IMAC October Corporate governance and earnings forecasts accuracy Nurwati Ashikkin Ahmad-Zaluki Wan Nordin Wan-Hussin [College of Business, UUM]

2IMAC October 2009 Presentation outline 1. Introduction 1. Introduction 2. Background and motivation 2. Background and motivation 3. Literature review 3. Literature review 4. Objective 4. Objective 5. Sample/Methods 5. Sample/Methods 6. Results 6. Results 7. Conclusions 7. Conclusions

3IMAC October 2009 Introduction  Companies that seek initial public offerings (IPOs) on Bursa Malaysia are required to provide management earnings forecasts in their IPO prospectuses.  To minimize information asymmetry that creates friction between management and shareholders.  it is associated with lower cost of capital and higher stock liquidity.

4IMAC October 2009 Background and motivation  Many Malaysian IPO companies failed to achieve their earnings within the limit imposed (deviation of ±10%).  32 out of 57 IPO companies in 2005 that announced audited results by July 2006, had fallen short of their earnings forecasts. (Source: The Edge Malaysia, July 17, 2006).  More than half of these optimistic earnings forecasts showed deviations exceeding 20% (Source: New Straits Times, July 11, 2006).

Background and motivation The Malaysian Securities Commission (SC) focused on corporate boards as the crucial means for improving the quality of financial information provided by listed companies. The Malaysian Securities Commission (SC) focused on corporate boards as the crucial means for improving the quality of financial information provided by listed companies. Financial reporting practices can also be monitored by having effective board audit committees. Financial reporting practices can also be monitored by having effective board audit committees. Revised code on Corporate Governance 2007 Revised code on Corporate Governance IMAC October 2009

Background and motivation Corporate governance structures affect the quality of financial disclosure practices. Corporate governance structures affect the quality of financial disclosure practices. The accuracy of management earnings forecasts is an important factor in building and maintaining investors’ confidence. The accuracy of management earnings forecasts is an important factor in building and maintaining investors’ confidence. 6IMAC October 2009

7 Literature review Prior studies on management earnings forecasts using Malaysian data Prior studies on management earnings forecasts using Malaysian data Example: Example: Jelic et al. (1998); Ismail & Weetman (2007) Jelic et al. (1998); Ismail & Weetman (2007) Focused on factors unrelated to corporate governance Focused on factors unrelated to corporate governance (company age, earnings reduction prior to IPO, type of industry, and economic condition) (company age, earnings reduction prior to IPO, type of industry, and economic condition)

8IMAC October 2009 Literature review The effect of corporate boards on disclosure quality is not extensively examined in the literature. The effect of corporate boards on disclosure quality is not extensively examined in the literature. Karamanou and Vafeas (2005) in the US Karamanou and Vafeas (2005) in the US Beekes and Brown (2006) in Australia Beekes and Brown (2006) in Australia Cheng and Courtenay (2006) in Singapore Cheng and Courtenay (2006) in Singapore Chin et al. (2006) in Taiwan Chin et al. (2006) in Taiwan Bedard et al. (2008) in Canada Bedard et al. (2008) in Canada

9IMAC October 2009 Objective  To investigate:  whether effective corporate governance is associated with higher financial disclosure quality

10IMAC October 2009 Sample / Methods  235 IPOs listed on the Main and Second Boards  Sample period :  Absolute forecast error is used to proxy for earnings forecast accuracy and to represent financial disclosure quality.  Greater accuracy corresponds to a smaller absolute forecast error.

Regression model AFE i = α 0 + β 1 INED + β 2 BDSIZE + β 3 ACNED + β 4 ACSIZE + β 5 PFMSHIP +β 6 AUDITOR + β 7 COSIZE + β 8 EARNRED + β 9 FHORIZON + β 10 AGE + ε i 11IMAC October 2009

12IMAC October 2009 Results: (Table 1) Distribution of IPO sample by year & board of listing

Results 13IMAC October 2009

14IMAC October 2009 Results: Descriptive statistics MeanMedian Attributes All (n=235) MB (n=90) SB (n=145) t-stat All (n=235) MB (n=90) SB (n=145) z-stat Forecast error (%) Absolute forecast error (%) Independent NED (%) Board size Audit committee NED (%) ** Audit committee size Professional memberships (%) na Auditor - BIG4/5 (%) *** na Total assets (RM million) *** *** Earnings reductions (%) * na Forecast horizon (months) Company age (years) *** ***

15IMAC October 2009 Results: Determinants of earnings forecast accuracy Model 1Model 2Model 3Model 4 All boards and audit committees characteristics Only boards characteristics Only audit committees characteristics Selected variables VIFEx pected sign Coefft-statCoefft-statCoefft-statCoefft-stat INED BDSIZE ACNED ** * * ACSIZE * PFMSHIP AUDITOR * * * COSIZE1.28? *** ** *** *** EARNRED FHORIZON AGE Constant n211 F-value1.95**1.89*2.17**3.00** R-square7.62%5.71%6.85%5.64% Adj R-sq3.00%2.46%3.16%3.50%

16IMAC October 2009 Conclusions Companies with a higher percentage of NEDs in the ACs and larger AC size are found to exhibit greater forecast accuracy. The accuracy of IPO earnings forecast is also positively influenced by the use of brand-name auditor. The results are consistent with the belief that effective corporate governance is associated with higher financial disclosure quality.

17IMAC October 2009 Dr. Nurwati Ashikkin Ahmad-Zaluki College of Business Universiti Utara Malaysia