The Relationship between Voluntary Disclosure and Independent Directors in the Presence of a Dominant Shareholder

Abstract

Differently from prior studies that examine the role of stand-alone control systems within the relationship between owners and managers, our study investigates the correlation between two control mechanisms – voluntary disclosure and independent directors – in companies characterized by the presence of a dominant shareholder that is supposed to mitigate the classical agency problem. Based on agency theory, we hypothesize that the two mechanisms tend to coexist, since the presence of either one reduces the costs of introducing the other. Two further effects – the reputation and the domino effect – contribute to determine a positive relationship between the two mechanisms. We carried out the empirical analysis on 175 non-financial Italian listed companies, all controlled by a dominant shareholder. Voluntary disclosure is measured through three alternative disclosure indexes. Independent directors are identified not only according to a formal/legal definition, but also through stricter criteria. The empirical test is based on a multivariate analysis controlling for size, residual ownership diffusion, leverage, profitability and labour pressure. Results support our hypothesis and are robust to alternative criteria to identify dominant shareholders. Our study contributes to a better understanding of the relationship between different control mechanisms in particular agency settings.

Acknowledgements

We thank the participants at the 27th EAA Annual Conference Meeting in Prague, at the 6th Emerging Issues in International Accounting and Business Conference Meeting in Padua, and at the seminar at Erasmus University Rotterdam for their helpful comments. Special thanks to Wim Van der Stede for his suggestions. We gratefully acknowledge Professor Botosan for providing us with all the details necessary to use her instrument to measure voluntary disclosure.

Notes

¹All that we affirm in the paper can also be referred to the case in which there is a dominant ‘group of shareholders’, that is, the case in which a group of shareholders agreed to vote and behave like a single shareholder.

²For a more complete literature review on these topics, see Hermalin and Weisbach (2003).

³For a wider review of such studies, see Anderson and Reeb (2004).

⁴The professional press provides many articles, suggesting that the outsiders are aware of the risk of collusion and are able to distinguish formal from real monitoring. See, for example, Plutino (2002), Il Mondo (2003, 2004), De Rosa (2004), Incorvati (2004) and Sabbatini (2004).

⁵In most cases, this was due to the fact that these companies were no longer listed when we carried out the data collection.

⁶Commented description of the five categories of information can be found in the article written by Botosan and published in The Accounting Review in 1997.

⁷Neither Italian law nor Italian accounting standards specifically deal with segment information, apart from sale revenues. The only reference to segment data is stated in Communication No. DAC/98084143, a document issued in October 1998 by the Commissione Nazionale per le Società e la Borsa (CONSOB, the Italian Stock Exchange Commission). This document consists of an invitation to all listed companies to disclose segment information according to IAS 14-revised, but since no clear sanction is stated for the failure to meet this request, it is not considered mandatory. Earlier studies showed that there is high variety in the segment information disclosed by Italian companies (Prencipe, 2004).

⁸In particular, the variable measuring the company's leverage (LEV) shows two outliers. These are companies reporting a negative value for equity, resulting in leverage with no clear meaning. Two other outliers were found in relation to the other variables. The inclusion of these values in the empirical multivariate model does not change our results.

⁹A recent study on voluntary disclosure conducted on a European country (Depoers, 2000) proposes foreign activity (measured as exports on sales ratio) and barriers to entry (measured as gross fixed assets) as two determinants of the level of discretionary information disclosed by the companies in their annual reports. This information is not always disclosed by Italian listed companies. For companies with available data, we ran our main regression model including these additional control variables. Regression results still strongly support our hypothesis.

¹⁰We still eliminated those items which are mandatory according to Italian regulation.

¹¹In addition to 50%, of voting rights, we considered several other thresholds to identify the presence of a dominant shareholder, that is, 20, 30 and 40%. Moreover, we considered not only the voting rights but also the shares owned by the shareholders. All the different proxies provide similar and consistent results.

¹²Similarly, previous studies focused on relatively small samples. For example, Botosan (1997) analysed 122 reports and Depoers (2000) analysed 102 reports.