The Effect of the Adoption of Statement of Taiwan's Financial Accounting Standard No.34,36 on Corporation's Use of the Derivative Financial Instruments

of Taiwan

’s Financial Accounting

Standard No.34, 36 on Corporation

’s

Use

of

the

Derivative

Financial

Instruments

李

李

李

李

合

合

合

合

龍

龍

龍

龍

HE-LUNG, LI

劉

劉

劉

劉

錦

錦

錦

錦

花

花

花

花

FLOWER, LIOU

Associate Professor , Department of Accounting ,National Kaohsiung University of Applied Sciences

**

國立高雄應用科技大學會計系 講師

Senior Lecturer , Department of Accounting, National Kaohsiung University of Applied Sciences

Abstract

The main purpose of this study is to test whether after the adoption of the statement of Taiwan’s financial accounting standard (STFAS) No.34, 36 will influence the enterprise’s use of the derivatives. This paper selected samples from Taiwan’s publicly listed companies from year 2004 to 2006 with annual report as the sample. According to these three years’ financial reports, including the income statement, balance sheet, statement of cash flow, and all related footnotes disclosures etc., we select the relevant independent variable and dependent variable, and using logistic regression analysis to carry on a substantial evidence examination. Because the adoption of the STFAS, No.34, 36 begins in 2006, so we test not only two years 2005 and 2006, but also including those 2004 and 2005. If the degree of the use of the derivatives at year 2004-2005 are not decreasing apparently, instead, year 2005-2006 are significant decreasing. Then, we can conclude that the STFAS, No.34, 36 can significantly influence the use of the firm’s derivatives.

we find that the p-values of the dummy variable in equations A1 and A2 are all less than 0.05. But equation A3, the p-value of the dummy variable is more than 0.05. In equation A1, owing to the p value is less than 0.05, prior to the adoption of the STFAS, No.34,36, the mechanism of the corporate governance has significant effect on the degree of the use of the derivatives. But the coefficientββββ1of the dummy variable is positive, it

means the degree of the firm’s use of the derivatives in year 2005 is obviously more than that in 2004. In equation A2 the coefficientββββ1of the dummy variable is negative and its

No.34, 36 on Corporation’s Use of the Derivative Financial Instruments 57

year 2006 is significantly less than that in 2005. It means that the adoption of STFAS No.34,36 can obviously impact on the use of the firm’s derivatives. However, in equation A3, although the coefficientββββ1 of the dummy variable is positive, the p-value is more

than 0.05. It means that the degree of the use of the firm’s derivatives in year 2006 is not significantly more than that in 2004.

Introduction

1.Introduction

At present, accounting is becoming more and more important because the increasing business information resulting from the booming financial market and financial instruments is significant to investment decisions. Prior to the Statement of Taiwan’s Financial Accounting Statement, No.34, 36 (STFAS, No.34, 36) issued, it is uncertain to realize the full view of financial instruments from the corporation’s financial statement published. To resolve these departures in practice, thus, the STFAS, No.34, 36 have been taken into practice since January 1, 2006.

With regard to the enterprise holding non-derivatives and derivatives financial instruments, it should evaluate the financial instruments fair value for recognition, measurement, and disclosure. In addition, the Statement renders the criterion for the change of financial instruments evaluation. Hence it is much more suitable to represent real value of the financial statements. Moreover the irregularity of enterprises can be avoided. Considering the whole accounting environments and capital markets, it further allowed Taiwan to convergence with international markets and to raise the investment inclination.

The remaining of this paper is organized as follows. Section 2 discusses the prior literature researches and hypothesis. The methodology is described in section 3. Section 4 discusses the empirical results and findings. Finally, section 5 concludes.

2.Prior literature researches and hypothesis

Jensen and Meckling (1976) point out that under (1) the separation of the firm’s ownership and management, (2) information asymmetry, and (3) the goal divergence, shareholders can establish the governance system to monitor the manager’s behavior not wasting firm’s resources according to his self-interests. On the contrary, this system will

No.34, 36 on Corporation’s Use of the Derivative Financial Instruments 59

encourage the management to create maximizing the shareholders’ profit. Generally specking, the corporate governance mechanism includes outside market mechanism, financial mechanism, the board of director, compensation, and structure of ownership and board of director, and so on.

Basically, the core part of corporate governance is the board of director. The responsibility of the board of director is to ensure the well operations forever and to monitor the management’s effective operations. Hence, the system of the board of director can resolve the agency problem(Fama, 1980；Williamson, 1983). The main point of the board of director include the independent members of board of director, the experience and expertise of the directors, and members of the board of director.

Generally, the shareholders with larger shareholding may have more willingness and motives to collect relevant information for corporation. La Porta et al. (1999) concluded that shareholdings have over 20% of voting rights can control the firm effectively and participate in firm’s operation decisions. As a result, it will lead to the decrease of the firm’s value.

Chen(2003) points out that (1) A significantly positive relation existed between the ratio of institute investor’s shareholding and the degree of derivatives investing, (2) A significantly positive relation existed between the ratio of manager’s shareholding and the degree of derivatives investing, (3) A significantly negative relation existed between the CEO duality and the degree of derivatives investing, (4) A significantly positive relation existed between the income smoothing and the degree of derivatives investing. Lai(2004) indicates that the net profit or loss has a great negative covariance to security companies’ stock prices. As with the variance for each stock, the net profit and loss has no influence on derivatives business.

Jao(2004) concludes that the export growth of Taiwan’s electronic industry linked to worldwide prosperity especial USA and the amount of using derivatives is positively correlated with export growth. Also, net operating income, export ratio and overseas subsidiaries have significant effect to decide derivatives using. Tien (2003) investigates the incentives that firms use derivatives as risk management instruments and examines

how firms use derivatives to affect firms’ risk. Tien’s results are consistent with firms using derivatives to hedge, and not to increase, entity risk.

Li(2004) check up if the certified of banks and financial holding companies listing on Taiwan Stock Exchange and Taiwan Over the Counter Market obey the STFAS No.27 (Disclosure of Financial Instrument). He find obviously that no one obey STFAS No.27 more completely.

Based on the prior researches, we find that the elements of corporate governance are significant relations with the use of derivatives. Hence, we establish the following hypothesis.

H1：The adoption of Statement of Taiwan’s Financial Accounting Standard No.34, 36 can significantly decrease the corporation’s operation of the derivative financial instrument.

3.Methodology

However, whether the public-trade corporations use the derivatives decreasingly since the STFAS, No.34, 36 adopted in 2006 or not. In this study we establish one hypothesis. To test the above hypothesis, we apply the logistic regression in the study. Therefore we establish the following logistic regression equation. Also, in this study we survey all public-traded corporations as samples from 7 kinds of industries with years from year 2004 to 2006.

3.1 Model

USEDERit====ββββ0+ββββ1Dum1(2,3)i+ββββ2DIRit+ββββ3INVESTORit+

β ββ

β4MANAGERit+ββββ5DIRPREit+ββββ6BDSit +ββββ7INDBit+

β ββ

β8SMOOTHit+ββββ9ACCRUALit+ββββ10LEVit+ββββ11MVit +

β β β

No.34, 36 on Corporation’s Use of the Derivative Financial Instruments 61

where，i = firm 1,2, 3, 4,……… n； t =2004, 2005, 2006.

USEDER = whether the use of derivative financial instrument, if having the use of

derivatives, the p value is 1. Otherwise is 0.

Dum1 =Dummy1(2004, 2005)，if the firm is selected from 2005, its dummy

variable is 1. Otherwise is 0.

Dum2 =Dummy2(2005, 2006)，if the firm is selected from 2006, its dummy variable is 1. Otherwise is 0.

Dum3 =Dummy3(2004, 2006)，if the firm is selected from 2006, its dummy

variable is 1. Otherwise is 0.

DIR =the ratio of board of director’s shareholding.

INVESTOR = the ratio of institute investor’s shareholding . MANAGER = the ratio of manager’s shareholding.

DIRPRE = the president served as general manager. If it is true, the dummy value

is 1.Otherwise is 0.

BDS = members of the board of director.

INDB = independent members of the board of director.

SMOOTH =the degree of the income smoothing. If the change of net income is

within 20%, its dummy value is 1. Otherwise is 0.

ACCRUAL =the accrual adjusting items (discretionary), denoted by( OCF/net

income). OCF represents the cash flow from operation. LEV = the ratio of debt to total asset.

MV =the market value of the firm denoted by multiplying the shares outstanding with the beginning market price of the share, calculated by natural log. RD = the ratio of the R&D to net sales.

3.2 Definition of variables

USEDER：the use of derivative financial instrument

Whether the use of derivative financial instrument or not, if having the use of derivatives, the p value is 1. Otherwise is 0.

Independent variable：

(1) DIR：the ratio of board of director’s shareholding.

The responsibilities of the board of director are (1) to choose the competent manager, (2) to set up the firm’s strategy, and (3) to access and monitor the firm’s performance. Boyd (1994) concludes that the higher the shares held by the members of the board of director, the greater performance is. Thus, we anticipated that the DIR and USEDER both have negative relation. That is,

[△(USEDER) /△(DIR)]＜0

(2) INVESTOR： the ratio of institute investor’s shareholding

Rajgopal and Venkatachalam (1998) point out that the institute’s investors can effectively monitor the firm’s management and reduce the possibility of manipulating earnings. Thus, we anticipated that the INVESTOR and USEDER both have negative relation. That is,

[△(USEDER) /△(INVESTOR)]＜0

(3) MANAGER： the ratio of manager’s shareholding

No.34, 36 on Corporation’s Use of the Derivative Financial Instruments 63

In general, the higher the shares held by firm’s managers can induce managers to implement discretionary accrual items with dressing the financial statement. Thus, we anticipated that the MANAGER and USEDER both have positive relation. That is,

[△(USEDER) /△(MANAGER)]＞0

(4) DIRPRE： the president served as general manager. If it is true, the dummy value is 1. Otherwise is 0.

Dechow (1996) discover that if the management can control both the president and general manager, then he will easily leeway the firm’s earning. Other researches also find that the president served as general manager may produce earnings manipulated seriously. Therefore, we expected that the DIRPRE and USEDER both have positive relation. That is,

[△(USEDER) /△(DIRPRE)]＞0

(5) BDS：members of the board of director

In recent years, researches about the members of the board of director have two dimensions. One considers that the greater members of the board of director can absorb a variety of experts to increase its quality of decisions. However on the other hand, some point out that the lesser members of the board of director can increase effectiveness in decisions and monitoring (Kohlbeck and Mayhew, 2004). Therefore, we expected that the BDS and USEDER both have negative relation. That is,

[△(USEDER) /△(BDS)]＜0

Recently TSEC survey the public-traded corporations about whether having adoption the ideas of the independent member of the board of director and agreeing their great contribution in firm’s decisions. Firms amounting to 72% and 84%, respectively answer positive conclusions. If the shares held by the members not employees of the firm of the board of the directors are higher, it represents their benefit linked to shareholder tightly. So, they can contribute better efficiency in monitoring (Kohlbeck and Mayhew, 2004).So, we expected that the INDB and USEDER both have negative relation. That is,

[△(USEDER) /△(INDB)]＜0

(7) SMOOTH：the degree of the income smoothing. If the change of net income is within 20%, its dummy value is 1. Otherwise is 0.

Hepworth (1953) considered that corporations may not seek the maximum current earnings. Conversely, they may try to keep earning smooth from period to period. So, we expected that the SMOOTH and USEDER both have positive relation. That is,

[△(USEDER) /△(SMOOTH)]＞0

(8) ACCRUAL：the accrual adjusting items (discretionary), denoted by( OCF/net income).

OCF represents the cash flow from operation.

OCF represents the cash flow from operation. Accounting standards give management too much discretionary spaces to choose. Hence, if a firm implements much discretionary, then the quality of accounting information will be worse. So, we expected that the ACCRUAL and USEDER both have positive relation. That is,

References

Chen, Hsiang-Lan, 2003, “An Empirical Study of the Relationship Between Corporate Governance and Derivatives Investing”, Master degree paper.

Chan, Su Han, Martin, J. and Kensinger, J., 1990,”Corporate research and development expenditures and shares value”, Journal of Financial Economics, 26, 255-276.

DeChow, P.R., Sloan and A, Sweeney, 1996, “Cause and Consequence of Earnings Manipulation: An Analysis of Firms Subject to Enforcement Actions be the SEC”, Contemporary Accounting Research, 13, 1-36.

Defond, M. L., and J. Jiambalvo, 1994, ” Debt covenant violation and manipulation of accruals.”, Journal of Accounting and Economics 17(1-2), 145-176.

Fama,E.F., 1980, “Agency problems and the theory of the firm”, Journal of Political Economy, 88, P288-307

Garen, J. and Harjoto, M.A., 2000,”Beyond the IPO: The evolution of corporate ownership concentration”, Working Paper.

Hepworth, S.R., 1953, “Periodic income smoothing”, The Accounting Review,28, 32-39. Jao, Hsiu-Man, 2003, “An Empirical Evidence of Using Derivatives Hedge and

Performance Relation in Taiwan Electronic Industry”, Master degree paper.

Jensen,M.c. and Meckling, W.H. 1976, “Theory of the Firm：Managerial Behavior, Agency Costs and Ownership Structure”, Journal of Financial Economics, 3, 305-360. Kohlbeck and Mayhew, 2004, ” Agency costs, contracting, and related party

transactions.”, Working paper series, University of Wisconsin-Madison.

Lai, Yu-Ching, 2003, “Influence of Derivative Business on the Stock Price of the Brokerage Firms”, Master degree paper

Raigopal, S. and M, Venkatachalam, 1998, “The role of institutional investors in corporate governance : an empirical investigation”, Working Paper.

No.34, 36 on Corporation’s Use of the Derivative Financial Instruments 79

Journal of Law and Economics, 26, 351-366

Zantout, Z.Z. and George Tsetsekos, 1994, “The wealth effects of announcements of R&D expenditures increases”, Journal of Financial Research, 86, 1197-1215.