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Internal and External governance and the Voluntary Disclosure of Financial and
non-financial Performance

Article · January 2003

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 1

The impact of internal and external governance mechanisms on the voluntary

disclosure of financial and non-financial performance

Marleen Willekens
Heidi Vander Bauwhede
Ann Gaeremynck
Linda Van de Gucht

KULeuven

Correspondence:
marleen.willekens@econ.kuleuven.ac.be

Abstract
In this paper we examine the impact of internal and external governance mechanisms on the disclosure
of financial and non-financial performance information in corporate annual reports. We used the
balanced scorecard (Kaplan and Norton 1992, 1996) as a framework to create an index of the extent of
disclosure of financial and non-financial performance information. We assessed the impact of internal
and external governance mechanisms by creating a corporate governance index that includes the
following governance information: board independence, audit committee existence, external audit
quality and internal audit existence. We also examined the incremental and individual impact of each
one of these governance mechanisms.

Using unique survey data on corporate governance for a broad set of Belgian listed companies, we find
that firms with a higher corporate governance index report more financial and non-financial
performance information. External audit quality has the highest individual impact on disclosure of
financial and non-financial performance information, followed by board independence and the
existence of an internal audit department. We also report strong evidence that the extent of performance
information increases with agency costs and information asymmetry problems.

Our results suggest that governance mechanisms can aid in enhancing corporate disclosure of financial
and non-financial performance information, and that disclosure of performance measures is used as a
means to reduce information asymmetry and agency problems.

Keywords: corporate governance, voluntary disclosure, non-financial performance measures, balanced

scorecard.
 2

The impact of governance mechanisms on the voluntary disclosure of financial and

non-financial performance measures

1. Introduction

Recent corporate reporting scandals (Enron, Worldcom, etc.) have put a discussion on reforms to the

current financial reporting model on the top of the political agenda (SEC, February 2002 and AICPA

March 2002). Disclosure of non-financial performance information may be one means to improve

companies' business reporting. The AICPA Special Committee on Financial Performance (Jenkins

Committee) already called for more forward-looking and non-financial disclosures in 1994, and results

of the FASB's Business Reporting Project, started in 1999 and finalized in 2001, indeed show that

leading companies voluntary disclose additional data - also non-financial data - in order to

communicate business performance more effectively1. Also the FASB is considering the usefulness of

non-financial performance measures in their deliberations on performance reporting (see Maines et al.

2002).

The current corporate reporting discussion does however not only pertain to specific disclosure and

reporting practices, but also to the role of the external auditor and other corporate governance

mechanisms (such as internal audit, the audit committee, board independence) in the business reporting

process. Financial accounting information has a corporate governance role, since other corporate

governance (henceforth CG) mechanisms such as, for example, takeovers and bank finance (see

Schleifer and Vishny 1997), make explicit or implicit use of this information (Bushman and Smith,

2001, Sloan 2001) to assure suppliers of finance a return on their investment (Schleifer and Vishny

(1997, p. 737). Financial accounting information - and information regarding a company's business in

general - is in itself however also a product of a governance process. We follow the latter approach in
 3

this paper, since we examine whether CG can help enhance business reporting and corporate disclosure

by examining the impact of some CG mechanisms (i.e. presence of an independent board, an audit

committee, a high quality auditor and an internal audit department) on voluntary disclosure of financial

and non-financial performance information by Belgian listed companies. We use the balanced

scorecard as a framework to develop our disclosure index, since this instrument gives a comprehensive

overview of measures of the companies' performance on some critical success factors.

We contribute to the CG literature and voluntary disclosure literature. Our research contributes to the

voluntary disclosure literature by studying the impact of CG on the extent of non-financial

performance disclosure. Prior research was limited to an examination of the impact of CG on the

comprehensiveness of financial disclosures (Ho and Wong2001) or on the disclosure of some specific

items, such as interim reporting (Leftwich et al. 1981) and share option disclosures (Forker 1992). We

also study a broad range of CG attributes, namely board independence, existence of an audit committee

and internal audit department and the quality of the external auditor.

Our second contribution to the voluntary disclosure literature is that we use the Balanced Scorecard

(Kaplan and Norton 1996) as a framework for the creation of a non-financial performance measure

disclosure index. Prior voluntary disclosure studies typically used researcher-created indices. Those

indices score whether companies disclose some well-specified items, such as for example discussion of

the competitive environment, cash flow forecast, the number of employees, etc.. The selection of the

disclosure score items is based on an analysis of investor needs (e.g. Jenkins’ report (AICPA 1994)) or

observed practices (see for example Robb et al. 2001, Chow and Wong-Borren 1987).

1
The objective of Business Reporting Project was to study how companies can make there business reporting more reliable
and relevant. Apart from the report on voluntary disclosures, there were two other reports. One on the electronic distribution
of business information, and one on redundancies between GAAP and SEC disclosure requirements.
 4

Our study contributes to the CG literature by examining whether stronger CG systems can enhance

corporate reporting by increasing the level of (voluntary) disclosure of non-financial performance

information, whereas prior studies on the relationship between CG and corporate reporting rather

examined whether CG can prevent low qualitiy financial statements ( i.e. fraud, earnings management

and audit qualifications) (see for example Becker et al. 1998, Francis et al. 1999, Beasley 1996 and

2000, Peasnell et al. 1999 and 2000, Dechow et al. 1996, Abbott et al. 2000a and 2000b, DeFond and

Jiambalvo 1991, Parker 2000, Carcello and Neal 2000, Reynolds and Francis 2000).

The paper is organized as follows. In the next section we give an overview of the CG regulation in

Belgium. We then develop the research questions in section 3. Section 4 describes our empirical model.

We discuss our sample and report the results in section 5. Section 6 concludes.

2. Corporate governance regulation and corporate reporting practices in Belgium

2.1 Corporate governance regulation in Belgium

Continental European accounting and auditing regulations can be found in company law and tax codes.

In addition, stock exchanges may impose additional auditing and reporting requirements as part of their

listing rules. At this moment, Belgian CG law is limited. Accounting law specifies for example that all

companies (listed and non-listed) that adopted a certain legal form and exceed some size criteria have

to appoint an external auditor for the audit of the statutory and consolidated financial statements.

The rule book of the Brussels Stock Exchange (now part of Euronext) does not include additional CG

requirements2. However, in 1998 the Brussels Exchanges (Commission Cardon), The Banking and

Finance Commission (CBF) as well as the Federation of Belgian enterprises (VBO – Verbond van

Belgische Ondernemingen) issued recommendations on good CG. The recommendations of the CBF

2
Note that Euronext has not yet a harmonised set of listing requirements (see The Euronext Rulebook) so that the
requirements of the individual exchanges Paris, Brussels and Amsterdam apply.
 5

deal with the disclosure on corporate governance, whereas the recommendations of the Brussels

Exchanges and VBO - which are in fact quite similar - deal with the “content” of corporate

governance3. The latter recommendations pertain to the responsibilities, size, composition and working

procedures of the board of directors (BOD), the responsibilities and remuneration of non-executive

directors, remuneration of management and reporting and control. The Brussels Exchanges

recommend, for example, that the board should not consist of more than 12 directors, and that the

majority of the directors be non-executives. They also advise that part of the non-executive directors be

independent of management as well as of the majority shareholders and that the company establishes

an audit committee.

These Belgian requirements and recommendations differ in various respects from American rules and

regulations. A first observation is that the American rules and regulations issued by the Securities and

Exchange Commission (SEC) and New York Stock Exchange (NYSE), and which are applicable to

NYSE registrants, are not only larger in number, but are also mandatory, which contrasts with the mere

recommendations issued by the Brussels Stock Exchange and the Banking and Finance Commission.

We next also observe differences in specific CG rules or recommendations between the U.S. and

Belgium, which can often be explained by institutional differences between countries. A first example

is that in Belgium, and in contrast to the U.S., also the financial statements of non-listed companies

should be audited. One explanation for this extended audit requirement is that non-listed companies are

extremely important (both in number and in contribution to the GDP) to continental-European

economies. An additional explanation is that the use of earnings reported in statutory accounts for tax

assessment calls for audits of financial statements of listed and non-listed companies.

3
These are recommendations and or in no way mandatory regulations. The regulation of the internal audit function within
credit banks (see CBF 1997) is an exception.
 6

A second example of differences between Belgian and American CG rules and regulations is that the

Belgian CG recommendations specify that some of the non-executive directors should not only be

independent from management, but also from majority shareholders. The reason is that ownership of

Belgian companies -listed as well as non-listed companies - is concentrated, and agency problems

between minority and majority shareholders become an important issue.

A third example of differences between American and Belgian CG requirements is that Belgian

companies, unlike registrants on the NYSE, are not obliged to have an audit committee and internal

audit function. AC formation and the establishment of an internal audit function are still voluntary in

Belgium4.

We mention as a final example that American (NYSE) rules are more severe concerning the

composition of the BoD: they require that the majority of the board consists of independent (and not

only non-executive) directors.

2.2 Corporate reporting practices in Belgium

Belgian accounting law requires that all companies - listed as well as non-listed companies- that exceed

certain legal form and size criteria submit financial statements with the Belgian national Bank. These

financial statements include the companies statutory (and if appropriate consolidated) balance sheet,

profit and loss account and notes to the financial statements. Only few studies have examined the

reporting practices of Belgian companies. Some of those studies deal with earnings management

behaviour of listed and non-listed Belgian companies (see for example Sercu et al. 2002, Vander

Bauwhede et al. 2003) or the use of accounting methods (such as for example the revaluation of assets)

as a signalling device (Gaeremynck and Veugelers 1999). A recent study (Willekens et al. 2003) also

examined value and risk reporting practices among listed companies in Belgium. Using an index based

4
Except for Credit companies and Insurance companies. The Banking and Finance Commission and Supervisory body for
Insurance Companies (“Office de Contrôle des Assurances”) demand that they set up an internal audit function.
 7

on PricewaterhouseCoopers' ValueReportingTM framework and ValueReporterTM diagnostic tool, they

find that Belgian firms perform good on disclosure of items from the categories Management &

Performance and Organization & Strategy, while they perform poor on disclosure of Value Drivers and

Risk Management. Their results also show that manufacturing firms do best, followed by

retail/distribution/media and then technology.

3. Literature review and research questions

The board of directors, the audit committee, the external auditor as well as the internal audit department

within an organization all have an impact on corporate reporting. While corporate law explicitly

requires that financial statements be audited by an external auditor, the board of directors actually bears

first responsibility for the truthfulness of the financial statements (see for example article 92 of the

Belgian Company Law) and the underlying financial reporting process. Boards may however delegate

the actual review of the financial reports to an audit committee. Boards may also install an internal

audit department that examines the adequacy of the internal control system to preserve the integrity of

(financial) information that will be used for external reporting purposes. It follows that more effective

boards, external audits of higher quality, the existence of an audit committee and the existence of an

internal audit department may positively influence corporate reporting in general and the extent of

disclosure of financial and non-financial performance measures in particular.

Board effectiveness is itself influenced by its size and its composition (see for example Jensen 1993

and various reports on corporate governance). It is generally believed that a higher proportion of

independent directors increases board effectiveness. There is however less consensus on the impact of

size on board effectiveness. Some argue that a minimum number of board members is necessary for the

board to have some monitoring ability (see, for example Jensen 1993 and Lipton and Lorsch 1992).
 8

Other reason, however, that as boards grow larger, communication and coordination problems arise

which reduces board effectiveness. The quality of the external audit (audit quality) is believed to

increase in audit firm size (see for example DeAngelo 1981, Klein and Leffler 1981).

The evidence on the impact of various corporate governance elements on disclosure is scarce. Chen an

Jaggi (2001) found for example that the proportion of independent non-executive directors on boards

has a positive impact on the comprehensiveness of financial disclosures and that this impact is smaller

for family-controlled firms compared to non-family controlled firms. Similarly, Leftwich et al. (1981)

and Forker (1992) report evidence of a positive association between board independence and interim

reporting and share options disclosure respectively. Ho and Wong (2001) find that the extent of

voluntary disclosure by listed Hong Kong firms that have an audit committee is significantly higher

than for firms that have no such audit committee. Forker (1992) found evidence of a weak significant

and positive relationship between the existence of an audit committee on the share option disclosures.

We add to this literature by examining the impact of five corporate governance elements - board size,

board independence, audit quality, audit committee existence and internal audit department existence -

on the level of disclosure of both financial and non-financial performance measures in annual reports.

We will first examine whether companies with a stronger corporate governance structure disclose more

financial and non-financial performance information. Following the discussion above, we conclude that

an independent board, a high quality external auditor, the existence of an audit committee and the

existence of an internal audit department are all attributes of a strong corporate governance system. We

then measure the strength of the corporate governance system by a corporate governance index that

indicates how many of the attributes of a strong system are present. Note that we do not include board
 9

size in the corporate governance index, since there is no consensus on the impact of board size on

board effectiveness.

We next examine the individual impact of each one of the corporate governance attributes - board size,

board independence, audit committee existence, quality of the external auditor, and the existence of an

internal audit department - since some corporate governance elements may have a stronger impact on

disclosure than the other ones.

4. Model Specification and Variable Measurement

We estimate the following multiple regression models (OLS) to test our hypothesis on the relationship

between corporate governance and the disclosure of non-financial performance information.

DISCL = β0 + β1 CGIND+ β2 LNBS + β3 LEV + β4 YQUOTED + β5 LNTA

+ β6 ROA + β7 NYSE + β8 FIN + ε (1)

DISCL = β0 + β1 PBINDD + β2 AC + β3 B5 + β4 INTAUD + β5 LNBS + β6 LEV + β7 YQUOTED

+ β8 LNTA + β9 ROA + β10 NYSE + β11 FIN + ε (2)

Where:

DISCL = disclosure index;

CGIND = corporate governance index;

PBINDD = dummy, =1 if more than half of the board members are independent from

management and the majority shareholders, zero otherwise;

5
The Brussels Exchanges recommend for example that boards should not include more than 12 directors.
6
Belfirst is a database of Bureau van Dijck which contains financial statement data of all Belgian companies that submit
their financial statements with the Belgian Central Bank.
 10

AC = dummy, =1 if an audit committee exists, zero otherwise;

B5 = dummy, =1 if the company is audited by a Big5 auditor, zero otherwise;

INTAUD = dummy, =1 if the company has an internal audit department, zero otherwise;

LNBS = natural logarithm of board size;

LEV = leverage measured as long-term debt over total assets;

YQUOTED = number of years the company has been quoted on the Brussels Stock

Exchange;

LNTA = natural logarithm of total assets;

ROA = return on assets;

FIN = dummy =1 if the company is a holding company, a real estate business or a

bank, zero otherwise.

Table 2 gives an overview of the measurement of the variables and the predicted sign on the

coefficients.

[Insert Table 1 about here]

4.1 Disclosure proxy

We use the Balance Scorecard (BSC) – a set of measures that gives top management a fast but

comprehensive view of the business (Kaplan and Norton 1992, p. 71) - as a framework to create a non-

financial performance disclosure index. We use the BSC as a framework because it has been shown

that using the BSC does not only enhance company performance (see for example Banker et al. 1998,

Anderson et al. 1994 and 1997, Hoque and James 2000) but may also be useful for market participants.
 11

Ittner and Larcker (1996) find, for example, that if customer satisfaction measures (i.e. an element of

the BSC information) are used to form hedge portfolios, then those portfolios outperform the market.

The BSC does, in contrast to current practice, not only include financial but also operational measures

of performance. Financial performance measures only capture results of actions already taken. Non-

financial (operational) measures are by contrast drivers of a firm’s future financial performance.

Kaplan and Norton (1992) argue therefore that a firm’s performance should not only be evaluated from

a financial perspective, but also from the following three operational perspectives: a customer

perspective, an internal processes perspective and a learning and growth perspective. These

perspectives are related to the following questions (Kaplan and Norton 1996, p. 9): To achieve our

vision, how should we appear to our customers?; To satisfy our shareholders and customers, what

business processes must we excel at?; To achieve our vision, how will we sustain our ability to change

and improve?. The BSC includes measures that give indications of a firm’s performance in each one of

these three areas. Customer satisfaction measures are typically operational measures that are related to

the customer perspective. The number of new products developed and defect rates are examples of

operational measures with respect to innovation and production, two internal business processes.

Typical examples of operational measures that belong to the learning and growth perspectives are

employee satisfaction and employee retention (see Kaplan and Norton 1996, Kaplan and Atkinson

1998, Horngren et al. 2002).

Our disclosure proxy is an index that measures whether a company reports information on each one of

the balanced scorecard perspectives, i.e. the financial, customer, internal business processes and

learning and growth perspectives. Following the BSC literature we further divided the internal business

processes perspective in the innovation and production perspectives. We then identified for each
 12

company and for each perspective (i.e. financial, customers, innovation, production and learning and

growth) whether the company reports:

1. quantitative historic information;

2. qualitative historic information;

3. segment information;

4. quantitative forward-looking information;

5. qualitative forward-looking information.

We give the company a score of 1 for each item for which performance measures are available. We

then compute an average score per company by summing the item scores and then scaling this value by

the maximum score, i.e. 25 (5 perspectives * 5 items).

4.2 Corporate governance index and individual corporate governance variables

Our first goal is to assess the joint impact of the alternative corporate governance systems on the extent

of disclosure of financial and non-financial performance information. We therefore created a

“corporate governance index” which measures the overall the strength of a company’s corporate

governance system. Theory predicts that board independence, the existence of an audit committee,

higher audit quality as well as the existence of an internal audit department can enhance corporate

reporting. We therefore use as a corporate governance index a measure of the number of (the four)

corporate governance components that are present within the company. That is, we identify for each

company the quality of the external auditor (Big5 vs. non-Big5 auditor) and whether an independent

board, an audit committee and/ or internal audit department are present. We give a score of one for
 13

each item that is present and scale by the total number of items, i.e. 49. Higher scores indicate stronger

corporate governance systems. We thus predict a positive coefficient on CGIND. Note that board

independence is not a dichotomous variable. We identified a board as being independent when more

than half of the board members are independent. We do not include board size in our corporate

governance index because there is no consensus on the direction of the impact on board effectiveness

(see section 3). We therefore preferred to include it as a separate control variable in our multiple

regression model (cf. infra).

Our second objective is to assess the individual impact of board independence, audit committee

existence, quality of the external audit and existence of an internal audit department on disclosure of

financial and non-financial performance information. We replace therefore the variable CGIND by four

indicator-variables: PBINDD, AC, B5 and INTAUD. Those variables take the value of 1 if more than

half of the board members of the company are independent, there exists an audit committee, the

company has a Big5 auditor and the company has an internal audit department, respectively, and the

value of zero otherwise.

4.3 Control variables

Board size. We include the natural log of the size of the board of directors (LNBS) as a first control

variable because prior studies argue that board size affects board effectiveness and hence corporate

reporting (see for example Dechow et al. 1996 and Beasley 1996). We prefer the natural log to control

for non-linearities in the relation between of board size and board effectiveness (see also Yermack

9
We do not use a weighted index because there is no theory that predicts that one CG component will increase the strength
of the CG system more than another component.
 14

1996). We do not predict the sign of the coefficient since there is no consensus on the direction of its

impact on board effectiveness (cf. infra).

Other control variables were derived from a review of the voluntary disclosure literature. Those control

variables proxy for the potential costs and the benefits of disclosure. Those costs and benefits reduce,

respectively increase, the propensity of disclosure. Costs include direct costs of information production,

political costs as well as proprietary costs of information dissemination. The benefits of disclosure stem

from reductions in agency costs and information asymmetry problems. We include the following

proxies to control for these effects.

Agency costs. Agency costs may arise from both equity and debt financing. We do not include a proxy

for the agency costs of equity since ownership is - even for listed companies - concentrated in Belgium.

We include leverage (LEV), measured as long-term debt over total assets, as a proxy for the agency

costs between a company and its debtholders (see Watts and Zimmerman 1986 and 1990) and predict a

positive relationship with the extent of disclosure.

Information asymmetry. We proxy information asymmetry by a measure of firm age (YQUOTED)

(see for example Helwege and Liang 1996, Petersen and Rajan 1994), and more specifically by the

number of years the company is quoted on the Brussels Stock Exchange. Information asymmetry is

inversely related with firm age because there is more information available on companies that are

longer quoted on the stock exchange. We therefore predict a negative coefficient on YQUOTED.
 15

Disclosure costs. We include firm size (LNTA) as a proxy for the cost of information production,

proprietary costs and political costs (see for example Watts and Zimmerman 1986, Lang and Lundholm

1993, Wallace and Naser 1995). We measure company size by the natural logarithm of total assets. We

prefer the natural logarithm in order to control for non-linearities in the relationship between audit firm

size and the extent of disclosure. We do not predict the direction of the relationship between firm size

and disclosure since the hypothesised direction depends on which particular disclosure cost firm size is

proxying10.

Profitability. We next include profitability (ROA), measured as return on assets, as a control variable.

There is no consensus on the direction of the relationship between a company's profitability and its

disclosure behaviour. Some theoretical studies (see for example, Dye 1985 and 1986, Verrecchia 1983

and 1990, Darrough and Stoughton 1990) suggest that profitable companies will disclose more, while

other studies argue that profitability has no impact on the disclosure level (Lang and Lundholm 1993).

Neither does empirical research provide conclusive evidence on the direction of the relationship

between firm profitability and voluntary disclosure level (Lang and Lundholm 1993). We do hence not

predict the sign on ROA.

Industry. Operations of financial institutions (such as banks, real estate businesses and holding

companies) are significantly different from those of manufacturing and commercial companies.

Disclosure by financial institutions may therefore differ from disclosure by non-financial companies.

10
The costs of information production are assumed to decrease in firm size (see for example Lang and Lundholm 1993),
whereas political costs are argued to increase in firm size (Watts and Zimmerman 1986, Wallace and Naser 1995). There is
no consensus on the relationship between audit firm size and proprietary costs.
 16

We include a dummy (FIN) that indicates whether the company is operating in the financial industry

(FIN=1) or not (FIN=0) to control for this effect.

5. Empirical results

5.1 Sample and data

We examine disclosure by Belgian companies listed on the Brussels Stock Exchange (now Euronext

Brussels). Those companies are recommended, but not required, to disclose information on CG in their

annual reports. To avoid any selection bias caused by non-disclosure of CG information, we collected

this information by sending questionnaires to the chairman of the board of directors of all Belgian

listed companies for which we find company addresses on the Belfirst12, 145 companies in total. We

received 40 completed questionnaires from a first mailing in the fall of 2001 and 32 additional

questionnaires from a follow-up mailing in January 2002, i.e. a total response rate of 49.66%. We

collected the annual reports of the responding companies and read them back-to-cover to determine the

degree of disclosure on financial and non-financial performance measures (cf. infra). Consolidated

financial statement data were manually collected from the companies’ annual reports. Two companies

had no consolidated financial statements. We therefore use only 70 companies in our analyses. Table 2

reports a breakdown of our sample by industry. Our observations are split over 21 industries without

significant clustering in particular industries.

[Insert Table 2 about here]

5.2 Descriptive statistics

Table 3 reports the descriptive statistics on our dependent and independent variables. The results on

DISCL show that companies report on average only on 31.14% of the 25 disclosure items of our

12
Belfirst is a database of Bureau van Dijck which contains financial statement data of all Belgian companies that submit
their financial statements with the Belgian Central Bank.
 17

disclosure index (see DISCL). The results on DISCL also indicate that the best firm only reports on

68% of the 25 disclosure items. More detailed analysis (Table 3, Panel C) shows that all companies

report some financial performance information, while only 78.58% of the companies report some non-

financial performance information. The type of non-financial information that is most disclosed is

customer-related information (95.54%), followed by information on innovation (80%), production

(89%) and learning and growth (76%). All companies that disclose non-financial performance

information disclose historic information, 70.90% disclose forward-looking non-financial information

and 20% of them disclose some segment information. Historic non-financial performance information

is mostly qualitative in nature (98% of the companies). Only 87% of the companies that disclose non-

financial performance information release quantitative historic information. If forward-looking non-

financial performance information is released, then this information is mostly qualitative in nature

(94.87% of the companies). Only about 25 percent of the forward-looking information is quantitative in

nature. These results suggest that the level of reporting on non-financial performance measures (and

especially quantitative forward-looking information) is low and that there is still much room for

improving non-financial performance reporting. All companies that disclose financial performance

information disclose historic financial information, 62.85% disclose forward-looking information and

85.45% disclose some segment information. Historic financial information is mostly quantitative in

nature, while forward-looking information is mostly qualitative in nature.

The results on CGIND (Table 3, Panel A) show that at least 75 percent of the companies in our sample

have at least one of the four CG components, i.e. an independent board, an audit committee, a high

quality (i.e. Big5) auditor and an internal audit department. Results on PBIND, AC, BIG5 and

INTAUD in Table 3, Panels A and B indicate that, on average, less than half of the members of the
 18

board of directors are independent from management and the majority shareholders, about 57 percent

of the sample companies have an audit committee, 71 percent are audited by a Big5 auditor and about

43 percent have an internal audit department. We further find (PBINDD) that only about 22.85 percent

of the companies have an independent board (i.e. a board which contains for over 50% of independent

directors).

Further, average leverage (LEV) of the sample companies is about 18 percent and average profitability

(ROA) is 5 percent. Companies are on average about 27.26 years listed on the Brussels Stock

Exchange. 19 companies operate in the financial industry (see also Table 1).

[Insert Table 3 about here]

5.3 Regression results

Table 4 reports the results of the OLS estimation of our two multiple regression models. The F-values

are significant and the adjusted R-squared of the models is 57,06 percent and 55,73 percent

respectively. The variance inflation factors (VIF's) in table 4 and the Pearson correlation coefficients in

Table 5 do not indicate any multicollinearity problems.

[Insert Table 4 about here]

[Insert Table 5 about here]

We report in Table 4, Panel A a significantly negative coefficient on CGIND (p<0.001) which supports

our hypothesis that a stronger corporate governance system enhances the level of corporate reporting

on non-financial performance measures. We further report in Table 4, Panel B that three of the five

individual corporate governance characteristics have a positive impact on disclosure and an

incremental impact over one another. The presence of a Big5 auditor has the highest impact (coefficient

= 9.28, p<0.05) on disclosure followed by board independence (coefficient=7.99, p<0.05) and the
 19

existence of an internal audit department (coefficient=5.74, p<0.10). Panels A and B further show a

significantly positive coefficient on LEV (p<0.001) and a significantly negative coefficient YQUOTED

(p<0.05) which is consistent with more disclosure by firms with higher agency costs of debt and more

information asymmetry problems. Finally, the significantly negative coefficient on FIN (p<0.001)

confirms our conjecture that companies operating in the financial industry report significantly different

levels of non-financial performance measures as compared to non-financial companies. Board size,

company size and profitability have no significant impact on the extent of performance measure

disclosures (all p>0.10). The insignificant result on profitability is consistent with the inconclusive

theory on the relation between profitability and disclosure

6. Conclusion

This paper examined whether companies with stronger corporate governance systems disclose more

financial and non-financial performance information in their corporate annual reports. We proxied the

extent of disclosure by the extent to which the companies report qualitative and quantitative historic,

forward-looking, as well as segment information with respect to the perspectives of the balanced

scorecard, i.e. the customers, internal business processes and learning and growth perspectives. We first

proxied the strength of a corporate governance system by the extent to which the following

characteristics of a "good" corporate governance system are present: an independent board of directors,

an audit committee, a high quality auditor and an internal audit department. We next examined the

individual impact of each one of the characteristics of "good" corporate governance. We found that

companies with stronger corporate governance systems disclose more financial and non-financial

performance information. We also found that the presence of a Big5 auditor has the highest impact on

disclosure, followed by the presence of an independent board and an internal audit department. Our

results suggests that there is still much room for improving the value and usefulness of corporate
 20

reporting through more disclosure of financial and non-financial performance information and that

corporate governance may play a significant role in attaining this objective.

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 25

Table 1: Summary of our empirical models

Construct Proxy Predicted

sign
Dependent variable
DISCL Disclosure index (cf. infra)

Independent variables
Test variables
CGIND Corporate governance index = a +
percentage that indicates how
many of the following corporate
governance components/
characteristics are present: more
than half of the directors on the
board are independent from
management and the majority
shareholders, existence of an audit
committee, high quality (Big5)
auditor, presence of an internal
audit department
PBINDD Dummy, = 1 if more than half of +
the board members are
independent from management and
the majority shareholder, =0
otherwise
AC Dummy, =1 if the company has an +
audit committee, =0 otherwise
B5 Dummy, =1 if the company has a +
Big5 auditor, =0 otherwise
INTAUD Dummy, =1 if the company has an +
internal audit department, =0
otherwise

Control variables
LNBS Board size = natural logarithm of +/-
the number of directors on the
board
LEV Leverage = Long term debt/ total +
assets
YQUOTED Years quoted on the Brussels Stock -
Exchange
LNTA Firm size = natural logarithm of +/-
total assets
ROA Profitability = Return on assets= +/0/-
profit before taxes and financial
charges/ total assets
FIN Dummy, =1 if the company is a -
holding company, a real estate
business or bank, =0 otherwise
 26

Table2: Breakdown of our sample companies by two-digit FTSE* industry code

Two-digit FTSE industry code FTSE description Number of companies

11 Chemicals 4
13 Construction and building 8
material
15 Forestry and paper 1
24 Diversified industrials 1
25 Electronic and electrical 2
equipment
26 Engineering and machinery 5
34 Household goods and textiles 2
41 Beverages 5
43 Food producers and processors 5
44 Health 2
48 Pharmaceuticals 4
53 Leisure, entertainment and 2
hotels
54 Media and photography 2
58 Support services 1
63 Food and drug retailers 2
72 Electricity 1
73 Gas distribution 1
81 Banks 2
85 Investment companies 10
86 Real estate 7
97 Software and computer services 3
Total 70

* The FTSETM Global Classification System is used as the default industry classification
system on Euronext.
 27
Table 3: Descriptive statistics*

Panel A: Continuous variables

Variable N Mean St. dev. Min. 1st Median 2nd Max.
quartile quartile
DISCL 70 35.14% 17.87 4% 20% 36% 48% 68%
CGIND 70 55% 29.36 0% 25% 50% 75% 100%
BS 70 9 4.85 2 6 8 11 27
LNBS 70 2.06 0.53 0.69 1.79 2.07 2.39 3.29
LEV 70 0.18 0.15 0 0.08 0.15 0.27 0.68
YQUOTED 70 27.26 30.77 1 3 12 45 99
TA (in thousand Euros) 70 12246915 64960707.9 993 127697 329972 1110951 482970000
LNTA 70 12.98 2.13 6.90 11.75 12.70 13.92 19.99
ROA 70 0.05 0.08 -0.1398 0.02 0.05 0.09 0.45
PBIND 70 0.42 0.25 0 0.29 0.43 0.50 1

Panel B: Discrete variables

Variable N Proportion of dummy=1
PBINDD 70 22.85%
INTAUD 70 42.86%
BIG5 70 71.42%
AC 70 57.14%
FIN 70 27.14%

Panel C: Disclosure index

Financial 70 Historic 70 Quantitative 70
performance 62.85%a 100%b 100%
measures Qualitative 65
92.86%
Forward- 44 Quantitative 19
looking 62.85%b 43.18%d
Qualitative 41
93.18%d
Segment 47
85.45%b
Non-financial 55 Historic 55 Quantitative 48
performance 78.58%a 100%c 87.27%e
measures
Customer related 52 Qualitative 54
perspective 95.54%c 98.18%e
Internal business 44 Forward- 39 Quantitative 10
processes: Innovation 80%c looking 70.90%c 25.64%f
Internal business 49 Qualitative 37
processes: 89%c 94.87%f
Production
Learning and growth 42 Segment 14
perspective 76%c 20%c

* For variable definitions see Table 1. PBIND= proportion of independent board members, measured as the number
of independent directors on the board divided by the total number of directors on the board; TA= Total assets; BS=
board size measured by the total number of directors on the board.
a
As a percentage of the total number of sample companies.
b
As a percentage of the total number of companies that report financial performance measures.
c
As a percentage of the total number of companies that report non-financial performance measures.
d
As a percentage of the companies that report financial forward-looking information.
e
As a percentage of companies that report historic non-financial performance measures.
f
As a percentage of companies that report forward-looking non-financial performance measures.
 28

Table 4: OLS results of the multiple regression model of disclosure (DISCL) on

corporate governance and control variables*

Panel A: Corporate governance index (CGIND)

Parameter Standard Variance

Variable Estimate Error t Value Pr > |t| Inflation

Intercept 25.13274 9.01687 2.79 0.0070 0

CGIND 0.23841 0.05231 4.56 <.0001 1.18677
LNBS -2.18597 3.12624 -0.70 0.4870 1.39061
LEV 45.12617 9.84172 4.59 <.0001 1.11849
YQUOTED -0.12817 0.04866 -2.63 0.0106 1.12768
LNTA 0.01918 0.78112 0.02 0.9805 1.39714
ROA 21.62521 18.56538 1.16 0.2486 1.16077
FIN -18.12769 3.46979 -5.22 <.0001 1.21488

F-value = 10.36
Pr > F < 0.0001
R-Square 0.6142
Adj R-Sq 0.5706

Panel B: Individual corporate governance characteristics (i.e. board independence, audit

committee existence, audit quality, internal audit department existence and board size)
Parameter Standard Variance
Variable Estimate Error t Value Pr > |t| Inflation

Intercept 26.46905 9.21093 2.87 0.0056 0

PBINDD 7.99041 3.82550 2.09 0.0411 1.27717
AC 0.77153 3.18485 0.24 0.8094 1.22947
B5 9.28821 3.59849 2.58 0.0124 1.30797
INTAUD 5.74364 3.13358 1.83 0.0719 1.19020
LNBS -0.61625 3.34401 -0.18 0.8544 1.54330
LEV 40.57798 9.89973 4.10 0.0001 1.09772
YQUOTED -0.11915 0.05027 -2.37 0.0211 1.16738
LNTA -0.09483 0.80221 -0.12 0.9063 1.42934
ROA 13.80966 19.26556 0.72 0.4763 1.21243
FIN -19.29994 3.84961 -5.01 <.0001 1.45049

F-value = 9.69
Pr > F < 0.0001
R-Square 0.6215
Adj R-Sq 0.5573

* For variable definitions see Table 1.

 29
View publication stats

Table 5: Pearson correlation coefficients between independent variables*

Pearson Correlation Coefficients, N = 70

Prob > |r| under H0: Rho=0
CGIND PBINDD AC B5 INTAUD LNBS LEV YQUOTED ROA LNTA FIN

CGIND 1.00000
CGIND

PBINDD N/A 1.00000

PBINDD N/A

AC N/A 0.26517 1.00000

AC N/A 0.0265

B5 N/A 0.11834 0.28299 1.00000

B5 N/A 0.3292 0.0176

INTAUD N/A 0.00982 0.16667 0.22822 1.00000

INTAUD N/A 0.9357 0.1679 0.0574

LNBS 0.25185 -0.13468 0.14552 0.26772 0.18872 1.00000

LNBS 0.0354 0.2663 0.2293 0.0251 0.1177

LEV -0.12488 -0.03694 -0.00576 -0.07937 0.04926 0.18129 1.00000

LEV 0.3030 0.7614 0.9623 0.5137 0.6855 0.1331

YQUOTED -0.12093 -0.06360 -0.01255 -0.19237 0.02767 0.15598 0.14436 1.00000

YQUOTED 0.3187 0.6009 0.9179 0.1106 0.8201 0.1973 0.2331

ROA 0.02334 0.08924 0.08159 0.00166 0.07469 0.18864 0.10573 0.24245 1.00000
ROA 0.8479 0.4625 0.5019 0.9891 0.5389 0.1178 0.3837 0.0431

LNTA 0.15431 0.07236 0.14988 0.12183 0.13301 0.44777 0.15657 0.15822 0.07535 1.00000
LNTA 0.2022 0.5517 0.2156 0.3150 0.2723 0.0001 0.1955 0.1908 0.5353

FIN -0.13222 0.20328 -0.12056 -0.11175 -0.26893 0.06301 -0.09647 0.01484 -0.22009 0.25898 1.00000
FIN 0.2752 0.0914 0.3202 0.3571 0.0244 0.6043 0.4270 0.9029 0.0671 0.0304

* For variable definitions see Table 1.