Hypotheses Development 1. Board Composition

Annual reports are found to be a primary source of information to users, especially the shareholders (see for example Mautz, 1968; Anderson and Epstein, 1995; Abu-Nassar and Rutherford, 1996). Similar pattern is also found in developing countries where annual reports are viewed as the main source of corporate information (Abu Baker and Naser, 2000).

Due to the important role that annual reports play, it is therefore argued that providing the annual reports in a timely manner is not only a matter of satisfying the legal requirements, it is a matter of responsibility.

According to Cadbury (1997: 15), “information is the lifeblood of markets” and “openness by companies is the basis of public confidence in the corporate system”. He stresses the need to provide relevant information, which is very crucial for efficient markets, without which market manipulation may result. Rezaee (2003: 26) also contends that “… for capital markets to function efficiently and effectively, participants (including investors and creditors) must have confidence in the financial reporting process”. Information that reaches users early is predicted to contain a higher value than information that reaches users much later.

Timeliness of reporting has also been argued to not only increase the value of the information but also help minimize the level of insider trading, information leakage and rumors in the markets (Owusu-Ansah, 2000). Empirical evidence shows that timeliness of reporting affects the pricing of a firm’s securities (Chambers and Penman, 1984;

Kross and Schroeder, 1984). Audit lag has been used as an indicator of timelines of reporting because a company cannot publish its accounts in the annual reports without an audit report (Johnson, 1998). One of the earliest empirical studies on reporting timeliness was conducted by Dyer and McHugh (1975) who find that firm’s size and the fiscal year-end significantly influence reporting timeliness.

Several studies have then followed (e.g. Courtis, 1976; Whittred, 1980; Carslaw and Kaplan, 1991;

Bamber and Schoderboek, 1993; Knechel and Payne, 2001). It has also been concluded that audit lag determines the financial reporting timeliness (Givoly and Palmon, 1982). The board of directors is important in corporate governance and in financial reporting processes because it links the shareholders and managers. In fact, Fama and Jensen (1983) argue that the board plays an important governance role in large corporations and the role of the board of directors has been the focus in corporate governance guidelines. Jensen (1993: 862) further reiterates on the significant role of the board of directors when he claims that “The board, at the apex of the internal control system, has the final responsibility for the functioning of the firm”. In Malaysia, the Malaysian

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Companies Act 1965, which among others, states that both the directors and the managers are required to keep proper records to ensure the true and fair view of the profit and loss accounts and the balance sheet (Section 167). Thus, the importance of directors’ roles in ensuring managers to keep the firm’s proper accounts is already well recognized in law. Should the directors discharge these duties effectively, the firm should not take long to issue the audited financial statements as all the records are kept in good order. In a similar vein, the Cadbury Report (1992) asserts that the board has a duty “… to present a balanced and understandable assessment of the company’s position” (p. 7). The importance of the role of the board in promoting transparency is also recognized in Australia when the Australian Stock Exchange’s (ASX) Corporate Governance Council (2003) states that better-governed firms are

“more transparent” and make “more timely”

disclosures that are “better balanced” in terms of the release of good and bad news. The Malaysian Code further identifies duties of the board of directors that include, among others, ensuring the firm has adequate and sufficient internal control systems and management information systems, ascertaining compliance systems with the applicable laws, regulations and rules. Having proper and adequate internal systems would enable firms to prepare the financial reports in a more timely fashion as compared with companies that do not have such proper and adequate internal systems.

Timeliness of corporate reporting is reflective of accounting quality. Timelier reporting is associated with higher accounting quality as users are able to use the information for such purpose as valuation and evaluation. Several studies have examined the link between board independence and accounting quality. Beasley (1996) for instance, shows that the proportion of outside directors is lower among firms that were found to have frauds in the financial statements than firms that did not.

Deechow, Sloan and Sweeney (1996) document a link between violations in accounting that were subjected to SEC accounting enforcement actions and board structure. Peasnell, Pope and Young (2001) and Klein (2002) reconfirm the link between board independence and accounting quality by focusing on accrual management permitted within GAAP. More recently, Beekes, Pope and Young (2004) find that the proportion of outside directors on the board is associated with the likelihood of timelier recognition of bad news. Thus, their evidence supports the contention that board independence is associated with accounting quality.

The link is predicted to exist between the board of directors and timeliness of reporting due to the fact that it is the board of directors that authorizes the firm’s annual report for public release. Thus, the board has the discretion either to speed up or delay the issuance of the annual report depending, among

others, on the incentives that they have. The effectiveness of the board in carrying out its monitoring roles, such as on accounting quality, it is argued and found, depends largely on it being independent of management (Beasley, 1996;

Deechow, Sloan and Sweeney, 1996; Peasnell, Pope and Young., 2000; Klein, 2002; Beekes, Pope and Young, 2004). This evidence supports Fama and Jensen (1983) who argue that outside directors are experts in decision controls. It is further argued that good corporate governance is said to exist when the independence of the board of directors is maintained (Abdullah, 2002b).

Similarly, Rezaee (2003: 28) claims, “aligning the interests of managers and shareholders requires vigilant, independent, effective boards”. Empirical evidence generally shows that board effectiveness is related to its independence (see for example Weisbach, 1988; Byrd and Hickman, 1992; Brickley, Coles and Terry, 1994; Kini, Kracaw and Mian, 1995; Beasley, 1996). Outside-dominated board’s greater incentives to monitor management are attributed to the fact that outsiders of these boards do not want to associate themselves with troubled companies, which could impair their reputation (Weisbach, 1988). Daynton (1984: 35) argues that

“… the board must be independent of management”

to enable it to carry out its oversight duties more effectively. Kini, Kracaw and Mian (1995) further demonstrate that the extent of outside directors’

dominating the board substitutes for market-based corporate controls. Brown and Caylor (2004) find that board independence is associated with higher operating performance measures, namely ROE, net profit margin, dividend yield and share repurchases.

However, their evidence shows a negative and significant association between board independence and firm’s Tobin’s Q and sales growth. Thus, these findings suggest that the link between board independence and firm performance is not conclusive as has been documented in earlier studies (see for example, Fosberg, 1989; Rosenstein and Wyatt, 1990; Hermalin and Weisbach, 1991; Bhagat and Black, 2002; Anderson, Mansi and Reeb, 2004).

When compared with other corporate governance variable, Brown and Caylor (2004) find that the link between board independence and firm performance is inferior to the link between nominating committee independence and firm performance, as indicated by the correlation coefficients. Therefore, from this study, it seems that the independence of the nominating committee is more important than board independence. This evidence might mean that the extent to which the nominating committee is independence of management is associated more strongly with timeliness of reporting than board independence is. However, in Malaysia, maintaining a nomination committee prior to the adoption of the Malaysian Code on Corporate Governance was rare.

The issue of a nominating committee is only

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addressed in the Malaysian Code’s best practices composed solely of non-executive directors.

Following the adoption of the Malaysian Code by the Bursa Malaysia, disclosure on the compliance (or non-compliance) with the Code’s best practices is mandatory.

The importance of the board having an optimal mix of outside directors and executive directors lies on the belief that this structure would contribute different skills, knowledge and expertise, which are vital for an effective board (Baysinger and Butler, 1985). The incentives for outside- dominated boards to report the firm’s performance more quickly than inside-dominated boards lie primarily on the fact that outside directors are regarded as decision experts who derive their value by discharging their duties effectively. These outside directors are well respected in their fields. Providing annual reports to the firm’s shareholders in a more quickly manner should be seen as discharging their duties to the shareholders more effectively because the annual reports are one of the primary sources of information for shareholders. By doing so, they should be able to enhance their reputation as being experts in decision control (Fama and Jensen, 1983). Empirical evidence by Beekes, Pope and Young (2004) supports this contention who find that board independence is associated with the timeliness of bad news recognition in earnings. The Bursa Malaysia Listing Requirements state that the board of a listed company should be composed of at least two independent directors or one-third of the board size whichever is higher. Kini, Kracaw and Mian (1995) also define outside directors as those who are not full-time employees of the firm. Thus, the maintained hypothesis is as follows:

H1: The extent of outside directors on the board leads to reporting timeliness.

2.2. Audit Committee Composition

Audit committee acts as a means of communication between external and internal auditors (Vinten and Lee, 1993) and it could enhance the reliability of a firm’s financial reporting process (Treadway Committee, 1987). These benefits are derived because it helps to reinforce the independence of the company’s external auditor (High Level Finance Committee, 1999). The fact that management prepares the firm’s financial statements, which in turn are audited by external auditors, could lead to differences of opinion between management and external auditors on how to best apply GAAP (Magee and Tseng, 1990; Antle and Nalebuff, 1991;

Dye, 1991). Empirical evidence also reveals that many reported earning figures are negotiated (Nelson, Elliott and Tarpley, 2000). Klein (2002), based upon prior research on audit committees, argues “… the audit committee’s role as arbiter between the two parties is to weigh and broker

divergent views of both parties to produce ultimately a balanced, more accurate report” (p. 378).

To ensure the audit committee is effective, the Cadbury Report (1992) recommends that an audit committee be comprised at least three outside directors with written terms of references (Section 4.3). The Malaysian Code states that an “… audit committee serves to implement and support the oversight function of the board…” (p. 46). It further stresses that its independence “… reinforces the independence of the company’s external auditor…”

(p. 46). In terms of composition, the Malaysian Code adopted the requirement set out in the Bursa Malaysia Listing Requirements of having at least three members, the majority of whom should be independent directors. Jemison and Oakley (1983) also argue that an effective audit committee requires its composition to be solely independent directors.

The independence of the audit committee is important because it ensures its objectivity (Kolins, Cangemi and Tomasko, 1991). Studies have also found greater outside directors’ proportion on a board leads to audit committee formation (Pincus, Rusbarsky and Wong, 1989; Collier, 1993a). Menon and Williams (1994) further show that the proportion of outside directors on a board is associated positively with the frequency of audit committee meetings, indicating that the intensity of the audit committee to oversee the financial reporting process is influenced by the proportion of outside directors on the committee. Thus, an audit committee that is composed solely of outside directors should increase its incentive to oversee the financial reporting process and this is reflected by the new requirement by the NYSE and NASDAQ, which was introduced in December 1999. The new requirement mandates all listed companies to maintain audit committees consisting of at least three directors, all of whom have no relationship to the company that could impair the exercise of their independence from management and the company.

Audit committee independence is predicted to be associated with the timeliness of reporting because of the extent of outside directors making up the audit committee and the experiences they bring to the firm. The firm could exploit these outside directors’ experiences to improve its financial reporting processes. Further, these outside directors could help strengthen the firm’s internal control systems as one of the audit committee’s roles is to discuss the effectiveness of the firm’s internal controls with internal auditors (Collier, 1993b).

Improving the firm’s financial reporting processes and strengthening the internal control systems should help shorten the time taken to issue the audited financial statements. In planning the audit, the auditor will need to assess the firm’s internal control systems as the outcome of the internal control assessment determines the extent of audit investigation. If the internal control systems are

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strong, fewer tests of details will be performed.

Thus, this should lead to timelier reporting. In fact, Kadir (2000: 20) asserts that the primary roles of an audit committee being “… the first among equals, oversees the work of the other actors in setting up internal controls and financial reporting process.” He also contends that the audit committee and the board of directors are among the key participants in the areas of financial and risk management, internal controls and financial reporting.

Criticisms have, nonetheless, been leveled against the audit committee because it is established for window-dressing purposes (Menon and Williams, 1994). The evidence in Malaysia by Abdullah (2002a) shows that audit committee formation is primarily to satisfy the Bursa Malaysia Listing Requirements, which supports criticism of the window-dressing purposes argued by Menon and Williams (1994). However, the study was carried out on listed companies at an initial stage when the Bursa Malaysia had just introduced the requirement to form audit committees. Given time, the role of the audit committee might have improved in due course as the members gained sufficient experience.

Abdolmohammadi and Levy (1992) argue that audit committee members need 3-5 years to obtain the needed skills and experience. It is therefore predicted that the extent of directors who are not full time employees of the firm leads to timelier reporting.

The hypothesis is therefore as follows:

H2: The extent of outside directors on the audit committee is associated positively with reporting timeliness.

2.3. CEO Duality

Daynton (1984) argues that having a board chairman who is also the firm’s CEO impairs the board independence. In fact, Rechner (1989) suggests that the ideal corporate governance structure is one in which the board is composed of a majority of outside directors and a chairman who is an outside director and argues that the weakest corporate governance is one where the board is dominated by insider directors and the CEO holds the chairmanship of the board. In an empirical study, Collier (1993a) argues that the formation of an audit committee is negatively associated with the presence of a dominant personality in the board of the firm. The importance of maintaining non-executive board chairman is reflected in the Cadbury Report (1992), which recommends the separation of these two top posts, which has been advocated by the Hampel Report (1998). The Malaysian Code also proposes a similar board structure. The reason for the need for a separation is that when the monitoring roles (i.e. the board chairman) and implementation roles (the CEO) are vested in a single person; the monitoring roles of the board will be severely impaired. Thus, a conflict of interest is predicted to arise. However, separating

these top roles is not without problems as the independent chairman monitors the performance of the CEO while the performance of the board chairman is left unmonitored (Brickley, Coles and Terry, 1994). The performance of the board chairman and the board as a whole nonetheless, is evaluated by the shareholders as well as other externally originated corporate controls.

Separating the top two roles is, nevertheless, not without costs and the substantial costs of the separation could come from “… the incomplete transfer of company information, and confusion over who is in charge of running the company” (Goodwin and Seow, 2000: 43) which is not found in a unitary system. These costs could perhaps explain the fact that empirical evidence of CEO duality is not conclusive. For instance, findings by Berg and Smith (1978) indicate that there is no significant difference in various financial indicators between firms that experienced CEO duality, and firms that did not.

Chaganti, Mahajan and Sharma (1985) document evidence that shows firms that experienced bankruptcy (failure) and survival are not significantly different in the leadership structure.

Rechner and Dalton (1991) also report that firms with CEO duality consistently outperform firms with CEO non-duality structure, which contradicts their expectations. Baliga, Moyer and Rao (1996) further show that the market was indifferent to firms’

announcements on changes in the leadership structure. The insignificant influence of CEO duality on firm’s performance was later reconfirmed among Malaysian companies in a study by Abdullah (2004a). However, Brown and Caylor (2004) provide evidence that shows that the separation of chairman and CEO is associated with a higher firm value, as measured by Tobin’s Q. Thus, their evidence signals that the market recognizes the importance of separating these two roles and firms that separate these roles receive a higher valuation.

The link between the separation of the CEO and board chairman roles and timeliness of reporting is expected to exist because having a non-executive chairman could lead the board to promoting a higher level of corporate openness, as argued by Miller (1997). This should therefore lead to timely reporting. The higher market valuation for firms that separate these roles, as found by Brown and Caylor (2004), means that the market is in favor of the separation. The separation should provide greater incentives to the non-executive chairman to act in the interest of the shareholders rather that than to protect the interest of the CEO. Annual reports are the primary source of information for the shareholders.

Thus, if the non-executive chairman acts in the best interest of the shareholders, he or she would strive to provide the annual reports in a timely manner to shareholders. This is because the shareholders need the annual reports to enable them to make informed investment-related decisions. Thus it is predicted the

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separation is associated with reporting timeliness.

Thus, the following is tested, which is as follows:

H3: Separating the CEO and board chairman’s roles is associated positively with reporting timeliness.

3. Methodology

Non-financial companies listed in the Main Board of the Bursa Malaysia were included in this study involving financial years 1998 and 2000. The financial year 1998 was chosen for two reasons.

First, during the year, the Malaysian economy was still experiencing the 1997 crisis. Findings for this financial year relating to reporting timeliness could

First, during the year, the Malaysian economy was still experiencing the 1997 crisis. Findings for this financial year relating to reporting timeliness could