Research links quality of voluntary financial disclosure to corporate governance

Before we invest in publically listed companies, we need to be able to access information about the firm’s financial position and performance.

Bill Shen graduating with a Master of Commerce degree.

For thirty-five year-old University of Auckland postgraduate student and teaching staff Bill (Yijun) Shen, this means having the most accurate financial information possible. But how do we judge the quality of a firm’s unaudited voluntary information? 

Shen, who will graduate with a Master of Commerce degree this week, carried out a study that established links between the quality of a company’s voluntary financial disclosure with the quality of their corporate governance.

In New Zealand, publically listed companies are required to report on their financial information by using generally accepted accounting principles (GAAP). According to the requirements from NZ IFRS and NZX, the unique GAAP earnings that are compulsory to disclose on firms’ financial statements is the profit after tax.

Non-GAAP earnings are treated as important supplementary financial information, and adopted widely by management. Non-GAAP earnings (e.g. earnings before interest and tax (EBIT)), under some circumstance, can provide a clearer and more accurate picture of a company’s financial performance. Moreover, some non-GAAP earnings are required to disclose by industry to reflect the industrial characteristic. As a result, both GAAP and non-GAAP information are equally important for stakeholders to make decisions.

Unlike GAAP earnings, non-GAAP earnings disclosure has not received much attention from accounting standard setting bodies and regulation setters. Globally, the US and Australia are the only two countries that have regulations to supervise firms’ non-GAAP earnings disclosure behaviour, while South Africa is unique in that it compulsorily urges listed firms to disclose non-GAAP earnings. Except for these special cases, non-GAAP earnings disclosure in the world is largely unregulated.

This leaves the onus for the accuracy and quality of non-GAPP earnings disclosure on firm’s corporate governance. The Financial Market Authority in New Zealand (FMA) expressed concerns about listed firms’ non-GAAP earnings disclosure and issued guidelines in 2012, since modified in 2017.

The FMA (2012) listed ten principles to guide firms’ Non-GAAP earnings disclosure behaviour. However, as the guidelines are not mandatory for public firms to follow, the problem of unbalanced quality in Non-GAAP earnings disclosure remains unresolved among New Zealand-listed firms.

Shen’s dissertation for his degree reviewed the FMA guidelines for firm’s non-GAAP earnings disclosure, and he created an index to reflect non-GAAP earnings disclosure quality. In addition, he also searched for the mechanism (e.g. corporate governance) that supervised the disclosure of the higher quality non-GAAP earnings information.

Shen found a positive association between board size, diversity and
independence, and the quality of non-GAAP earnings disclosure.

Using this method, Shen found a positive association between board size, diversity and independence, and the quality of non-GAAP earnings disclosure.

Graduating from the Faculty of Business and Economics, Shen’s dissertation entitled Disclosure Quality of Non-GAAP Earnings and Corporate Governance: Empirical Evidence from New Zealand, demonstrated that good quality corporate governance, measured by board quality, plays an important role in supervising and formalising firms’ disclosing behaviour. This is the first time research looking at this association has been tested in a New Zealand setting.

Shen’s research is highly relevant to investors and policymakers if they want to know the reliability of firms’ non-GAAP earnings quality.

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