THE DETERMINANTS OF FINANCIAL RATIO DISCLOSURES AND QUALITY: AUSTRALIAN EVIDENCE

Norhani Aripin Greg Tower1 Grantley Taylor School of Accounting Curtin University of Technology Perth, Western Australia Australia

Paper Submission to

Accounting & Finance Association of Australia and New Zealand (AFAANZ) Annual Conference Sydney, Australia 6-8 July 2008
Research Area: Financial Accounting
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Corresponding author:

Professor Greg Tower, FCPA

School of Accounting Curtin University of Technology GPO Box U1987, Perth, WA 6845, Australia Telephone +61 8 9266 2878 Facsimile +61 8 9266 7196 Email G.Tower@curtin.edu.au

THE DETERMINANTS OF FINANCIAL RATIO DISCLOSURES AND QUALITY: AUSTRALIAN EVIDENCE Abstract This study examines the predictors of the extent and quality of financial ratio disclosures in the 2007 annual reports of a sample of Australian listed companies. Agency theory is utilised as the underlying theoretical framework to offer insights into financial ratio disclosure patterns. The extent of financial ratio disclosures is captured through a 43 items-template. In addition, a 16 items-template evolved from the IASB Conceptual Framework to measure the quality of financial ratio disclosures is utilised. Statistical techniques including t-tests, analysis of variance and regression confirm that the firms with higher proportion of independent directors on the board, larger in size and a higher proportion of independent auditors are likely to disclose financial ratios more extensively. Further, different industry categories tend to disclose different quality of financial ratios in the annual report. The above results are consistent with agency theory tenets. The findings of this research have important implications for understanding managerial disclosure incentives as they relate to the extent and quality of financial ratio disclosures in Australia. In particular, the extent of financial ratio disclosures is found to be very low. Interestingly, the finding reveals that the quality of financial ratio disclosures is high with some exceptions. Predictors such as board composition, firm size, auditors independence and industry clearly play their role to enhance the extent and quality of financial ratio disclosures in the annual reports. Key words: Financial ratio, voluntary disclosure, extent, quality, Australia

1.0 INTRODUCTION This study provides evidence on financial ratio disclosure patterns in the annual reports of Australian listed firms for the 2007 financial year. The objective of this research is to investigate the determinants of the extent and quality of financial ratios disclosures. Based on extant literature and agency theory tenets, corporate governance, ownership structure and firm size are predicted to influence the level and quality of these disclosures.

A financial ratio disclosure index is developed based on literature to investigate the extent of financial ratio disclosures in annual reports. The five main categories of financial ratio information examined are share market measures, profitability, capital structure, liquidity and other ratios (Wild et al. 2007; Hoggett et al. 2006; Stickney et al. 2004).

The quality of financial ratio disclosures is measured using the four key qualitative characteristics of financial information embedded within the Framework for the Preparation and Presentation of Financial Statements issued by International Accounting Standards Board (IASB 1989). These qualitative characteristics are relevance, reliability, comparability and understandability. This Framework is utilised by virtually all national accounting standard-setting bodies including the Australian Accounting Standard Board (AASB) and represents an objective means to measure disclosure quality. Further, these overarching principles are widely accepted both by academics and practitioners as a measure of quality (Giordano-Spring and Chauvey 2007).

The key research questions of this study are:

1.

What is the extent of disclosure of financial ratio information in the annual

reports of Australian listed companies? 2. What is the quality of disclosure of financial ratio information in the annual

reports of Australian listed companies? 3. What corporate governance and firm-specific factors influence the extent and

quality of financial ratio disclosures in the annual reports of Australian listed companies?

1.1 Significance of research Traditionally, financial ratio analysis has been used to predict the solvency of firms (Neophytou and Molinero 2004; Eisenbeis 1977; Wilcox 1971; Altman 1968; Beaver 1966). Horrigon (1965) found that financial ratios are an efficient predictor of a variety of financial problems and future profitability of firms. Gibson (1982, p.18) stated that probably no tool is more effective in evaluating the financial future of a company than the proper use of financial ratios.

Financial ratio disclosures are critically important for several reasons. First, the disclosures serve as the crucial information for users of financial statements, including sophisticated or non sophisticated users. Sophisticated users are reliant on disclosed financial ratios to assess the performance of companies. Therefore, providing a comprehensive set of financial ratios and clearly communicating how each was defined are crucial sources of information. For non-sophisticated users, the financial ratio disclosures enable them to make more informed investment decision making. In addition, many ratios computed

today are not standard. The lacks of uniformity limits the comparability in financial statements analysis and encourages companies to disclose the most favourable ratios to suit their firms business disposition and future objectives (Gibson and Boyer 1980). Thus, standardised and transparent financial ratio disclosures are essential to overcome these problems.

Gibson (1982) provides a list and description of ratios that are frequently used in annual reports. Despite their wide use and stated importance, there typically is a paucity of financial ratio information disclosed in companys annual reports. Watson et al. (2002) investigate the relationship between financial ratio disclosures and firm characteristics in U.K and they found that industry and size affect the ratio disclosures policy. Mitchells (2006) study of Australian companies financial ratios in the early 1990s suggests that share market measures and profitability ratios are the most informative and relevant items to be provided. To date there has been little agreement on what should be disclosed due to the voluntary nature of financial ratio disclosures (with the notable exception of Earnings per share or EPS). Importantly, there have been limited studies which compare differences in corporate governance attributes and financial ratio disclosures and its quality. This highlights the requirement to understand how and why financial ratio information disclosures, especially the quality of those disclosures, are made by firm management and the board of directors. Most studies in the field of financial reporting quality have solely focussed on the extent of disclosure. Few writers have been able to draw on a disclosure index or content analysis to measure the quality of financial reporting. Moreover, far too little attention has been paid

to the qualitative characteristics of financial information as inculcated into the IASBs (and AASBs) Framework. Thus, examination of the quality of financial ratios generates important new insights into managerial disclosure incentives.

This particular research study is thus significant for three main reasons. First, this is the first comprehensive analysis of financial ratio disclosures for Australian companies as empirical evidence in the context of extent and quality of disclosures. Second, past studies on financial reporting quality tend to solely focus on a perceived measure of quantity of disclosure rather than the inherent qualitative characteristics of the information itself. This study utilises the qualitative characteristics as a matrix to evolve a measure for the quality of financial ratio disclosures. Third, there are hypothesised associations between corporate governance, ownership structure and firms characteristics and the financial reporting practices by companies. This study aims to test these elements in relation to financial ratio disclosures to develop a better understanding of how and why these ratios are disclosed.

2.0 THEORETICAL BACKGROUND AND HYPOTHESES 2.1 Overview of agency theory This research employs agency theory to assist in determining suitable factors that could influence voluntary financial ratio disclosure patterns. Agency theory is concerned with the relationship between the principal (owner) and agent (manager) of the firms. The underlying basis of agency theory is that one party (the principal) assigns work to another (the agent) who performs that work. According to Jensen and Meckling (1976, p.308), agency relationship is defined as a contract under which one or more persons (the

principal/s) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent. Barley and Means (1932) suggests, an inevitable conflict of interest exists between the shareholders and the officers in a giant corporation, if share ownership is widely diffuses, as cited in Hessen (1983, p.277).

Jensen and Meckling (1976) explain that agency theory enhances understanding of the situation where separate ownership and control between owner and top management of the firm occurs. They also suggest that these parties have their own concerns and preferences giving rise to what is known as a conflict of interest. A conflict of interest arises from divergent goals between the principal and agent, and difficulties in monitoring agents actions (Eisenhardt 1989).

According to Fama and Jensen (1983), a considerably high cost is needed to monitor the actions and decisions made by an agent. This is because full monitoring of an agents actions seems unlikely in any principal-agent contract especially for firms in developed industrial societies (Scott 1997). This argument is in line with Akerlof (1970) who argued information asymmetry or a lemons problems exists that originates from divergence of information and motivation between shareholders and managers.

Further, Jensen and Meckling (1976) highlighted agency costs as a component of expenditures incurred by the principal to monitor the agent, the agents cost on bonding, and the residual loss. In addition, Healy and Palepu (2001) suggested the resolution to

agency problems may require formal contracts, monitoring of management by the board of directors, information intermediaries and the market for corporate control. This argument is in line with that of Fama and Jensen (1983) who suggested effective control procedures are crucial to minimise the potential for the agent to engage in opportunistic behaviour.

2.2 Agency theory and voluntary financial reporting A major agency problem is information asymmetry where the agents possess and utilise information for their own personal welfare, which the principal may not possess. This happens because it is assumed that the owner cannot explicitly scrutinise the managers behaviour (Beaver 1998; Scott 1997). An example of this situation is where a team of managers may have inside information on the positive future of a firm and take action and make decisions that will mostly benefit them at the potential expense of the principal. Meek et al. (1995, p.555) defined voluntary disclosure as disclosure in excess of requirements represent free choices on the part of company managements to provide accounting and other information deemed relevant to the decision needs of users of their annual reports. Over the past decade, there has been an increasing amount of literature focussing on voluntary financial reporting as a tool to mitigate the agency problem.

McNally et al. (1982) analysed the interaction between user preferences, firm attributes and disclosure practices of voluntary information in New Zealand. To get a view of user preferences, questionnaires were sent to financial editors and stock exchange members. They also incorporated the firms attributes such as financial characteristics, auditor and industry classification. They found significant differences between the level of disclosure

practised by companies and the level of disclosure perceived as important by users. The findings of their study demonstrate that information asymmetry between managers and stakeholders contribute to disclosure practices of firms.

A classic study on voluntary interim reporting by Leftwich et al. (1981) outlined three monitoring devices which can reduce agency costs. There are publication of accounting reports, appointment of outside directors and listing requirements of stock exchanges. In Denmark, Petersen and Plenborg (2006) investigated the level of voluntary disclosure that affects informational asymmetry for individual industrial companies listed on the Copenhagen Stock Exchange. By analysing the annual reports of 36 companies for the period 1997-2000, they investigated whether voluntary disclosure does have an impact on information asymmetry. The theoretical foundation employed for their study was that the information asymmetry should be reduced by greater disclosure. Kelly (1994) noted that diversification can lead to higher agency cost of debt and equity capital. Thus, these studies show that disclosure can help reduce the cost of monitoring managers use of corporate assets for self-interested purposes.

In addition, McKinnon and Dalimunthe (1993) examined the level of voluntary disclosure of segment information in Australia. One of the variables that attracted attention is the presence of minority interests of firms. They found favourable support that Australian diversified firms are more likely to voluntarily disclose segment information if they have minority interests in their subsidiary companies. This result indicates that disclosure of

segment information provides incentives to align the interests between managers and minority interests and is therefore likely to reduce information asymmetry problems.

Botosan and Harris (2000) tested the association between cost of capital and extent of disclosures. They argued that having more frequent disclosure should trim down the cost of capital by reducing the uncertainty of a firms value. They found that U.S. firms initiating quarterly segment disclosures experienced an increase in information asymmetry, which is measured by analysts consensus. They conclude that managers use disclosure policy to accommodate the higher information asymmetry situation of firms.

Healy and Palepu (2001) suggested that information asymmetry and agency conflicts between contracting parties in an organisation lead to the development of financial reporting and disclosure policy of the firm. They posited that outside investors have less information compared to managers with regards to a firms performance. In the real business world where the market is not perfectly-efficient, they believed that managers use financial disclosure policy to balance the decisions they make and communicate to the outside shareholders. This illustrates that information asymmetry problems influence the financial disclosure policy choice of the company.

Lundholm and Winkle (2006) discussed the motivation for disclosure. They argued that voluntary disclosure can be utilised to reduce the information asymmetry problems. They noted that conflicts arise when managers make decisions either to disclose or not disclose

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certain information. This conflict generally occurs because of the information asymmetry problem.

The aforementioned discussion demonstrates that the agency problem including information asymmetry is an important and interesting area to consider. As asserted by Barako (2004), managers may focus on their own personal interests, rather than maximising shareholders wealth. Thus it is essential for shareholders to create the mechanisms to mitigate agency problems by aligning the interests between principal-agent or by monitoring the agents opportunistic behaviour. As posited by Mallin (2007, p.14): The call for improved transparency and disclosure embodied in corporate governance codes and in International Accounting Standards should improve the information asymmetry situation so that investors are better informed about the companys activities and strategies. Therefore, as suggested by agency theory tenets, corporate governance could serve as one of the monitoring mechanisms.

2.3 Corporate governance Corporate governance factors have the potential to minimise agency problems between managers and shareholders (Barako 2004; Bathala and Rao 1995; Baysinger and Hoskisson 1990). There are internal and external governance mechanisms designed to reduce agency costs. These mechanisms are essential to moderate the self-serving activities of managers. In Australia, the ASX Corporate Governance Council has recommended that Australian listed companies adopt key governance attributes. The ASX listing rules require disclosure

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of these attributes in the annual reports of listed firms and any departure from the ASX best practice governance recommendations and principles. Adoption of governance attributes as recommended by the Council constitute one mechanism to reduce agency problems arising from the separation of ownership and control (Jensen and Meckling 1976).

For the purpose of this study, the strength of corporate governance is measured as the proportion of independent directors on the board. As posited by Bathala and Rao (1995), composition of the board is one of several factors that can mitigate agency conflicts within the firm. Their argument is that independent directors are needed on the boards to monitor and control the actions of executive directors who may engage in opportunistic behaviour (Jensen and Meckling 1976) and also to ensure that managers are working in the best interest of the principal (Baysinger and Hoskisson 1990).

Cheng and Courtenay (2006) found that boards with a larger proportion of independent directors are significantly and positively associated with higher levels of voluntary disclosure in Singapore. In addition, Chen and Jaggi (2000) examined the association between independent directors and corporate disclosure. They found a positive relationship between a board with a higher proportion of independent directors and comprehensive financial disclosure. These findings are consistent with agency theory tenets where a higher proportion of independent directors enhances voluntary financial reporting (Barako et al. 2006). The reason for this is that the presence of independent directors reduces the cost of voluntary information because directors are generally independent of the day-to-day business operations of the firm (Patelli and Prencipe 2007).

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Palmieri (1979) stated that independent directors are critically important because their extensive knowledge, experience and they are independent from management, and therefore serve an important role to minimise agency problems. As highlighted by John and Senbet (1998), board composition is an important element to determine the effectiveness of the board. Haniffa and Cooke (2002) argue that an independent board serves as an important check and balance mechanism in enhancing boards effectiveness. Support for these assertions is further provided by Fama and Jensen (1983), Pettigrew and McNulty (1995) and Eng and Mak (2003) .

Further, the effect of good governance practices on the quality of financial reporting has recently received attention from researchers (Beasley et al. 2000). Beasley (1996) found that no-fraud firms have boards that have a significantly higher percentage of outside members than fraud firms. Goodwin and Seow (2002) argue that sound governance by board of directors influence the quality of financial reporting.

Consistent with this rationale, it is expected that the extent and quality of financial ratio information disclosed will be positively related to the percentage of the independent directors on the board. Therefore, the following hypotheses are proposed: H1a: The extent of financial ratio disclosures is positively associated with the proportion of independent directors on the board. H1b: The quality of financial ratio disclosures is positively associated with the proportion of independent directors on the board.

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2.4 Ownership structure Ownership structure is another mechanism well established in the literature that aligns the interest of shareholders and managers (Eng and Mak 2003; Haniffa and Cooke 2002; Chau and Gray 2002; Hossain et al. 1994). It is believed that agency problems (Jensen and Meckling 1976) will be higher in the widely held companies because of the diverse interests between contracting parties (Mohd Ghazali and Weetman 2006). By utilising voluntary disclosure, managers provide more information to signal that they work in the best interests of shareholders.

In this study, ownership structure is proxied by ownership concentration. Using agency theory tenets, it is argued that firms with higher concentration of ownership structure may disclose less information to shareholders through discretionary disclosure. It is because the concentrated ownership structure provides firms lower incentives to voluntarily disclose information to meet the needs of non-dispersed shareholders groups. In Australia,

McKinnon and Dalimunthe (1993) note that companies with a dispersed ownership structure disclose more voluntary information. In addition, Hossain et al. (1994) reported a negative association between ownership structure concentration and the level of voluntary disclosure by Malaysian listed firms. In France, Lakhal (2005) found that share ownership concentration is statistically and negatively associated to voluntary earnings disclosures. Oliveira et al. (2006) also documented that firms with a lower shareholder concentration voluntarily disclose more information about intangibles in Portugal. The significant role of

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ownership concentration in influencing financial disclosures practices is clearly evident in previous studies worldwide regarding financial reporting practices of firms.

It is expected that ownership structure will influence the voluntary disclosure of financial ratio as well as its quality. These hypotheses are formally stated as: H2a: The extent of financial ratio disclosures is negatively associated with a higher ownership concentration. H2b: The quality of financial ratio disclosures is negatively associated with a higher ownership concentration.

2.5 Firm size A large body of literature have noted the impact of firm size on the disclosure practices of firms (Hossain et al. 1994; Wallace et al. 1994; Chow and Wong-Boren 1987; Buzby 1975; Singhvi and Desai 1971). Most of these studies found that size does affect the level of financial reporting of companies.

Watson et al. (2002) investigated the voluntary disclosure of accounting ratios in UK. Their result suggests that large companies are more likely to disclose ratios than small companies. Barako et al. (2006) studied the factors influencing voluntary corporate disclosure by Kenyan companies and found that size is one of the factors that encourage the firm to disclose more information. In another voluntary environmental disclosure study by large UK companies, Brammer and Pavelin (2006) also noted that the larger the firm, the more likely they will make voluntary disclosures of environmental issues.

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Based on the study done world wide, for example USA (Singhvi and Desai 1971; Buzby 1975); UK (Watson et al. 2002); Mexico (Chow and Wong-Boren 1987); Sweden (Cooke 1989); Spain (Wallace et al. 1994); Hong Kong (Ho and Wong 2001); New Zealand (Hossain et al. 1994), they suggested the underlying reasons why larger firms disclose more information. For instance, Singhvi and Desai (1971) argued that larger firms tend to provide better quality disclosure because of the lower cost of accumulating detailed information. The other reasons proposed are that managers of larger companies are more likely to realise the possible benefits of better disclosure and small companies are more likely to feel that full disclosure of information could endanger their competitive position. According to Jensen & Meckling (1976), larger firms tend to have a higher proportion of outside capital and higher agency costs. It can be concluded that firm size does matter to the voluntary financial reporting practices of companies. Thus, the impact of firm size is expected to be positively associated with the extent and quality of financial ratio disclosures. The hypotheses designed to test this assertion are formally stated as:

H3a: The extent of financial ratio disclosures is positively associated with firm size. H3b: The quality of financial ratio disclosures is positively associated with firm size.

3.0 EMPIRICAL TESTS 3.1 Sample selection and data source The 2007 year annual reports of 40 listed Australian companies are examined to relate the extent of disclosures of financial ratio information and the quality of financial ratios

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information disclosed to key predictor variables. The companies are stratified randomly selected from Australian Stock Exchange (ASX). The following criteria are applied in selecting sample firms: 1. The firms are selected from the four major categories of industry, namely resources, manufacturing, services and financials. 2. The annual reports of firms are available on-line, either through ASX or firms website.

3.2 Dependent variable measure There are two dependent variables for this study, the Extent of Financial Ratio Disclosure (EFRD) and the Quality of Financial Ratio Disclosure (QFRD).

3.2.1 Extent of financial ratio disclosure (EFRD) The Extent of Financial Ratio Disclosure (EFRD) Index is the proxy measure for the extensiveness of financial ratio disclosures. This variable captures the amount of voluntary financial ratio disclosures in the annual reports. A disclosure index template comprising a comprehensive list of ratios commonly discussed by seminal authors is developed. They are categorised into five major categories as advocated by Mitchell (2006). These metacategories are Share Market Measures, Profitability, Capital Structure, Liquidity and Other Miscellaneous. Earning per share (EPS) ratio is excluded since it is the sole financial ratio mandated by the AASB. Each voluntary ratio is dichotomously scored as being disclosed (1) if present in the annual report for each company and (0) otherwise. The EFRD score is computed by summing up all items disclosed divided by the maximum number as

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determine by the literature (see Appendix 1). represented as follows: EFRDj =

The EFRD2 score is mathematically

total number of financial ratios disclosed total possible financial ratios (43) (non applicable items)

Where EFRDj = Extent of Financial Ratio Disclosures for firm j 3.2.2 Quality financial ratio disclosure (QFRD) The Quality of Financial Ratio Disclosure (QFRD) Index measures the quality of financial ratio disclosure using the qualitative characteristics of financial information as advocated by the IASB/AASB theoretical framework. Sixteen key criteria (see Appendix 2) based on IASB authoritative pronouncements are used to construct the quality index. This qualityoriented template comprises four elements of qualitative characteristics include relevancy, reliability, comparability and understandability (Giordano-Spring and Chauvey 2007; Mensah et al. 2006; Jonas and Blanchet 2000). For each element, four components are proposed in measuring the quality of ratio disclosures: 1) Relevancy- predictions, feedback, timeliness, comprehensiveness 2) Reliability- verifiability, faithful representation, audit quality, independent audit committee 3) Comparability- over time, industry benchmark, consistency, segmental ratio 4) Understandability- comprehension, presentation, location, explanation.

Thus, a 16 item quality matrix (4x4) is evolved. Each ratio disclosed is dichotomously scored as: one (1) if met each criterion or otherwise zero (0) otherwise. A QFRD score is
2

For items that are clearly not applicable to sample firms, the denominator (43) is reduced accordingly. For instance, financial ratios that examine inventory turnover may not be applicable to financials companies.

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then computed3 by summing all items disclosure quality divided by maximum score of quality which in this case is 16. A QFRD score is calculated for each firm. The QFRD score is mathematically represented as follows: QFRDj = total score for disclosure quality total possible qualitative characteristics (16) (non applicable items)

Where QFRDj = Quality Financial Ratio Disclosure for firm j. 3.3 Independent variables measure To examine the extent and the quality of financial ratio disclosures in the annual report, the following independent variables are tested: board composition, ownership concentration and firm size. Board composition (BODCOMP) is defined as the proportion of independent directors on the board. The Principles of Good Corporate Governance and Best Practice

Recommendations (ASX Corporate Governance Council 2003) state a company should have a majority of independent directors on their board. Therefore, BODCOMP is a measure of the percentage of independent directors to total number of directors on the board of directors. The BODCOMP is treated as a continuous variable.

To create a proxy measure for Ownership Concentration Score (OCS), total shareholding of top 20 shareholders is used. OCS will be treated as a continuous variable by dividing number of shares owned by top twenty shareholders by the total number of shares issued. Firm size measurement is extensively studied in the past research. In Australia, McKinnon and Dalimunthe (1993) used log of total assets and log of number of shareholders to
3

For items that are clearly not applicable to sample firms, the denominator (16) will be reduced accordingly.

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measure firm size. For this research, firm size is measured as the natural logarithm of total assets. As noted by Hossain et al. (1994), natural logarithmic transformation reduces skewness in the data set.

In order to control for other effects on the dependent variables, six (6) control variables are employed. These are: Industry (IND) - categorised into four major classifications [1] Resources [2] Manufacturing [3] Services [4] Financials; Leverage (LEV) ratio of total debt to total assets; Return on assets (ROA) ratio of net profit to total assets; Liquidity (LIQ) ratio of current assets to current liabilities; and auditors independence (AUDIND) is measured as a ratio of audit service fees to non-audit service fees. These variables (LEV, ROA, LIQ and AUDIND) are characterised as continuous variable. Finally, type of auditor (AUD) is measured as a categorical variable, where a score of one (1) is assigned to Big4 audit firm, otherwise zero (0).

4.0 RESULTS Table 1 displays the descriptive statistics. The first dependent variable, EFRD has a very low mean of 9.2% (median 8.1%) with a standard deviation of 7.3%. A minimum score for the EFRD is 0 and the maximum extent of financial ratios disclosed is only 34.9%. QFRD measures the quality of financial ratio disclosures. The mean score for this variable is 32.2% (median 34.4%) with standard deviation of 14.5% (ranging from 6.3-62.5%). The board composition (BODCOMP) average score is high 72.5% (median 77.4%) with a standard deviation of 16.4% (20-91.7%). Average OCS (Top20 shareholding) is 58.5% (median 55.5%) with standard deviation of 23.3%. This again has a broad spectrum

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ranging from 1.5 to 97.5%. The mean of total assets is $49,411,357,253 (median is much lower at $2,945,899,000) with a standard deviation of $134,242,322,819. The smallest firm is a company with total assets amounted to $5,299,799 and biggest company has total assets of $564,634,000,000. In order to reduce the skewness, LOG SIZE variable use in this study is measured using the natural log of total assets (see Table 1). Table 1: Descriptive statistics
Variables EFRD (%) QFRD (%) BODCOMP(%) OCS-TOP20 (%) FirmSize ($) LOG SIZE Minimum 0.0 6.3 20.0 1.5 5,299,799 15.5 Maximum 34.9 62.5 91.7 97.5 564,634,000,000 27.1 Mean 9.2 32.2 72.5 58.5 49,411,357,253 21.5 Median 8.1 34.4 77.4 55.5 2,945,899,000 21.8 Standard deviation 7.3 14.5 16.4 23.3 134,242,322,819 2.9

Table 2 presents the ANOVA result revealing the industry4 variable is highly significant for both dependent variables, EFRD and QFRD. The mean shows that the industries that disclosed the most financial ratios are services and financials, while resources5 have far fewer financial ratios in their annual report. Table 2: ANOVA
Variables Mean IND4 Resources Manufacturing Services Financials IND6 Energy Materials
4

EFRD F 7.408

Sig. 0.001*

Mean 20.0 35.0 32.0 41.3

QFRD F 4.888

Sig. 0.006*

2.3 8.1 13.5 12.8 6.541 3.9 1.7 0.000*

3.262 22.9 18.8

0.016**

Two other more extensive industry classifications are employed for sensitivity analysis. ANOVA results demonstrates that the six industry category is highly significant (at 0.01 level) for EFRD and moderately significant (at 0.05 level) for QFRD. Consumer staples and the financial sector provide more financial ratios as compared to other industries. The broader 17 categories of industry is also found to be highly significant (at 0.01 level) for EFRD. 5 Tukey HSD (honestly significant different) post-hoc test shows that services and financials industry sectors are statistically (at 0.05 level) higher than resources for the extent of financial ratio disclosures.

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Industrials Consumer Discretionary Consumer Staples Financials IND17 Energy Materials Capital goods Commercial services & supplies Transportation Automobiles & components Consumer durable & apparel Consumer services Media Retailing Food & staples retailing Food, beverage & tobacco Household & personal product Banks Diversified financials Insurance Real estate * Highly significant (p-value < 0.01) ** Significant (p-value < 0.05)

8.1 8.8 18.1 12.8 3.959 3.9 1.7 14.0 8.7 4.7 0.0 0.0 5.8 9.3 14.0 24.4 14.0 0.0 15.1 10.9 14.0 7.0 0.001*

35.0 27.5 37.5 41.3 1.545 22.9 18.8 37.5 40.6 28.1 0.0 0.0 28.1 18.8 43.8 37.5 37.5 0.0 42.2 45.8 34.4 37.5 0.167

Table 3 presents the Spearman and Pearson correlation coefficients. It shows that the extent of financial ratio disclosures (EFRD) is highly significant (at 0.01 level) correlated with quality of disclosures (QFRD), corporate governance, firm size, four types of industries, leverage and auditors independence for both Pearson and Spearman correlations (except for Spearman significant at 0.05 level between EFRD and auditors independence). In addition, QFRD is highly significant (at 0.01 level) correlated with firm size and industries and significant (at 0.05 level) correlated with leverage and ROA for both Pearson and Spearman correlations.6

For Pearson correlation, another variable that highly correlated is between industry and board composition as well as firm size. Liquidity also highly correlated with leverage and ROA, while leverage is highly correlated with firm size. Apart from that, significant correlations exist between leverage and industry, ROA and firm size, liquidity and firm size as well as auditors independence and firm size. For Spearman correlations, highly significant correlations exist between board composition and industry, industry and size, leverage and size, liquidity and size, auditors and size and, between liquidity and leverage. Firm size and board composition, as well as auditors independence and industries have significant correlations.

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Table 3: Pearson and Spearman correlations EFRD EFRD QFRD BODCOMP OCS-TOP20 LOG SIZE IND LEV ROA LIQ AUDIND QFRD BODCOMP .464* .291 1 -.085 .389** .485* .239 -.022 -.110 .211 OCSTOP20 .029 .271 -.115 1 -.011 -.136 .176 .297 -.052 -.126 LOG SIZE .575* .523* .266 .026 1 .695* .694* .082 -.552* .419* IND .569* .477* .411* -.149 .680* 1 .296 .103 -.294 .400** LEV .413* .369** .112 .217 .765* .316** 1 -.025 -.702* .280 ROA .259 .392** -.051 .305 .338** .224 .225 1 -.197 .105 Pearson correlations LIQ AUDIND -.342 -.238 .017 -.294 -.405** -.125 -.608* -.444* 1 -.164 .500* .109 .197 -.100 .315** .260 .220 -.154 .068 1

1 .555* .559* 1 .559* .300 .047 .312 .642* .498* .639* .424* .452* .360** .259 .374** -.301 -.204 .367** .204 Spearman correlations

* Highly significant (p-value < 0.01) (2-tailed) ** Significant (p-value < 0.05) (2-tailed)

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The correlation matrix also reveals that all correlation coefficients are less than 0.80 critical limit (Hair et al. 2006), which could suggest that the multicollinearity problem does not exist between the independent variables in multiple regression analysis. Table 4 presents the summary backward multiple regression best-model fit findings. Table 4: Backward Multiple Regressions Regression model n F value Significance Adjusted R Squared Variables Constant BODCOMP OCS-TOP20 LOG SIZE IND (control variable) AUDIND (control variable)
* Highly significant (p-value < 0.01) ** Significant (p-value < 0.05) ns- not significant

Findings EFRD 40 annual reports 13.212 0.000 0.49 B p-value -3.5 0.001 2.5 0.019** ns 3.2 0.003* ns 2.6 0.014** QFRD 40 annual reports 9.839 0.000 0.31 B p-value 0.3 0.739 ns 2.6 0.013** ns 3.9 0.000* ns

Table 4 presents backward multiple regressions result for the two key dependent variables, EFRD7 and QFRD. For the extent of financial ratio disclosures (EFRD), the overall model is statistically significant (p-value<0.001) with F-value of 13.212 and p-value of 0.000. In addition, almost 50% of variation (adjusted R squared) in the EFRD can be explained by independent variables.

Board of directors composition (BODCOMP) measured by the percentage of independent directors on the board is significant (p-value<0.05) with p-value of 0.019 in a positive direction. The result indicates that the higher the percentage of independent directors on the board, the extent of financial ratio disclosures in the annual reports will increase. Therefore, hypothesis 1a is supported. In addition, the ownership concentration (OCS-TOP20) variable is not statistically significant predictor for the EFRD. The level of concentration does not affect the extent of financial ratio disclosures.
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Another measure of EFRD is examined as a form of sensitivity analysis. Using an alternate measure of averaging the five major ratio categories (instead of being based on the 43 separate ratios) the statistics reveal the result is not statistically different. In other words, it makes no difference whether the extent of ratios is measured using a broad template of 43 possible financial ratios or a far more aggregate five category template.

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Therefore hypothesis 2a is not supported. However, LOG SIZE is highly significant (p-value<0.01) with a p-value of 0.003 in a positive direction as expected. Bigger Australian companies disclose more financial ratios in their annual report. Therefore, hypothesis 3a is supported. For the industry category (IND) as a control variable, the result reveals that it is not a statistically contributor factor in determining the extent of financial ratio disclosures in the annual reports, despite the somewhat contradictory univariate findings. Further, auditors independence (AUDIND) is also significant (pvalue<0.05) with p-value of 0.014 in a positive direction. It implies that the more independent the auditor, the higher the extent of financial ratio disclosures in the annual report.

Backward regressions are also conducted for the quality of financial ratio disclosures (QFRD). The overall model is statistically significant (p-value<0.001) with F-value of 9.839 and p-value of 0.000. About 30% of variation (adjusted R squared) in QFRD can be explained by independent variables. BODCOMP is not statistically significant predictor to determine the quality of financial ratio disclosures in the annual reports. Having independent directors on the board does not influence the quality of financial ratio disclosures. Hence hypothesis 1b is not supported. In contrast, OCS is significant (p<0.05) with p-value of 0.013 but in a positive direction. This unexpected finding suggests that the more concentrated the ownership, the higher the quality of financial ratio disclosures in the annual reports. Hypothesis 2b is thus rejected. For the firm size (LOG SIZE), this variable does not significantly predict the quality of financial ratios disclosures. Consequently, hypothesis 3b is not supported. However, industry category (IND) is highly significant (p-value<0.01) with p-value of 0.000; this is also consistent with the univariate analysis. This finding suggests that different industries will have different quality of financial ratio disclosures.

5.0 CONCLUSIONS This study provides evidence on the extent and quality of financial ratio disclosures in the Australian listed firms annual reports. Agency theory is utilised to test the relationship between corporate

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governance, ownership concentration and firm size with the dependent variables, EFRD and QFRD. The EFRD template (43 items) is developed based on past literature and the QFRD template (16 items) is evolved from the IASBs Framework for the Preparation and Presentation of Financial Statements.

The multiple regression results indicate that corporate governance mechanism (independent board of directors) is significant in predicting the extent of financial ratio disclosures. This is consistent with agency theory where the higher proportion of independent directors on the board may mitigate the agency problem through voluntary financial reporting, in this case financial ratio disclosures. In addition, size of the firm also does impact the financial ratio disclosure practices of the firms. This result is consistent with Watson et al. (2002) findings that large firms are more likely to disclose ratios than small firms in their annual reports. Ownership concentration does not make any

difference in the extent of financial ratio disclosures. However, industry category provides a mixed message. It does not affect the extent of financial ratio disclosures using regression model but is statistically significant using the univariate test. The financial and service sectors provide the highest level of disclosed financial ratios in their annual reports as compared to resource firms. This result is consistent with Mitchell (2006) who noted that mining industry has significantly lower ratio disclosures in the 1991 annual reports as compared to other industry. This is also somewhat consistent with Watson et al. (2002) who found that media and utility industry disclose more ratios than other industry. Finally, auditors independence also influences the financial ratio disclosure practices of the firm. The more independent the auditor leads to the more disclosure of ratios in the annual report. This is consistent with the agency theory.

For the quality of financial ratios disclosures, the corporate governance mechanism does not have predictive properties. This finding implies the need for a stronger focus for board concerning the quality of reporting. Size also does not affect the quality of financial ratio disclosures. Whereas,

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ownership concentration is significantly affect the quality of financial ratio disclosures but in opposite direction with the expectation. However, industry does impact the quality of financial ratio disclosures. Different industries will affect the financial ratio disclosures practices in their annual reports. Overall, agency theory tenets are not particularly insightful in the prediction of the quality of financial ratios. Consideration should be given to other theoretical applications.

To conclude, the findings of this research reveal that independent board of directors, firm size and auditors independence do influence the extent of financial ratio disclosures. On the other hand, different industries have different quality of financial ratio disclosures.

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REFERENCES

Appendix 1 Categories and Listing of Financial Ratios

Major Category (Percentage disclosure score) 1. Share Market Measures (14.3%) Specific ratio 1. Total shareholders return 2. Dividend payout 3. Net tangible assets backing per share 4. Net assets backing per share 5. Market capitalisation 6. Price-to-earning ratios 7. Dividend yield 8. Earnings yield 9. Price-to-book 10.Book value per ordinary share 11.Market to book value ratio 1. Return on equity 2. Expense revenue ratio 3. Net profit margin 4. Return on assets 5. Pre-tax profit margin 6. EBITDA revenue ratio 7. Gross profit margin 8. Return on sales 9. Sales turnover 1. Gearing 2. Times interest earned 3. Total debt to equity 4. Capitalisation ratio 5. Equity ratio 6. Long term debt to equity ratio 7. Liabilities to assets ratio 1. Current ratio 2. Quick ratio 3. Inventory turnover 4. Account receivables turnover 5. Days to sell inventory 6. Collection period 7. Payment period 1. Operation index 2. Cash flow ratio 3. Repayment of long term borrowings 4. Dividend payment 5. Reinvestment 6. Debt coverage 7. Cash flow to revenue Percentage disclosure score 62.5 42.5 35.0 7.5 5.0 2.5 2.5 0.0 0.0 0.0 0.0 50.0 22.5 15.0 12.5 12.5 10.0 5.0 2.5 2.5 25.0 25.0 12.5 12.5 10.0 0.0 0.0 5.0 2.5 2.5 2.5 2.5 0.0 0.0 5.0 0.0 0.0 0.0 0.0 0.0 0.0

2. Profitability (14.7%)

3. Capital Structure (12.1%)

4. Liquidity (2.1%)

5. Others (0.5%)

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8. Cash flow adequacy 0.0 9. Cash flow return on assets 0.0 Legend: All 43 ratio percentages are calculated as the mean average of 40 sample companies. The five major subcategories mean averages are also measured. Note: the ration Earnings per Share is a mandatory disclosure in Australia and thus not included in this table.
Appendix Source: 1. Bergevin, P. M. 2002. Financial statement analysis: An integrated approach. New Jersey: Prentice Hall. 2. Fridson. M. and Alvarez, F. 2002. Financial statement analysis: a practitioners guide. New York: John Wiley & Sons, Inc. 3. Hoggett, J., Edwards, L. and Medlin, J. 2006. Financial accounting. 6th edition. Queensland: John Wiley & Sons, Inc. 4. Horngren, Harrison, Bamber, Best, Fraser, Willett. 2006. Financial accounting. 5th edition. NSW: Pearson Education Australia. 5. Hoskin, R. E. 1994. Financial accounting: A new perspective. New York: John Wiley & Sons, Inc. 6. Larson, K. D. 1997. Essentials of financial accounting: Information for business decision. 7th edition. Boston: Irwin McGraw Hill. 7. Maxwell, R., Onus, P. and Fox, P. 1998. Financial accounting. 3rd edition. Sydney: Prentice Hall. 8. Peirson, G. and Ramsay, A. 2006. Financial accounting: An introduction. 4th edition. New South Wales: Pearson Education Australia. 9. Stickney, C. P., Brown, P. R. and Wahlen, J. M. 2004. Financial reporting and statement analysis: A strategic perspective. United States: Thomson South Western. 10. Wild, J. J., Subramanyam, K. R. and Halsey, R. F. 2007. Financial statement analysis. 9th edition. New York: McGraw Hill Irwin.

Appendix 2

IASB Qualitative Characteristics Relevance Reliability Future Verifiability performance Audit quality Ratios are use to -purely audit predict about service (1) companys future -otherwise (0) prospect (1) No (0) 12.5 Historical confirmation Ratios are use to confirm the performance of targets, Yes (1) No (0) 5.0 Faithful Representation No qualification audit report (1) If qualified in any manner (0) 97.5 Completeness Provide ratios for all of share market measures, profitability, capital structure, liquidity & cash sufficiency (1) If not (0) 0.0 Independent audit committee % Financial

Comparability Over time Direct comparison between 2 consecutive years (1) If not (0)

Understandability Comprehend meaning Provide formulas or clear definition or glossary for all disclosed ratios -above median (1) -below median (0) 0.0 Presentation Graphs or table (1) None (0)

Percentage Disclosure Score

65.0 Industry benchmark Ratios Comparing within industry provided (1) None (0) 0.0 Consistency Completely use same formula between last year and this year (1) Otherwise (0)

Percentage Disclosure Score

27.5 Timeliness Number of days annual report is audited from year end -below median /early (1) -above median/later (0)

62.5 Location Financial highlights or Composition of Directors Report (1) If not (0)

Percentage Disclosure Score

60.0 70.0 Importance Consequences of ratios to entity/ 0.0 Segment Ratios Provided Ratios for Explanation Provide explanation/ 30

shareholders Given (1) Otherwise (0)

expertise on audit committee -above median (1) -below median (0)

segmental reporting -yes (1) -no (0)

elaboration -Context of ratio -Discussion of changes in ratio (1) If not (0) 32.5

Percentage Disclosure 15.0 67.5 0.0 Score Adapted from: Giardano-Spring and Chauvey (2007); AASB(2004); IASB (1989).

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