policies and estimates. We predict that disclosures made by

privatized firms with Big Five auditors will better reflect underlying economic performance by

constraining insiders’ discretion over the financial reporting process, translating into lower

ownership concentration:

H2: Choosing a Big Five auditor will lower ownership concentration.

Besides firms’ auditor choice, the country-specific auditing infrastructure may help

reduce the private benefits that accrue to controlling shareholders, which are evident in the

7 Apart from lending more credibility to financial statements, privatized firms with Big Five auditors may benefit from their greater implicit insurance coverage against investor losses stemming from audit failure (Watts and Zimmerman, 1986; and Dye, 1993).

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extent of ownership concentration. Prior research stresses the impact of legal institutions on

curbing the amount of these private benefits by providing investors with recourse against

controlling shareholders. The right to sue management (Zingales, 1995) and minority

shareholder rights (La Porta et al., 1997) curtail the ability of insiders to extract private benefits.

Similarly, a common law legal origin constrains management by lowering the standard of proof

in civil litigation and expanding the scope of management decisions that are subject to judicial

review (Johnson et al., 2000; and Dyck and Zingales, 2004).

We extend this research by focusing on the importance of legal institutions that

discipline privatized firms’ auditors, rather than their controlling shareholders. Securities laws

affecting auditors are another mechanism available to governments to try to mitigate the agency

conflict between minority investors and controlling shareholders. LLS (2005) explain that U.S.

securities laws reflect that the private recovery of investors’ losses is more efficient when the

lowest-cost information intermediaries such as auditors not only produce information, but also

are held liable for its veracity. According to Ball (2001, p. 157): “Litigation rights seldom are

raised in the context of international accounting, but in my view they constitute the single most

essential requirement for an efficient disclosure system. Without litigation, the incentives of

auditors to reduce management’s discretion over financial reporting are considerably

reduced…”

Investors may perceive that incentives for Big Five auditors to supply higher-quality

audits to safeguard their brand name reputations are insufficient to induce credible disclosures

by privatized firms. Moreover, resorting to the general investor protection under private tort

and contract law may be an expensive, unpredictable way for investors to recover damages in

the event of audit failure. Consequently, in the absence of specific legal provisions outlining

auditors’ standard of care, minority investors may be reluctant to rely on firms’ financial

statements. Securities laws governing the ability of minority investors to recover losses through

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civil litigation against the firm’s auditor for misleading audited financial statements vary

widely across countries, which motivates the following prediction:

H3: Ownership concentration will be lower when plaintiffs’ burden of proof in civil lawsuits against auditors is lower.

Another country-level institutional determinant of insiders’ private control benefits may

be public enforcement in criminal cases of financial fraud involving auditors. Governments

may consider public enforcement of their laws an important complement to private

enforcement in supporting securities markets. In fact, recent high-profile financial reporting

scandals in several countries have stimulated regulatory interest in imposing criminal sanctions

on auditors for violations of securities laws as a mechanism to improve accounting quality. In

our final testable hypothesis, we predict that the ownership of privatized firms will be more

dispersed in jurisdictions that have lower standards for holding auditors criminally liable for

issuing a clean opinion on materially misleading financial statements:

H4: Ownership concentration will be lower when governments’ burden of proof in criminal cases against auditors is lower.

3. Data and Descriptive Statistics

3.1 Data

Our sample of privatized firms is drawn from Boubakri, Cosset, and Guedhami (2005).

This database is unique in the sense that it tracks ownership concentration over the first four

years following privatization for a multinational sample of 209 firms privatized in 39 countries

over the period 1980 to 2001. We eliminate three firms from two countries due to incomplete

data on auditor identity. After merging this database with the country-level institutional

database compiled by LLS (2005), we lose another 16 firms from six countries.

Table 1 reports descriptive statistics by country on our final sample, which consists of

190 firms from 31 countries. The 592 firm-year observations in the sample are diversified across

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regions, development level, and legal origin. Specifically, 15 percent of the firms are from

Africa and the Middle East, 29 percent from East and South Asia and the Pacific, 28 percent

from Latin America, and 28 percent from Europe and Central Asia. The sample distribution by

development level reveals that 28 percent of the firms are from developed countries with the

other 72 percent from emerging markets. Additionally, 64 percent of the sample comes from

civil law countries (common=0) while 36 percent of the firms in our sample are located in

common law countries. The ample variation across geographic regions, development level, and

legal origin allows us to investigate whether cross-country differences in governance

infrastructure (i.e., legal and extra-legal institutions), particularly disclosure standards and

auditor-related characteristics, help explain the cross-firm differences in ownership structure.

3.2 Regression Variables and Descriptive Statistics

Ownership Concentration. We follow Boubakri et al. (2005) by specifying two measures of

private ownership concentration, the percentage of shares held by the three largest private

investors, L3, and an approximation of the Herfindahl index (the sum of squared ownership

shares by the three largest private investors), H3. Since ownership concentration is our

dependent variable, we apply a logistic transformation to L3, using the formula log(L3/(1-L3))

aiming to convert a bounded variable into an unbounded one, and a logarithmic transformation

to H3 (Demsetz and Lehn, 1985; Himmelberg et al., 1999; and Boubakri et al., 2005). The

resulting variables are LL3 and LH3. For the sake of space, we focus on the LL3 measure of

ownership concentration (CONCENTRATION), although replacing this variable with LH3 does

not affect our inferences. In Table 2, we review the definitions and data sources for all of the

regression variables.

Column (3) of Table 1 presents the average ownership concentration for the average firm

in each country over four years (including the privatization year). The average ownership

concentration of the three largest shareholders varies drastically across countries, with the

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lowest level in Japan and Norway (0 percent) and the highest levels in Mexico (98.9 percent),

followed by Columbia (83.7 percent), and Egypt (80 percent). Additionally, as expected, civil

law countries exhibit higher levels of ownership concentration compared to common law

countries. For example, out of the ten countries with an average ownership concentration

greater than 50 percent, seven have a civil law origin. Other descriptive statistics (not reported)

include that the average stake held by the three largest shareholders is 42.8 and 27.6 percent for

civil law countries and common law countries, respectively. This difference is statistically

significant at the 1 percent level.

Disclosure Standards and Auditor-related Characteristics. To characterize the quality of

disclosure standards, auditor choice, and the surrounding auditing environment, we rely on the

following constructs: (a) DISCLOSURE. LLS (2005) tabulate a disclosure standards index that

captures the regulation of information available to minority investors. This variable measures

the strength (quality) of stock exchange-mandated disclosure requirements related to: delivery

of a prospectus; compensation of directors and key officers; ownership structure; insider

ownership; contracts outside the ordinary course of business; and transactions between the

issuer and its directors, officers, and/or large shareholders. (b) BIG FIVE. We set this variable

equal to one when a firm chooses a Big Five auditor and zero otherwise.

(c) SUE AUDITOR. This variable, which we also borrow from LLS (2005), measures the

capacity of investors to recover losses in the form of damages from the auditor in a civil lawsuit

for misleading audited financial information accompanying the prospectus. LLS (2005) collect

this data from answers to questionnaires sent to attorneys from the 49 countries with the largest

stock market capitalization in 1993. This variable reflects four liability standards by equaling:

one when investors are only required to prove that the audited financial information

accompanying the prospectus contains a misleading statement; two-thirds when investors must

also prove that they relied on the prospectus and/or that their loss was caused by the

misleading accounting information; one-third when investors must also prove that the auditor

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was negligent; and zero when restitution from the auditor is either unavailable or the liability

standard is intent or gross negligence. (d) SANCTION AUDITOR. Again derived from LLS

(2005), this index measures the burden of proof in criminal prosecutions of auditors for

misleading financial information accompanying the prospectus. This variable equals: zero

when the auditor cannot be held criminally liable if the financial statements accompanying the

prospectus are materially misleading; one-half when the auditor can be held criminally liable if

aware that the financial statements accompanying the prospectus are materially misleading;

and one when the auditor can also be held criminally liable if negligently unaware that the

financial statements accompanying the prospectus are materially misleading.

The summary statistics reported in Table 1 show wide variation in the country-level

variables. The mean (median) quality of disclosure standards (DISCLOSURE) is 0.61 (0.58),

with the lowest value of 0.17 for Venezuela and the highest value of 1 for Singapore. The ability

of an investor to sue the firm’s auditor for misleading financial information (SUE AUDITOR)

ranges from 0 for Austria, Germany and Thailand to 1 for the Philippines, with half of the

sample countries clustered at the median score of 0.66. The criminal sanctions applicable to the

firm’s auditor (SANCTION AUDITOR) range from the lowest value of 0 for Brazil, Japan,

Mexico, and Portugal to the highest value of 1 for India, Malaysia, Nigeria, Norway, Singapore,

and Thailand. BIG FIVE, however, suffers from poor variation with all of the firms hiring a Big

Five auditor in 21 countries out of the 31 in the sample. Among the remaining sample

countries, Brazil has the highest percentage of BIG FIVE (91.3 percent), followed by Chile (83.3

percent), Thailand and Turkey (80 percent), Malaysia (77.8 percent), France (77 percent), and

Portugal (75 percent). Interestingly, none of the firms in India and Pakistan have a Big Five

auditor, while 40 percent of the firms in Nigeria retain a Big Five auditor. We note that India

and Nigeria, which exhibit the lowest fraction of firms audited by a Big Five auditor, rank quite

high in the quality of their disclosure standards and auditing infrastructure.

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Legal and Extra-Legal Institutions. In specifying four proxies for the legal environment,

we rely on LLSV’s (1998) extensive database of the regimes in 49 countries from Africa, Asia,

Australia, Europe, North America, and South America: (a) COMMON. This variable identifies

the legal origin of the company law or commercial code of each country. It is set equal to one

for English common law economies and zero otherwise. (b) RIGHTS. This variable measures

the level of minority shareholders’ protection against managers or controlling shareholders

afforded by statutory corporate law. This proxy, which LLSV (1998) label “antidirector rights”,

aggregates six aspects related to voting rights: the country allows shareholders to mail their

proxy vote; shareholders are not required to deposit their shares prior to the General

Shareholders’ Meeting; cumulative voting or proportional representation of minorities on the

board of directors is allowed; an oppressed minorities mechanism is in place; the minimum

percentage of share capital that entitles a shareholder to call for an Extraordinary Shareholders’

Meeting is less than or equal to ten percent (the sample median); and when shareholders have

preemptive rights that can only be waived by a shareholders meeting. (c) JUDICIAL. This

variable measures the efficiency of the judiciary using the International Country Risk Guide.

(d) RULE. This variable reflects an assessment of the rule and order tradition in a country. The

last two variables gauge the quality of enforcement of legal rules pertaining to the rights of

investors.

In addition to the legal determinants of ownership concentration, we consider three

extra-legal determinants developed by Dyck and Zingales (2004): (a) COMPETITION. Product

market competition is based on responses to a survey question on the effectiveness of federal

laws in preventing unfair competition as reported in the World Competitiveness Yearbook for

1996. (b) NEWS. We measure the diffusion of the press with the circulation of daily

newspapers standardized by population. (c) TAX. The extent of tax enforcement is captured by

the Global Competitiveness Report assessment of the level of tax compliance in a country for

1996 and ranges from 0 to 6, where higher scores reflect higher compliance.

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Similar to the securities laws relating to disclosure standards and auditor discipline,

there is plenty of variation in the other legal and extra-legal institutional measures. The

descriptive statistics in Table 1 indicate that common law countries require more extensive

disclosure and specify a lower burden of proof in both civil and criminal litigation against

auditors, corroborating LLS’s (2005) findings.

Control Variables. Our choice and specification of control variables closely follows prior

research; e.g. Demsetz and Lehn (1985), Haw et al. (2004), and Boubakri et al. (2005): Operating

risk, for which we use as our proxy the standard deviation of the annual return on equity ratios

(RISK) during the three years preceding the privatization year; Growth, for which we use as our

proxy the average annual real sales growth rate (GROWTH) during the three years preceding

the privatization year; and Firm size, for which we use as our proxy the natural logarithm of

total sales (SIZE). We also control for the characteristics of the privatization process:

Privatization timing. A dummy variable (LATE) that takes the value of one if the sample-firm is

privatized after the median privatization date in the country, and zero otherwise. As argued by

Boubakri et al. (2005), “this variable captures the privatizing government’s preferences on the

choice of the to-be-privatized firm and the extent of the stake sold.” For method of

privatization, we specify a dummy variable (PRIVATE) that is equal to one if the firm is

privatized through a private sale given that the literature suggests that more concentrated

ownership should result from such sales compared to share issued privatizations, and zero

otherwise. Finally, we control for the level of economic development with the natural

logarithm of GDP per capita (LGDPC).

4. Empirical Evidence

The international corporate governance literature is incomplete with respect to the

impact of accounting transparency on ownership structure. We contribute to closing this gap

by examining the importance of disclosure standards and auditor-related characteristics in

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explaining ownership concentration around the world. Recent research emphasizes that large

shareholding is widespread and associated with stronger incentives to extract private benefits

of control at the expense of minority shareholders, particularly in countries with lax legal

systems. Our tests analyze whether minority investors perceive that certain incentives

genuinely motivate auditors to improve financial reporting quality⎯specifically, their interest

in protecting their brand-name reputations and legal institutions that discipline auditors in the

event of audit failure⎯which, in turn, lowers ownership concentration.

4.1 Univariate Analysis

Table 3 reports Pearson correlation coefficients between the regressions variables.

DISCLOSURE, SUE AUDITOR, and SANCTION AUDITOR are negatively correlated with

ownership concentration, consistent with H1, H3, and H4, respectively. This preliminary

evidence suggests that more extensive disclosure standards and legal institutions that discipline

auditors curtail the private benefits of control evident in ownership concentration. Inconsistent

with the prediction in H2, we fail to find that choosing a Big Five auditor reduces ownership

concentration. Given that this analysis suffers from the standard limitations of univariate tests,

in the next section we more formally examine in the presence of control variables whether these

test variables affect ownership concentration. It is also important to note the significant and

negative correlations between the proxies for legal and extra-legal institutions and ownership

concentration, corroborating recent research on their roles in limiting the extraction of private

benefits of control.

With some important exceptions, we find relatively low cross-correlations between the

test variables (DISCLOSURE, BIG FIVE, SUE AUDITOR, and SANCTION AUDITOR) and the

other explanatory variables, providing some assurance that other determinants of ownership

concentration are not spuriously responsible for any evidence supporting our hypotheses. Still,

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we follow standard practice by initially entering the legal and extra-legal institutional controls

one at a time in our regressions to coarsely address concerns about multi-collinearity.8

4.2 Multivariate Analysis

In estimating the following pooled time-series, cross-sectional OLS regression model

(firm and time subscripts are omitted), we control for the influence of other legal and extra-legal

institutions on ownership concentration given the recent evidence on their roles in limiting

expropriation activities:

Concentration = γ0 + γ1 Transparency + γ2 Institution + γ3 Control + 1,…4 Industry + φ1,…3 Year + η (1)

where Concentration stands for private ownership concentration measured by LL3 and LH3;

Transparency represents the disclosure standards and auditor-related characteristics

(DISCLOSURE, BIG FIVE, SUE AUDITOR, and SANCTION AUDITOR); Institution refers to the

legal (COMMON, RIGHTS, JUDICIAL, and RULE) and extra-legal variables (COMPETITION,

NEWS, and TAX); Control comprises a set of firm- and country-level control variables (RISK,

GROWTH, SIZE, LATE, PRIVATE, and LGDPC); Industry is a dummy variable identifying the

firm’s industry (financial; utilities; telecommunication; oil and gas, petrol/petrochemical,

cement, and mining) that is intended to capture the effect of regulation (Demsetz and Lehn,

1985) and the privatizing government preferences in deciding which industry to privatize and

to what extent; Year is a dummy variable identifying the postprivatization year that is intended

to capture unobservable changes at the firm and country levels; and, finally, η is an error term.

4.2.1 The Role of Disclosure Standards, Auditor-Related Characteristics, and Legal Institutions

Table 4 presents the least-squares estimation results for the impact of disclosure

standards and auditor-related characteristics, along with legal institutions, on ownership

8 Given that the high correlations between some country-level explanatory variables may cast doubt on any evidence consistent with our predictions, we return to this issue later in the paper.

19

structure.9 Evidence from the basic model reported in column (1), which excludes the legal

variables, indicates that our test variables, apart from auditor choice, vary systematically with

ownership concentration. Consistent with our prediction in H1, we find that the point estimate

of the coefficient associated with DISCLOSURE is negative and significant at the 10 percent

level (t-statistic = -1.48), suggesting that high-quality disclosure standards reduce the private

benefits attributable to large shareholding by helping outside investors identify any

diversionary practices.

The coefficient for BIG FIVE is not significantly negative as predicted in H2, implying

that external monitoring by a Big Five auditor does not help prevent the expropriation of

corporate resources by controlling shareholders.10 Importantly, we provide strong evidence

that the country-specific auditing infrastructure matters to ownership concentration. Consistent

with H3, we find that the coefficient for SUE AUDITOR is negative and significant at the 1

percent level (t-statistic = -3.62), suggesting that the ability of minority investors to recover

losses from the firm’s auditor in a civil lawsuit for misleading audited financial information

moderates the agency problems that accompany concentrated ownership. Highlighting the

first-order economic importance of this coefficient estimate, a one standard deviation increase in

SUE AUDITOR (0.24) is associated with a 35 percent decrease in ownership concentration. To

provide more perspective on its economic magnitude, we note that the mean (median)

ownership concentration, not reported, in the sample is 40 (36) percent three years after

privatization.

The coefficient for SANCTION AUDITOR is also negative and significant at the 1 percent

level (t-statistic = -4.35), consistent with the prediction in H4 that the extent of ownership

concentration is significantly lower in jurisdictions with lower standards for holding auditors

9 We apply a one-tailed t-test when directional directions are made and two-tailed t-tests otherwise. 10 One potential explanation for this finding is the low variation in BIG FIVE as reported in Table 2; i.e., 87 percent of the sample firms have a Big Five auditor.

20

criminally liable for issuing a clean opinion on materially deficient financial statements.

Additionally, the estimated coefficient indicates that a one standard deviation increase in

SANCTION AUDITOR will translate into a decline of 31 percent in ownership concentration.

We interpret this evidence as implying that private and public enforcement of securities laws

applying to auditors provide essential support for the financial reporting infrastructure.

The specifications in columns (2) through (5) separately control for the impact of

individual legal institutions on ownership structure. After controlling for different dimensions

of the legal system, we still find a negative and significant (at the 1 percent level) relation

between ownership concentration and the auditing infrastructure variables, namely SUE

AUDITOR and SANCTION AUDITOR. The coefficient for DISCLOSURE is also generally

negative and significant, consistent with our prediction in H1. However, we continue to fail to

find that auditor choice affects ownership concentration. Surprisingly, some legal variables are

statistically insignificant (COMMON and RIGHTS) or load with an unexpected sign (JUDICIAL).

Column (5) shows a different story since the coefficient for RULE is negative and significant at

the 1 percent level (t-statistic = -5.30), suggesting that a strong system of legal enforcement

reduces the value of the private control benefits. Moreover, this is another economically

material determinant with the estimated coefficient indicating that a one standard deviation

increase in RULE (2.67) will reduce ownership concentration by 12.5 percent. Interestingly, in

our data, the economic importance of this legal variable to ownership concentration is smaller

than that found for SUE AUDITOR and SANCTION AUDITOR.

The last column of Table 4 presents the results from estimating a full model that includes

our test variables and all of the legal institution controls. This evidence reinforces the

importance of the auditing infrastructure variables (SUE AUDITOR and SANCTION AUDITOR)

and the rule of law (RULE) in lowering ownership concentration. Again, RULE is the only

significant legal institution control, suggesting that this metric may better capture variation in

the legal environment. In contrast, the coefficient on DISCLOSURE becomes insignificant in

21

this horse race regression, while BIG FIVE is almost identically zero. These findings clearly

suggest that securities laws that facilitate civil and criminal litigation against auditors as well as

a strong system of legal enforcement subsume the influence of other factors in alleviating the

agency conflict between controlling shareholders and minority investors. Finally, we note that

the specifications reported in Table 4 have adjusted R2 of at least 40 percent, with the audit

infrastructure variables responsible for the lion’s share of the explanatory power for ownership

concentration.

Turning to the firm-specific control variables, all statistically significant relations are in

the predicted directions. For example, the regressions show a significant positive effect of the

operating risk (RISK) and growth (GROWTH) variables, and a significant negative effect of firm

size (SIZE) on ownership concentration, consistent with Boubakri et al. (2005). We also find a

negative and significant relation between the privatization method (PRIVATE) and ownership

concentration, suggesting that private sales are more likely than share issued privatizations to

result in higher concentrated ownership, again consistent with Boubakri et al. (2005). However,

PRIVATE becomes statistically indistinguishable from zero when all of the legal institutions

variables are introduced in the last column of Table 4, consistent with prior research that the

choice of the privatization method is influenced by the extent of investor protection (Bortolotti

et al., 2000; Megginson et al., 2004). Finally, an examination of the industry and year estimates

(not reported in Table 4) reveals significant effects for the former only. Consistent with

Demsetz and Lehn (1985) and Boubakri et al. (2005), we find significantly lower levels of

ownership concentration in regulated industries.

In sum, the evidence in this section strongly supports Ball’s (2001) argument that

instituting the proper surrounding auditing environment by liberalizing civil and criminal

litigation against auditors is crucial for governments to improve the quality of financial

reporting in their countries, thereby constraining the diversion of corporate resources by

controlling shareholders.

22

4.2.2 The Role of Disclosure Standards, Auditor-Related Characteristics, and Extra-Legal Institutions

Recent studies argue and find that extra-legal institutions can lead to lower the private

benefits of control (e.g., Dyck and Zingales, 2004; Boubakri, Guedhami, and Sy, 2005). Table 5

presents the regression results for the impact of disclosure standards and auditor-related

characteristics along with three extra-legal institutions, COMPETITION, NEWSPAPER, and

TAX, which respectively proxy for the degree of product market competition, the level of

diffusion of the press (public opinion pressure), and the effectiveness of the tax system.

Across all of the specifications, the results corroborate those in Table 4, including that

SUE AUDITOR and SANCTION AUDITOR are negatively and significantly (at the 1 percent

level) associated with ownership concentration. In comparison, the quality of disclosure

standards (DISCLOSURE) and auditor choice (BIG FIVE) are insignificant, although consistently

with the predicted negative sign. Surprisingly, none of the extra-legal institutions affect

ownership concentration. This finding stands in sharp contrast to recent evidence that extra-

legal institutions, particularly tax compliance (e.g., Dyck and Zingales, 2004; Haw et al., 2004),

limit the extraction of private benefits by insiders. The results for the firm-level controls closely

mirror those in Table 4. Importantly, the coefficient for LGDPC is negative and significant at the

5 percent level across all specifications, suggesting that private control benefits are smaller in

more developed countries that generally enjoy better institutions.

More interesting for our purposes, the results presented in this section strongly suggest

that imposing more severe private and public enforcement on auditors is more effective than

extra-legal institutions in reducing ownership concentration.

4.3 Sensitivity Analysis

Table 6 summarizes our main robustness tests. In the interest of parsimony, we include

only the legal and extra-legal institutional variables that were statistically significant in any of

regressions reported in Tables 4 and 5 when examining the sensitivity of our results to the

23

following issues. First, a few countries contributing a disproportionate share of observations to

the sample might drive our evidence. In particular, firms from Brazil and Nigeria comprise 14.2

percent and 13.7 percent of the sample, respectively. We address this concern by re-estimating

our equations after dropping⎯both sequentially (not tabulated) and altogether (column (1))

⎯firms from these countries. Our results, including that ownership concentration is decreasing

in both SUE AUDITOR and SANCTION AUDITOR, persist in these regressions, implying that

our evidence reflects pervasive economic phenomena rather than some countries dominating

the data.

Second, to ensure that our results are not seriously affected by serial correlation, we

gauge statistical significance with Newey-West (1987) standard errors, which correct for

heteroskedasticity and (first-order) serial correlation. These results, which are reported in

Column (2) of Table 6, continue to support our primary evidence on the importance of the audit

infrastructure variables. Additionally, our results (not tabulated) remain qualitatively identical

when we estimate the models for each postprivatization year, reinforcing that our evidence is

not spuriously induced by multiple observations of the same firm.

Third, some argue that the impact of legal institutions on ownership structure,

particularly ownership concentration, stems from the political orientation of a country. For

example, Roe (2000) contends that social democracies emphasize distributional considerations

and are associated with weaker legal institutions including accounting transparency, making

concentrated ownership the most viable means of control available to shareholders. We

examine this hypothesis by introducing the variable LEFT from LLS (2005), which measures the

percentage of years between 1975 and 1995 during which the party of the country’s chief

executive had a leftist political orientation.11 After including LEFT in the various models in

Tables 4 and 5, we find that the documented effect of each of the test variables is qualitatively

11 We note that this proxy for political orientation has low correlation with the test variables, DISCLOSURE (ρ=-0.03), BIG FIVE (ρ=0.19), SUE AUDITOR (ρ=0.15), and SANCTION AUDITOR (ρ=0.13).

24

unaffected. In particular, Column (5) of Table 6 reveals that results for SUE AUDITOR,

SANCTION AUDITOR, and RULE are not sensitive to the inclusion of LEFT. Interestingly, we

find that that LEFT is positively and significantly (t-statistic = 3.27) related to ownership

concentration, consistent with Roe (2000).

Fourth, we also consider the endogeneity of BIG FIVE and the causality between

ownership structure and auditor choice. Indeed, recent research finds that auditor choice could

be a response to the extent of agency problems associated with ownership structure and other

firm-specific characteristics (e.g., Fan and Wong, 2005). However, this argument can be

undermined by the fact that we conduct our investigation in the context of the privatization

event, which represents a fundamental change in the ownership structure that is seldom

accompanied by a change in the firm’s auditor. Consequently, BIG FIVE is a government choice

variable that is not associated with the ownership structure that emerges following

privatization. Nonetheless, we identified the sample firms that hired a different auditor after

privatization by inspecting their financial statements before and after privatization. This

process yielded three firms that we removed from the sample before re-running our

regressions. Predictably, the results reported in column (4) of Table 6 are virtually identical

with this slightly reduced sample.

Fifth, the results might be driven by some of the firm-level observations relating to the

1980s, while some of the country-level variables relate to the 1990s. Although there is little

evidence from prior corporate governance studies on the significance of this concern and most

of our sample firms are privatized during the 1990s, we respond by excluding all observations

from the period 1980-1989. In this smaller sample, column (5) of Table 6 reports that we still

find that both SUE AUDITOR and SANCTION AUDITOR load negative, consistent with H3 and

H4. Similarly, our evidence in column (6) is materially identical when we exclude observations

after 2000 to coarsely address the fallout from Enron’s restatement of its earnings in 2001,

including that surrounding events may have damaged the reputations of the Big Five auditors.

25

In column (7) of Table 6, our results for SUE AUDITOR and SANCTION AUDITOR are

not sensitive to replacing DISCLOSURE with CIFAR, which is an index that measures the

quality of the financial accounting regime for each country. Developed by the Center for

International Financial Analysis and Research, CIFAR represents the mean number of 90 items

included in the annual reports of a sample of domestic firms. Table 3 reports that the Pearson

correlations of DISCLOSURE with SUE AUDITOR and SANCTION AUDITOR are 0.37 and 0.74,

respectively. Although Bushman and Smith (2004) question its empirical validity as a

disclosure standards metric, the correlations of CIFAR with SUE AUDITOR and SANCTION

AUDITOR are much lower at 0.26 and 0.44, respectively. In contrast to LLSV (1998), who find

in cross-country research that CIFAR loads negatively and significantly in ownership

concentration regressions, we estimate a significant positive coefficient on this variable.

Finally, SUE AUDITOR and SANCTION AUDITOR continue to have significant and

negative coefficients when we: estimate a kitchen-sink specification that includes all of the legal

and extra-legal variables, rather than just the ones that were significant in earlier regressions;

include calendar year dummy variables; handle potential cross-sectional correlation within

countries by relying on robust standard errors that correct for this clustering; more finely

capture the role of legal origin by replacing COMMON with dummy variables indicating

French, German, and Scandinavian civil law countries; and exclude firms from regulated

industries that have considerably lower levels of ownership concentration according to our

descriptive statistics and prior research (Demsetz and Lehn, 1985 and Boubakri et al., 2005).

5. Conclusions

We rely on a unique data set to examine the impact of disclosure standards and auditor-

related characteristics on ownership concentration in 190 privatized firms from 31 countries.

Prior research suggests that high ownership concentration stems from information asymmetry

between minority investors and controlling shareholders, who have strong incentives to exploit

26

their position as insiders to extract private benefits. Transparent financial reporting plays a

natural role in reducing this agency conflict by protecting outside investors since the

expropriation of corporate resources by controlling shareholders depends on these private

benefits remaining hidden.

After controlling for firm-level and other country-level determinants, we find some

evidence that ownership concentration is decreasing in disclosure standards, although this

result is sensitive to model specification. Our research also indicates that auditor choice does

not affect ownership concentration, implying that minority investors perceive that Big Five

auditors’ interest in safeguarding their brand name reputations is inadequate to motivate them

to seriously constrain corporate insiders’ discretion over financial reporting.

However, we mainly contribute to our understanding of international corporate

governance by responding to Ball’s (2001) and Leuz’s (2001) calls for research that sheds light

on whether legal institutions that discipline auditors lead to firms becoming better known in the

capital markets. In particular, we estimate the influence of differences across countries in the

burden of proof required in civil and criminal cases against auditors on ownership

concentration. This evidence implies that governments that genuinely expose auditors to civil

and criminal penalties benefit from firms having more dispersed ownership, suggesting that

minority investors perceive that firms’ financial statements are more credible in these

jurisdictions. Moreover, in multivariate tests, we find that securities laws that facilitate civil and

criminal litigation against auditors subsume the influence of other legal, including disclosure

standards, and extra-legal factors.

In contrast to Dyck and Zingales (2004) and Haw et al. (2004), we find that imposing

more severe private and public enforcement on auditors dominates tax compliance in

explaining ownership concentration in our data. Altogether, consistent with Ball’s (2001)

predictions, our strong, robust evidence suggests that liberalizing the legal infrastructure that

27

governs auditors improves contracting by supporting high-quality financial reporting.

Accordingly, among the set of feasible public policy reforms, our research implies that countries

should pursue enacting securities laws that discipline auditors. In fact, countries could tailor

these reforms to suit their legal traditions with common (civil) law countries lowering the

burden of proof in civil (criminal) cases against auditors.

28

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32

TABLE 1 Summary of the Regression Variables

Country No.

of F

irm

s

No.

of O

bs.

CO

NC

ENTR

ATI

ON

DIS

CLO

SURE

BIG

FIV

E (N

o. o

f Obs

.)

SUE

AU

DIT

OR

SAN

CTI

ON

AU

DIT

OR

RIG

HTS

JUD

ICIA

L

RULE

CO

MPE

TITI

ON

NEW

SPA

PER

TAX

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)

Australia 4 7 0.227 0.75 100 (4) 0.66 0.50 4.00 10.00 10.00 5.52 3.00 4.58

India 12 39 0.058 0.92 0 (12) 0.66 1.00 5.00 8.00 4.17 ---- ---- ----

Malaysia 9 27 0.238 0.92 77.78 (9) 0.66 1.00 4.00 9.00 6.78 4.84 1.60 4.34

New Zealand 3 12 0.609 0.67 100 (3) 0.66 0.00 4.00 10.00 10.00 5.40 2.20 5.00

Nigeria 26 89 0.348 0.67 40 (25) 0.66 1.00 3.00 7.25 2.73 ---- ---- ----

Pakistan 2 6 0.570 0.58 0 (1) 0.66 0.00 5.00 5.00 3.03 ---- ---- ----

Singapore 6 11 0.133 1.00 100 (5) 0.66 1.00 4.00 10.00 8.57 5.21 3.20 5.05

South Africa 1 4 0.534 0.83 100 (1) 0.66 0.50 5.00 6.00 4.42 4.89 0.34 2.40

Thailand 5 17 0.148 0.92 80 (5) 0 1.00 2.00 3.25 6.25 4.77 0.60 3.41

Common Law 68 212 0.32 0.81 66.42 0.59 0.67 4.00 7.61 6.22 5.11 1.82 4.13

Austria 1 4 0.030 0.25 100 (1) 0 0.50 2.00 9.50 10.00 5.29 2.90 3.60

Brazil 27 93 0.585 0.25 91.30 (23) 0.33 0.00 3.00 5.75 6.32 4.90 0.40 2.14

Chile 6 18 0.373 0.58 83.33 (6) 0.33 0.50 5.00 7.25 7.02 5.40 1.00 4.20

Colombia 6 21 0.837 0.42 100 (6) 0.33 0.50 3.00 7.25 2.08 4.71 0.50 2.11

Egypt 1 3 0.800 0.50 100 (1) 0.33 0.50 2.00 6.50 4.17 4.60 0.40 3.57

Finland 6 23 0.051 0.50 100 (6) 0.66 0.50 3.00 10.00 10.00 5.26 4.60 3.53

France 14 50 0.177 0.75 76.92 (13) 0.33 0.50 3.00 8.00 8.98 5.83 2.20 3.86

Germany 3 9 0.163 0.42 100 (3) 0 0.50 1.00 9.00 9.23 5.91 3.10 3.41

Indonesia 5 16 0.143 0.50 100 (5) 0.66 0.50 2.00 2.50 3.98 4.42 0.20 2.53

Italy 1 4 0.063 0.67 100 (1) 0.33 0.50 1.00 6.75 8.33 5.14 1.00 1.77

Japan 1 4 0.00 0.75 100 (1) 0.66 0.00 4.00 10.00 8.98 5.64 5.80 4.41

Jordan 1 3 0.052 0.67 100 (1) 0.33 0.00 1.00 8.66 4.35 ---- ---- ----

Korea, Rep. 5 15 0.090 0.75 100 (5) 0.66 0.50 2.00 6.00 5.35 4.90 3.90 3.29

Mexico 6 16 0.989 0.58 100 (5) 0.33 0.50 1.00 6.00 5.35 4.93 1.00 2.46

Norway 1 3 0.00 0.58 100 (1) 0.66 1.00 4.00 10.00 10.00 4.96 5.90 3.96

33

Country No.

of F

irm

s

No.

of O

bs.

CO

NC

ENTR

ATI

ON

DIS

CLO

SURE

BIG

FIV

E (N

o. o

f Obs

.)

SUE

AU

DIT

OR

SAN

CTI

ON

AU

DIT

OR

RIG

HTS

JUD

ICIA

L

RULE

CO

MPE

TITI

ON

NEW

SPA

PER

TAX

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13)

Peru 5 10 0.668 0.33 100 (5) 0.66 0.50 3.00 6.75 2.50 5.05 0.80 2.66

Philippines 3 4 0.240 0.83 100 (3) 1 0.50 3.00 4.75 2.73 4.61 0.80 1.83

Portugal 12 33 0.590 0.42 75 (12) 0.66 0.00 3.00 5.50 8.68 4.81 0.80 2.18

Spain 1 4 0.300 0.50 100 (1) 0.66 0.50 4.00 6.25 7.80 5.07 1.00 1.91

Sweden 1 4 0.370 0.58 100 (1) 0.33 0.50 3.00 10.00 10.00 5.08 4.50 3.39

Turkey 13 33 0.381 0.50 80 (10) 0.33 0.50 2.00 4.00 5.18 5.14 1.10 2.07

Venezuela, RB 3 10 0.707 0.17 100 (3) 0.33 0.50 1.00 6.50 6.37 4.24 2.06 1.56

Non-Common Law 122 380 0.35 0.52 95.75 0.45 0.43 2.55 7.13 6.70 5.04 2.09 2.88

Mean (all countries) 0.34 0.61 87.24 0.49 0.50 2.97 7.27 6.56 5.06 2.03 3.16

Median (all countries) 0.24 0.58 100.00 0.66 0.50 3.00 7.25 6.37 5.05 1.10 3.39

Std. dev. (all countries) 0.28 0.21 26.68 0.24 0.32 1.28 2.16 2.67 0.40 1.70 1.05

Notes: This table provides information on the sample of 190 privatized firms from 31 countries and reports summary descriptive statistics for someregressions variables used in the hypotheses tests. The definitions and data sources for the variables are reported in Table 2.

34

TABLE 2 Variables, definitions, and sources

Variable Definition Source

Panel A. Legal Institutions

COMMON A dummy variable equal to one for firms from English common law countries, and 0 otherwise.

LLSV (1998)

RIGHTS This index of anti-director rights is formed by adding one when: (1) the country allows shareholders to mail their proxy vote; (2) shareholders are not required to deposit their shares prior to the General Shareholders’ Meeting; (3) cumulative voting or proportional representation of minorities on the board of directors is allowed; (4) an oppressed minorities mechanism is in place; (5) the minimum percentage of share capital that entitles a shareholder to call for an Extraordinary Shareholders’ Meeting is less than or equal to ten percent (the sample median); and (6) when shareholders have preemptive rights that can only be waived by a shareholders meeting. The range for the index is from zero to six.

LLSV (1998)

JUDICIAL Assessment of the efficiency and integrity of the legal environment as it affects business, particularly foreign firms, produced by the country risk rating agency International Country Risk (ICR). It may be taken to represent investors’ assessment of conditions in the country in question. Average between 1980 and 1983. Scale from 0 to 10, with lower scores representing lower efficiency levels. Source: International Country Risk Guide.

LLSV (1998)

RULE Assessment of the rule and order tradition in a country. LLSV (1998) DISCLOSURE An assessment of disclosure requirements relating to: (1) prospectus; (2)

compensation of directors and key officers; (3) ownership structure; (4) inside ownership; (5) contracts outside the ordinary course of business; and (6) transactions between the issuer and its directors, officers, and/or large shareholders. The index ranges from 0 to 1, with higher values indicating more extensive disclosure requirements.

LLS (2005)

CIFAR Index created by examining and rating companies’ 1995 annual reports on their inclusion or omission of 90 items. These items fall into seven categories: general information, income statements, balance sheets, funds flow statement, accounting standards, stock data, and special items. A minimum of 3 companies in each country were studied.

LLS (2005)

SUE AUDITOR Index of the procedural difficulty in recovering losses from the auditor in a civil liability case for losses due to misleading statements in the audited financial information accompanying the prospectus. Equals one when investors are only required to prove that the audited financial information accompanying the prospectus contains a misleading statement. Equals two-thirds when investors must also prove that they relied on the prospectus and/or that their loss was caused by the misleading accounting information. Equals one-third when investors must also prove that the auditor acted with negligence. Equals zero if restitution from the auditor is either unavailable or the liability standard is intent or gross negligence.

LLS (2005)

SANCTION AUDITOR An index of criminal sanctions applicable to the auditor (or its officers) when the financial statements accompanying the prospectus omit material information. Equals zero if the auditor cannot be held criminally liable when the financial statements accompanying the prospectus are misleading. Equals one-half if the auditor can be held criminally liable when aware that the financial statements accompanying the prospectus are misleading. Equals one if the auditor can also be held criminally liable when negligently unaware that the

LLS (2005)

35

financial statements accompanying the prospectus are misleading. Panel B. Extra-Legal Institutions COMPETITION Assessment of product market competition with higher scores

indicating consensus that product market competition is effective. DZ (2004)

NEWSPAPER Circulation of daily newspapers divided by population. DZ (2004) TAX Assessment of the level of tax compliance with the scale ranging from 0

to 1 to reflect the lowest to the highest rate of compliance. DZ (2004)

Panel C. Firm-Level and Other Country-Level Variables

CONCENTRATION A logistic transformation of the percentage of shares held by the three largest shareholders.

Authors’ calculation

BIG FIVE A dummy variable equal to unity for firms with Big Five auditors, and zero otherwise.

Authors’ calculation

RISK The standard deviation of the annual return on equity ratio during the three years preceding the privatization year..

Authors’ calculation

GROWTH Real sales growth rate during the three years preceding the privatization year.

Authors’ calculation

SIZE The natural logarithm of total sales for the year. Authors’ calculation

LATE A dummy variable equal to unity if the sample-firm is privatized after the median privatization date in the country, and zero otherwise.

Authors’ calculation

PRIVATE A dummy variable equal to unity for firms privatized through private sales, and zero otherwise.

Authors’ calculation

LGDPC The natural logarithm of country’s gross domestic product for the year.

Authors’ calculation

36

TABLE 3 Correlations between the Regression Variables

CO

NC

ENTR

ATI

ON

DIS

CLO

SURE

BIG

FIV

E

SUE

AU

DIT

OR

SAN

CTI

ON

AU

DIT

OR

CO

MM

ON

RIG

HTS

JUD

ICIA

L

RULE

CO

MPE

TITI

ON

NEW

SPA

PER

DISCLOSURE -0.413 BIG FIVE 0.147 -0.282 SUE AUDITOR -0.176 0.367 -0.209 SANCTION AUDITOR -0.329 0.741 -0.365 0.282 COMMON -0.228 0.683 -0.339 0.425 0.715 RIGHTS -0.186 0.408 -0.309 0.438 0.195 0.483 JUDICIAL -0.196 0.398 -0.056 0.282 0.307 0.375 0.473 RULE -0.177 -0.003 0.294 -0.211 -0.377 -0.267 0.056 0.374 COMPETITION -0.294 0.321 -0.064 -0.186 0.086 0.035 0.271 0.534 0.583 NEWSPAPER -0.413 0.429 0.091 0.276 0.344 0.191 0.121 0.701 0.578 0.480 TAX -0.390 0.743 -0.010 0.196 0.547 0.663 0.555 0.740 0.543 0.568 0.607

Notes: This table reports Pearson correlations for the regression variables. The definitions and data sourcesfor the variables are reported in Table 2. Boldface indicates statistical significance at the 1% level. Spearmancorrelations (unreported for brevity) are consistent with the Pearson correlations.

37

TABLE 4 Regressions of Ownership Concentration on Disclosure Standards, Auditor-Related Characteristics, and

Legal Variables

Variable Expected sign

BASIC (1)

LEGAL (2)

RIGHTS (3)

JUDICIAL (4)

RULE (5)

ALL (6)

Intercept (?) 6.884*** 7.211*** 6.805*** 7.074*** 3.643*** 2.687 (5.758) (5.503) (5.527) (5.564) (2.796) (1.394)

DISCLOSURE (-) -1.339* -0.961 -1.467* -1.337* -1.221* -1.794 (-1.478) (-0.913) (-1.335) (-1.439) (-1.350) (-1.149)

BIG FIVE (-) 0.425 0.396 0.446* 0.511* -0.034 0.071 (1.557) (1.476) (1.658) (1.818) (-0.134) (0.280)

SUE AUDITOR (-) -2.549*** -2.449*** -2.620*** -2.990*** -2.315*** -3.295*** (-3.624) (-3.611) (-3.861) (-3.814) (-3.424) (-4.570)

SANCTION AUDITOR (-) -2.508*** -2.404*** -2.469*** -2.888*** -2.512*** -3.149*** (-4.352) (-4.103) (-4.064) (-4.099) (-4.182) (-3.300)

COMMON (-) -0.410 0.277 (-0.920) (0.530)

RIGHTS (-) 0.042 0.115 (0.244) (0.503)

JUDICIAL (-) 0.130 0.230* (1.642) (1.847)

RULE (-) -0.578*** -0.730*** (-5.296) (-5.448)

RISK (+) 2.077*** 2.059*** 2.076*** 2.055*** 1.466** 1.275** (2.847) (2.816) (2.849) (2.834) (2.018) (1.765)

GROWTH (+) 0.357** 0.352** 0.361** 0.402** 0.337** 0.424*** (2.053) (1.995) (2.062) (2.297) (2.034) (2.689)

SIZE (-) -0.406*** -0.419*** -0.406*** -0.399*** -0.417*** -0.398*** (-6.037) (-6.129) (-6.040) (-5.998) (-6.226) (-5.761)

LATE (-) -0.172 -0.153 -0.165 -0.245 -0.251 -0.396* (-0.636) (-0.562) (-0.631) (-0.890) (-0.929) (-1.566)

PRIVATE (+) 0.949*** 0.950*** 0.920*** 0.839*** 0.595** 0.226 (2.695) (2.702) (2.692) (2.358) (1.717) (0.646)

LGDPC (?) -0.018 -0.052 -0.014 -0.124 0.880*** 0.961*** (-0.150) (-0.406) (-0.118) (-0.850) (4.525) (3.119)

INDUSTRY EFFECTS YES YES YES YES YES YES YEAR EFFECTS YES YES YES YES YES YES Adj. R2 0.395 0.395 0.394 0.397 0.424 0.434 F-statistics 13.66*** 9.57*** 13.26*** 10.82*** 13.55*** 13.51*** N 472 472 472 472 472 472

Notes: This table presents OLS regression results for the ownership concentration on disclosure standards and auditor-related characteristics, while controlling for legal institutions variables. The regression variables are specified in Table 2. Below each estimate is reported the robust t-statistic. F-statistic is for the test DISCLOSURE = BIG FIVE = SUE AUDITOR = SANCTION AUDITOR = 0. The superscripts asterisks ***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively, one-tailed when directional predictions are made, and two-tailed otherwise.

38

TABLE 5 Regressions of Ownership Concentration on Disclosure Standards, Auditor-Related Characteristics, and

Extra-Legal Variables

Variable

Expected sign

COMPETITION (1)

NEWSPAPER (2)

TAX (3)

ALL (4)

Intercept (?) 12.410*** 15.475*** 13.586*** 14.829*** (5.288) (5.315) (8.393) (4.683)

DISCLOSURE (-) -0.696 -0.174 -1.216 -0.856 (-0.604) (-0.136) (-0.899) (-0.597)

BIG FIVE (-) -0.105 -0.173 -0.133 -0.164 (-0.307) (-0.496) (-0.387) (-0.479)

SUE AUDITOR (-) -1.957*** -2.544*** -2.274*** -2.531*** (-2.595) (-3.002) (-3.257) (-2.786)

SANCTION AUDITOR (-) -2.827*** -3.423*** -3.017*** -3.460*** (-3.921) (-3.393) (-4.279) (-3.429)

COMPETITION (-) 0.342 0.191 (0.648) (0.352)

NEWSPAPER (-) 0.208 0.204 (0.953) (0.926)

TAX (-) 0.294 0.243 (1.018) (0.845)

RISK (+) 1.382* 1.435* 1.516** 1.545** (1.495) (1.570) (1.662) (1.689)

GROWTH (+) 0.235* 0.236* 0.245* 0.253* (1.307) (1.323) (1.392) (1.407)

SIZE (-) -0.508*** -0.516*** -0.478*** -0.489*** (-5.393) (-5.483) (-4.840) (-5.009)

LATE (-) 0.472 0.484 0.423 0.439 (1.445) (1.474) (1.271) (1.306)

PRIVATE (+) 0.808** 0.784** 0.753** 0.749** (2.195) (2.159) (2.084) (2.054)

LGDPC (?) -0.648*** -0.789** -0.675*** -0.915** (-2.696) (-2.410) (-2.930) (-2.298)

INDUSTRY EFFECTS YES YES YES YES YEAR EFFECTS YES YES YES YES Adj. R2 0.452 0.453 0.453 0.451 F-statistics 10.32*** 7.36*** 9.02*** 5.38*** N 348 348 348 348

Notes: This table presents OLS regression results for the ownership concentration on disclosure standards and auditor-related characteristics, while controlling for extra-legal institutions variables. The regression variables are specified in Table 2. Below each estimate is reported the robust t-statistic. F-statistic is for the test DISCLOSURE = BIG FIVE = SUE AUDITOR = SANCTION AUDITOR = 0. The superscripts asterisks ***, **, and * denote statistical significance at the 1%, 5%, and 10% levels, respectively, one-tailed when directional predictions are made, and two-tailed otherwise.

39

TABLE 6 Regressions of Ownership Concentration on Disclosure Standards and Auditor-Related Characteristics

Variable

Without Brazil

and Nigeria (1)

Newey-West Correction

(2) Political Ideology

(3)

Without Auditor Switchers

(4)

Without 1980-1989 period

(5)

Without 2001-2003 period

(6)

Alternative Disclosure

Standards Proxy (7)

Intercept 4.001*** 3.903*** 1.171 4.114*** 3.768*** 4.106*** 3.062** (2.925) (2.548) (0.933) (3.228) (2.677) (3.091) (2.100)

DISCLOSURE -1.698** -1.058 -1.768** -1.253* -1.143 -1.350* 0.051** (-1.939) (-0.972) (-2.090) (-1.392) (-1.281) (-1.359) (2.209)

BIG FIVE -0.232 -0.060 0.214 -0.020 0.324 -0.134 0.108 (-0.610) (-0.181) (0.782) (-0.074) (1.204) (-0.491) (0.389)

SUE AUDITOR -1.600*** -2.340*** -1.322*** -2.373*** -2.135*** -2.850*** -2.887*** (-2.441) (-2.751) (-2.400) (-3.511) (-3.073) (-3.870) (-3.700)

SANCTION AUDITOR -1.114** -2.621*** -1.807*** -2.574*** -2.705*** -2.4179*** -4.507*** (-1.820) (-3.620) (-3.325) (-4.344) (-4.456) (-3.757) (-6.544)

RULE -0.574*** -0.571*** -0.901*** -0.559*** -0.578*** -0.5692*** -0.731*** (-4.954) (-4.169) (-7.181) (-5.144) (-4.883) (-5.136) (-5.718)

LEFT 3.271*** (5.794)

RISK -0.167 1.439* 1.574** 1.426** 1.555** 1.628** 1.460** (-0.177) (1.640) (2.253) (1.961) (1.943) (2.151) (1.990)

GROWTH 0.258** 0.336** 0.367** 0.334** 0.351** 0.301** 0.372** (1.834) (1.768) (2.140) (2.020) (2.158) (1.7620) (2.269)

SIZE -0.448*** -0.437*** -0.662*** -0.437*** -0.407*** -0.440*** -0.433*** (-5.582) (-5.158) (-9.431) (-6.466) (-5.819) (-6.153) (-6.258)

PRIVATE 0.722** 0.590* 0.214 0.564* 0.371 0.558* 0.360 (2.214) (1.373) (0.608) (1.576) (1.034) (1.538) (0.982)

LGDPC 0.842*** 0.859*** 1.613*** 0.838*** 0.790*** 0.903*** 0.732*** (3.849) (3.605) (7.054) (4.403) (3.781) (4.618) (3.126)

INDUSTRY EFFECTS YES YES YES YES YES YES YES YEAR EFFECTS YES YES YES YES YES YES YES Adj. R2 0.462 0.425 0.476 0.426 0.425 0.428 0.449 F-statistics 7.14*** 9.19*** 11.07*** 13.23*** 10.92*** 14.19*** 15.10*** N 332 472 472 464 433 444 433