Compliance with International Financial Reporting Standards (IFRS) and the Value Relevance of Accounting Information in Emerging Stock Markets: Evidence from Kuwait By Mishari Alfaraih B.S. (Accounting and Auditing), Kuwait M.S. (Accountancy), USA CPA, USA Principal Supervisor: Professor Gerry Gallery Associate Supervisor: Professor Natalie Gallery A thesis submitted in fulfilment of the requirements for the degree of Doctor of Philosophy to the School of Accountancy Queensland University of Technology 2009
Transcript
Compliance with International Financial Reporting
Standards (IFRS) and the Value Relevance of Accounting
Information in Emerging Stock Markets: Evidence from
Kuwait
By
Mishari Alfaraih B.S. (Accounting and Auditing), Kuwait
M.S. (Accountancy), USA CPA, USA
Principal Supervisor: Professor Gerry Gallery Associate Supervisor: Professor Natalie Gallery
A thesis submitted in fulfilment of the requirements for the degree of Doctor of Philosophy
to the
School of Accountancy Queensland University of Technology
2009
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ACKNOWLEDGMENTS First and foremost, all praises and glories are due to almighty Allah for his blessings, mercy, and guidance for making this work possible. I would like to express my sincere thanks and deep appreciation to my principal supervisor, Professor Gerry Gallery, for his supervision, guidance, and motivation, and for the ceaseless encouragement he has given me since the day I arrived at QUT. His profound knowledge and experience gave me the opportunity to broaden my knowledge and make significant progress with my project. I am also deeply indebted to my associate supervisor, Professor Natalie Gallery, for her invaluable suggestions and continuous support during the writing of this thesis. I must say that I have been very fortunate to have worked with these two supervisors. Great respect and special thanks go to my father (may God have mercy on his soul), who is a true role model, one whose wisdom I always look up to and live by. My sincere appreciation and gratefulness goes to my beloved and blessed mother for her generous prayers, care, and her endless moral support throughout my life. Words fail to express adequately my feelings and gratitude toward my uncle, Dr. Hamed Alfraih, who guided, supported, and encouraged me to strive for the highest level of achievement. I am also eternally indebted to my brothers, Mishal and Suliman, and to my two dearest sisters, Noura and Dalal. Their constant prayers, support, inspiration, and encouragement were invaluable during the completion of this dissertation and in the attainment of my doctoral degree. I owe all I have ever accomplished to my beloved family. Last but not least, to my dear wife, Hessa, I extend my heartfelt thanks and sincere appreciation for her love, support, and sacrifice throughout my study. This PhD was a challenge that I would never have completed had it not been for her patience and constant support. And special thanks go to my lovely daughter, Maha, who is the daily joy of my life and my source of inspiration in completing this work.
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STATEMENT OF ORIGINAL AUTHORSHIP
The work contained in this thesis has not been previously submitted to meet
requirements for an award at this or any other higher education institution. To the
best of my knowledge and belief, the thesis contains no material previously
published or written by another person except where due reference is made.
Since the 1960s, the value relevance of accounting information has been an important topic in accounting research. The value relevance research provides evidence as to whether accounting numbers relate to corporate value in a predicted manner (Beaver, 2002). Such research is not only important for investors but also provides useful insights into accounting reporting effectiveness for standard setters and other users. Both the quality of accounting standards used and the effectiveness associated with implementing these standards are fundamental prerequisites for high value relevance (Hellstrom, 2006). However, while the literature comprehensively documents the value relevance of accounting information in developed markets, little attention has been given to emerging markets where the quality of accounting standards and their enforcement are questionable. Moreover, there is currently no known research that explores the association between level of compliance with International Financial Reporting Standards (IFRS) and the value relevance of accounting information. Motivated by the lack of research on the value relevance of accounting information in emerging markets and the unique institutional setting in Kuwait, this study has three objectives. First, it investigates the extent of compliance with IFRS with respect to firms listed on the Kuwait Stock Exchange (KSE). Second, it examines the value relevance of accounting information produced by KSE-listed firms over the 1995 to 2006 period. The third objective links the first two and explores the association between the level of compliance with IFRS and the value relevance of accounting information to market participants. Since it is among the first countries to adopt IFRS, Kuwait provides an ideal setting in which to explore these objectives. In addition, the Kuwaiti accounting environment provides an interesting regulatory context in which each KSE-listed firm is required to appoint at least two external auditors from separate auditing firms. Based on the research objectives, five research questions (RQs) are addressed. RQ1 and RQ2 aim to determine the extent to which KSE-listed firms comply with IFRS and factors contributing to variations in compliance levels. These factors include firm attributes (firm age, leverage, size, profitability, liquidity), the number of brand name (Big-4) auditing firms auditing a firm’s financial statements, and industry categorization. RQ3 and RQ4 address the value relevance of IFRS-based financial statements to investors. RQ5 addresses whether the level of compliance with IFRS contributes to the value relevance of accounting information provided to investors. Based on the potential improvement in value relevance from adopting and complying with IFRS, it is predicted that the higher the level of compliance with IFRS, the greater the value relevance of book values and earnings.
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The research design of the study consists of two parts. First, in accordance with prior disclosure research, the level of compliance with mandatory IFRS is examined using a disclosure index. Second, the value relevance of financial statement information, specifically, earnings and book value, is examined empirically using two valuation models: price and returns models. The combined empirical evidence that results from the application of both models provides comprehensive insights into value relevance of accounting information in an emerging market setting. Consistent with expectations, the results show the average level of compliance with IFRS mandatory disclosures for all KSE-listed firms in 2006 was 72.6 percent; thus, indicating KSE-listed firms generally did not fully comply with all requirements. Significant variations in the extent of compliance are observed among firms and across accounting standards. As predicted, older, highly leveraged, larger, and profitable KSE-listed firms are more likely to comply with IFRS required disclosures. Interestingly, significant differences in the level of compliance are observed across the three possible auditor combinations of two Big-4, two non-Big 4, and mixed audit firm types. The results for the price and returns models provide evidence that earnings and book values are significant factors in the valuation of KSE-listed firms during the 1995 to 2006 period. However, the results show that the value relevance of earnings and book values decreased significantly during that period, suggesting that investors rely less on financial statements, possibly due to the increase in the available non-financial statement sources. Notwithstanding this decline, a significant association is observed between the level of compliance with IFRS and the value relevance of earnings and book value to KSE investors. The findings make several important contributions. First, they raise concerns about the effectiveness of the regulatory body that oversees compliance with IFRS in Kuwait. Second, they challenge the effectiveness of the two-auditor requirement in promoting compliance with regulations as well as the associated cost-benefit of this requirement for firms. Third, they provide the first known empirical evidence linking the level of IFRS compliance with the value relevance of financial statement information. Finally, the findings are relevant for standard setters and for their current review of KSE regulations. In particular, they highlight the importance of establishing and maintaining adequate monitoring and enforcement mechanisms to ensure compliance with accounting standards. In addition, the finding that stricter compliance with IFRS improves the value relevance of accounting information highlights the importance of full compliance with IFRS and not just mere adoption.
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TABLE OF CONTENTS
Page
Acknowledgments………………………………………………………………. ii Statement of Original Authorship………………………………………………. iii Abstract…….…………………………………………………………………… iv List of Tables…………………………………………………………………… x List of Figures…………………………………………………………………... xiii CHAPTER 1: Introduction…………………………………………………… 1
1.1 Research Motivation ……………………………………………………….. 2 1.2 Research Questions ………………………….……………………………... 3 1.3 Theoretical Framework and Hypotheses …………….…………………….. 8 1.4 Research Design…………………………………………………………….. 10 1.5 Summary of Major Findings………………………………………………... 11 1.6 Contributions of the Study ………………………………………………..... 13 1.7 Organisation of the Study…………………………………………………... 14 CHAPTER 2: Regulatory Framework of Accounting and Securities Trading in Kuwait……………………………………………………………...
15
2.1 Background of the Kuwait Stock Exchange………………………………... 16
2.2 The Law of Commercial Companies……………………………………….. 18 2.2.1 Accounting and Financial Reporting Requirements…………………... 19 2.2.2 Compliance with and Enforcement of Accounting Standards………… 21
2.2.3 Role of External Auditor in Promoting Compliance with Accounting Standards……………………………………………………………....
23
2.2.4 Criticisms of the Effectiveness and Enforcement of the Securities Laws 25 2.3 The Kuwait Stock Exchange Regulations………………………………….. 27 2.3.1 Criticisms of the Administration of KSE Regulations…………….…… 28 2.3.2 Accounting and Financial Reporting Requirements………………….. 29 2.3.3 Improvement to the Existing KSE Regulations………………………... 31 2.3.4 KSE Listing Requirements…………………………………………….. 31 2.4 Conclusion………………………………………………………………….. 34 CHAPTER 3: Literature Review……………………………………………... 36
3.1 Research on the Value Relevance of Accounting Information …………….. 36 3.1.1 Interpretation of the Value Relevance Construct……………………… 39 3.1.2 Value Relevance Studies in Mature Financial Markets……….............. 41 3.1.3 Value Relevance Studies in Emerging Financial Markets…….............. 45
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3.1.4 The Influence of Institutional Factors on Financial Statement Value Relevance………………………………………………………………
51
3.2 Compliance with International Financial Reporting Standards (IFRS) Literature…………………………………………………………………….
53
3.2.1 Motivation for Compliance with IFRS Disclosures…………………… 53 3.2.2 Research on the Extent of IFRS Compliance………………………….. 57 3.2.3 Corporate Determinants of Compliance with IFRS Disclosure Requirements .…………………………………………………………..
60
3.3. Conclusion…………………………………………………………………. 63
CHAPTER 4: Theoretical Framework and Hypotheses Development…….
64
4.1 The Value Relevance–Information Quality Framework………………….… 64 4.1.1 External Governance………………………………………………….. 64 4.1.2 Internal Governance ………………………………………………...... 65 4.1.3 Components of the Framework…………………………………… ….. 66 4.2 Firm-Attribute Hypotheses…………………………………………………. 70 4.2.1 Firm Age………………………………………………………………. 71 4.2.2 Firm Liquidity………………………………………………………… 72 4.2.3 Firm Leverage…………………………………………………………. 74 4.2.4 Firm Size………………………………………………………………. 75 4.2.5 Firm Profitability……………………………………………………… 77 4.2.6 Size of Firm's External Auditor…………………………………….…. 78 4.2.7 Firm Industry………………………………………………………...... 80 4.3 Hypotheses on the Value Relevance of Accounting Information…………... 81 4.4 Hypotheses on the Value Relevance of Accounting Information and IFRS Compliance …………………………………………………………..
83
4.5 Conclusion………………………………………………………………….. 87 CHAPTER 5: Data and Research Methods ………………………………... 88
5.1 Data and Methods for Testing Compliance Hypotheses……………….…… 88 5.1.1 Data Collection………………………………………………………... 88 5.1.2 Time Period……………………………………………………………. 89 5.1.3 Selection of KSE-listed Companies…………………………………… 89 5.1.4 Measuring the Extent of IFRS Compliance……………….…………… 90 5.1.5 Dependent Variable (Disclosure Compliance Index)............................. 94 5.1.6 Weighting and Scoring the Disclosure Compliance Index……………. 96 5.1.7 Compliance with IFRS Regression Model……………………...……... 99 5.1.8 Determinants of Compliance with IFRS Disclosures ………………… 101 5.2 Data and Research Methods for Testing Value Relevance Hypotheses.…… 102 5.2.1 Time period, Sample and Data Description…………………………... 103 5.2.2 Empirical Valuation Models Assessing Value Relevance…………….. 105 5.2.3 Changes in Value Relevance of Earnings and Book Value…………… 111 5.2.4 Factors Influencing Value Relevance of Earnings and Book Value…. . 112 5.2.5 Extended Price and Returns Models…………………………………... 114
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5.3 Data and Methods for Testing Value Relevance and the Level of Compliance with IFRS Hypotheses …………………………………………
115
5.4 Conclusion …………………………………………………………………. 117
CHAPTER 6: Results of Company Compliance with IFRS-Required Disclosures……………………………………………………………………...
119
6.1 Descriptive Statistics………………………………………………………... 119 6.1.1 Dependent Variable (Extent of Compliance with IFRS-Required Disclosures)…………………………………………………………….
119
6.1.2 Independent Variables (Firm-Specific Characteristics)………………. 126 6.2 Analysis of Univariate Results……………………………………………… 130 6.2.1 Continuous Variables………………………………………………….. 130 6.2.2 Categorical Variables (More Than Two Groups) …………………… 131 6.3 Bivariate Relationships between Independent Variables………………… ... 136 6.4 Multivariate Regression Analysis Results (Hypotheses H1–H7)……… … . 137 6.4.1 Results of Hypothesis Testing: H1………………………………......... 138 6.4.2 Results of Hypothesis Testing: H2……………………………………. 140 6.4.3 Results of Hypothesis Testing: H3……………………………………. 140 6.4.4 Results of Hypothesis Testing: H4……………………………………. 140 6.4.5 Results of Hypothesis Testing: H5……………………………………. 141 6.4.6 Results of Hypothesis Testing: H6……………………………………. 141 6.4.7 Results of Hypothesis Testing: H7……………………………………. 142 6.5 Sensitivity Analysis…………………………………………………………. 142 6.5.1 Robustness of the Dependent Variable………………………………... 143 6.5.2 Robustness of the Independent Variables……………………………... 143 6.6 Conclusion………………………………………………………………….. 144 CHAPTER 7: Results of Value Relevance of Earnings and Book Value …
146
7.1 Descriptive Statistics………………………………………………………... 146 7.1.1 Descriptive Statistics for Dependent and Independent Variables Used in the Valuation Models………………………………………………..
146
7.1.2 Bivariate Correlation Results…………………………………………. 149 7.1.3 Checking Assumptions of the Multiple Regression Analysis……..…… 150 7.2 Empirical Results of Value Relevance of Earnings and Book Value……… 151 7.2.1 Value Relevance of Earnings and Book Value—Price Model Results (H8 and H9)…………………………………………………………….
152
7.2.2 Changes in the Value Relevance of Earnings and Book Value—Price Model Results (H10 and H11)………………………………………....
157
7.2.3 Factors Influencing the Value Relevance of Earnings and Book Value…………………………………………………………………...
162
7.2.4 Extended Price Model…………………………………………………. 164 7.2.5 Summary of Price Model Results…………………………………….... 167 7.2.6 Value Relevance of Earnings—Returns Model (H9)………………….. 168
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7.2.7 Changes in the Value Relevance of Earnings—Returns Model (H11)... 171 7.2.8 Factors Influencing the Value Relevance of Earnings………………… 176 7.2.9 Extended Returns Model………………………………………………. 177 7.2.10 Summary of Returns Model Results………………………………..... 179 7.3 Value Relevance and the Level of IFRS Compliance (H12 and H13).…….. 181 7.3.1 Value Relevance and IFRS Compliance—Price Model……………….. 181 7.3.2 Value Relevance and IFRS Compliance—Returns Model…………….. 184 7.4 Conclusion………………………………………………………………….. 187 CHAPTER 8: Conclusion…………………………………………………….. 189
8.1 Summary and Discussion of Findings……………………………………… 189 8.1.1 Results of Compliance with IFRS Required Disclosures…………….... 193 8.1.2 Results of Value Relevance of Accounting Information ………………. 196 8.1.3 Results of Value Relevance and Level of IFRS Compliance …….……. 200 8.2 Major Contributions and Implications……………………………………… 202 8.3 Limitations and Area for Future Research………………………………….. 204 References……………………………………………………………………… 207 Appendix A: IAS/IFRS and Effective Dates………………………………....... 220 Appendix B: IAS/IFRS Included and Excluded from Compliance Checklist…. 221 Appendix C: IAS/IFRS Compliance Checklist………………………………… 222 Appendix D: Detailed Sensitivity Analysis Results……………………………. 256 Appendix E: Detailed Descriptive Statistics for Variables Used in the Valuation Models…………………………………………………
259
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LIST OF TABLES
Table Page
2.1 Kuwait Stock Exchange—Number of Listed Companies 1995–2006…...
17
2.2 Kuwait Stock Exchange—Investment Sector and Number of Listed Companies 2006………………………………………………………….
17
2.3 Kuwait Stock Exchange—Price Index 1993–2006………………………
7.3 KSE-Listed Companies in Industry Categories 1995–2006……………... 149
7.4 Bivariate Correlations among Dependent and Independent Variables for Firm-Year Observations 1995–2006……………………………………..
150
7.5 Pooled and Yearly Cross-Sectional Regressions of Price on Earnings and Book Value 1995–2006……………………………………………...
154
7.6 Results of Regressions of Price on Earnings and Book Value After Incorporating a Pre- and Post-2001 Dummy Variable …………………
159
7.7 Regression of the R²T, R²EPS, and R²BVS on a Time-Trend Variable 1995–2006……………………………………………………………………..
160
7.8 Results of Regressions of Price on Earnings and Book Value after Incorporating Profit/Loss as a Dummy Variable. ………………………..
163
7.9 Regression Results of the Extended Price Model ……………………….
166
7.10 Pooled and Yearly Cross-Sectional Regressions of Annual Security Returns on Earnings Levels and Earnings Changes 1995–2006.……………………………………………………………………..
169
7.11 Results of Regressions of Returns Earnings Levels and Earnings Changes after Incorporating Pre- and Post-2001 as Dummy Variables…
172
7.12 Regression of the R²T, R²E, and R²∆E on a Time-Trend Variable 1995–2006……………………………………………………………………...
173
7.13 Results of Regressions of Annual Returns on Earnings Levels and Earnings Changes After Incorporating Profit and Loss as a Dummy Variable ………………………………………………………………….
176
7.14 Regression Results of the Extended Returns Model …………………….
179
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7.15 Results of Price Regression on Earnings, Book Value and IFRS Compliance Level ……………………………………………………......
183
7.16 Results of Regression of Annual Returns on Earnings Levels, Earnings Changes and IFRS Compliance Level ……………………………….….
185
8.1 Research Questions and Corresponding Hypotheses, and Hypotheses Test Results ……………………………………………….…………….
201
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LIST OF FIGURES
Figure Page
1.1 The Link Between the Quality of Accounting Information, Enforcement of Accounting Standards, and the Value Relevance of Financial Statements Information ………………………………….
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4.1 The Value Relevance–Information Quality Framework…………… 68
6.1 Mean Bars of Compliance Index Scores for Auditor Combinations Industry Category and Compliance with IFRS Disclosure Requirements ………………………………………………………...
133
6.2 Mean Bars of Compliance Levels with IFRS Based on Industry Categories ……………………………………………………………
136
7.1 Outline of Empirical Results Presented in Section 7.2………………
152
7.2 Changes in the Value Relevance of Earnings and Book Value 1995–2006 ………………………………………………………………….
161
7.3 Changes in the Value Relevance of Earnings Levels and Earnings Changes 1995–2006 …………………………………………………
174
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CHAPTER 1
Introduction
The primary objective of value relevance research is to investigate whether the
financial statements that companies produce provide investors and other users both
high-quality and valuable accounting information that enable them to make
informed decisions. The value relevance of accounting information is a major
concern for investors, regulators and other users of financial reports, and is a popular
study area for accounting researchers. Over the last 10 years, it has been a primary
area of capital market–based research (Beaver, 2002).1
Accounting information is expected to provide investors and other users of financial
statements useful information to help them make informed economic decisions. The
International Accounting Standards Board’s Framework for the Preparation and
Presentation of Financial Statements states that the objective of financial statements
is to ‘provide information about the financial position, performance and changes of
financial positions of an entity that is useful to a wide range of users in making
economic decisions’ (IASB, 2001, Paragraph 12). Therefore, any event that is likely
to affect a company’s current financial position or future performance should be
reflected in its financial statements.
Accounting theory does not directly address the role of accounting information in
emerging markets (Lopes, 2002). However, it could be argued that accounting
information is less relevant in these markets because stock prices may fail to reflect
completely all available company information due to a range of market
imperfections. For example, information asymmetry could be severer in emerging
markets than developed markets because information sources are fewer. However,
this makes accounting information potentially more important and powerful for
1 Value relevance research examines the association between stock price (returns) as a dependent variable and a set of independent accounting variables (e.g., earnings, book values, and cash flows). An accounting variable that is found to have a significant statistical association with the dependent variable stock price (returns) is considered value relevant from an investor’s perspective (Beaver, 2002).
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participants in emerging markets than other sources of information in more
developed markets (Lopes, 2002).
Empirical research on the role of accounting information in emerging markets can
investigate these issues and enhance our understanding of this role. To date,
however, very little research has investigated the particular importance of
accounting information to emerging markets. This study seeks to redress this gap by
examining the Kuwait’s emerging market, its compliance with accounting standards
and its value relevance issues.
1.1 Research Motivation
The study was motivated by three primary factors. The first was a recent study by
Hellstrom (2006) who argues that current value relevance research does not
distinguish between accounting regulations and the actual implementation of
accounting standards. She encourages future research on this issue.
A recent study by Al-Shammari et al. (2008) demonstrates that the Kuwaiti context
provides a suitable environment within which to investigate this issue. They
examine the extent to which companies that operate in the six Gulf Cooperation
Council (GCC) member states (Bahrain, Oman, Kuwait, Qatar, Saudi Arabia and
United Arab Emirates) comply with International Financial Reporting Standards
(IFRS). They show that significant compliance variations exist among GCC-based
companies that utilise IFRS standards. Non-compliance among GCC countries is
also greater than among developed countries, which reflects limited compliance
monitoring and enforcement by the bodies in these countries that oversee financial
reporting. Thus variations could exist in the way firms listed on the Kuwait Stock
Exchange (KSE) actually implement of accounting standards. In essence, a main aim
of this study is to address these issues, and explore the link between the value
relevance of IFRS-based accounting information and the influence of the IFRS
compliance level.
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The second motivation for this study was the lack of existing research on the value
relevance of accounting information in Kuwait. Thus this study contributes to an
understanding of value relevance in light of the Kuwait Stock Exchange’s rapid
expansion. Between 1995 and 2006, the number of KSE-listed companies increased
from 54 to 163. During this time, the average price index in the market also
increased from 1365 to 10,067 points (KSE, 2006). Additionally, in 2001, the
Ministry of Commerce and Industry (MCI) passed a law that allowed foreigners to
invest in KSE-listed companies. This substantially increased the number of market
participants on the exchange.
In Kuwait, the commercial company law is the primary regulation that governs
financial reporting (Al-Qahtani, 2005). Recently, investors and others have strongly
criticised this law, arguing that Kuwait’s financial reporting is weak and outdated
(Borsuly, 2007). In 2001, the MCI, the enforcement body that oversees Kuwait’s
financial reporting, acknowledged the law’s limitations and proposed a new
regulation. However, the proposed law has yet to be placed on the parliamentary
agenda due to a lack of cooperation between parliament and the government
(Alqabas, 2007). The third motivation for this study is to inform the regulatory
debate in Kuwait about the value relevance of accounting information in the KSE,
the level of compliance with IFRS, and how such compliance is associated with the
value relevance of accounting information based on the current securities law.
1.2 Research Questions
Since the seminal work of Ball and Brown (1968), most of the literature on the value
relevance of accounting information has comprehensively documented the statistical
association among earnings, book values and stock prices. This literature includes
Barth & Clinch, 1996; Collins et al., 1997; Francis & Schipper, 1999; and Chen et
al., 2001.
However, much of this literature has centred on developed markets, with little
attention given to emerging markets (Richards, 1996). The value relevance of
accounting information in developed countries may be different than in less
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developed countries (Graham et al., 2000), which have different economic, social,
and cultural characteristics.
Indeed, one might assume that the value relevance of accounting information in less
developed is generally lower than in well developed markets (Hellstrom, 2006).
However, in Kuwait, sources of credible and useful accounting information are
limited, so the role of financial statements may be more important. Thus their
influence on the stock market may be more significant than in developed countries.
For example, the Kuwaiti financial market does not have the same level of press
coverage as the US or other western countries. Bushee et al. (2007) argue that press
coverage significantly affects the information environment of business firms and
increases the amount of publicly available information about these firms. With its
reduced press coverage, this information source is likely to be less important in
Kuwait.
Relevance is one of the four principal qualitative characteristics that financial
information should possess to be useful for decision making (IASB, 2001, paragraph
24). Financial statement information is relevant when it influences users’ economic
decisions by (a) helping them evaluate past, present or future events relating to an
entity, and (b) confirming or correcting their past evaluations (IASB, 2001,
paragraph 26).
A fundamental prerequisite for the value relevance of accounting information is the
quality of the accounting regulations prescribed. High-quality accounting standards
are also necessary to ensure that capital markets and the economy as a whole
function well. Such standards are important for investors, firms and those who set
accounting standards (Hellstrom, 2006).
Arthur Levitt, former Chairman of the U.S. Securities and Exchange Commission
(SEC), stated:
I firmly believe that the success of capital markets is directly dependent on the quality of the accounting and disclosure system. Disclosure systems that are founded on high quality standards give investors confidence in the
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credibility of financial reporting – and without investor confidence, markets cannot thrive. (Levitt, 1998, p. 80)
Kothari (2000) observes that market participants seek high-quality accounting
information to mitigate information asymmetry between firm managers and outside
investors. Francis et al. (2004) identify seven desirable attributes of accounting
quality: accrual quality, persistence, value relevance, timeliness, predictability,
smoothness and conservatism. The authors find that value relevance, even if not the
only attribute, is one of the most important attributes of accounting quality. The
findings of Francis et al. are supported by Barth et al. (2005), who claim that higher
quality accounting information results in less earnings management, more timely
loss recognition, and more value relevant earnings and equity book values.
However, even if accounting regulations are high quality, reported accounting
information might be low quality if it does not fully comply with accounting
regulations or if the discretion provided for in accounting standards has been
exploited opportunistically. Therefore, increasing the value relevance of accounting
information requires more than just adopting high-quality accounting standards,
whether domestic or international. Effective regulation and enforcement
mechanisms must exist to ensure that companies adhere to the prescribed standards
(Hellstrom, 2006).
Consistent with Hellstrom, Barth et al. (2005) also argue that adopting higher
quality accounting standards, such as International Financial Reporting Standards
(IFRS),2 results in predictable improvement in the quality of financial reporting and
value relevance. However, they also note that lax enforcement of these high-quality
standards can result in limited compliance, which undermines the effectiveness of
these standards in producing high-quality information.
Similarly, Kothari (2000) argues that the quality of accounting information is not
influenced simply by the quality of accounting standards, but also by the nature of
2 The IASB’s objective is to produce a single set of high-quality global standards (IASB, 2003).
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corporate governance, the legal system, and the existence and enforcement of
effective laws that govern accounting standards. Kothari defines the quality of
financial information as a function of both the quality of accounting standards and
the enforcement of those standards. Thus, if enforcement is weak, then the quality of
accounting information is likely to be poor, regardless of the quality of the
accounting standards (Kothari, 2000). Glaum and Street (2003) indicate that high-
quality and rigorous independent audits are among the major mechanisms available
to promote legal and regulation compliance. Therefore, the nature and quality of
external audits is considered important in determining the accounting standards
compliance level.
Recognizing the critical role of high-quality accounting information in helping
investors make economic decisions, and in the expectation that adoption of
international accounting standards would yield high-quality accounting information,
the Regulator of the Kuwait Stock Exchange (KSE) issued Resolution No. 18 on
April 17, 1990. This resolution required KSE-listed companies to comply with
IFRS3 in preparing annual and semi-annual financial statements (Shuaib, 1999).
These reporting requirements were strengthened further in 1998 with an additional
KSE requirement, which mandated that all listed companies report their quarterly
financial statements at the end of each quarter (KSE, 2001). The KSE approach is
consistent with the view that an increased focus on the informational needs of
investors in accounting regulation should increase the value relevance of the
information contained in financial statements over time, as better informed investors
are able to determine value more precisely (Gjerde et al., 2005).
In 1994, the MCI recognised the importance of the role audits play in promoting
compliance with laws and regulations. In response, it revised the Commercial
Companies Law No. 15, which required all annual reports and quarterly financial
statements to be audited and reviewed by two external auditing firms. This became
effective for all financial statements after 1 January 1995 (MCI, 2000). 3 The IASB, known previously as the International Accounting Standards Committee (IASC), also issued the International Accounting Standards (IAS) prior to 2001.
7
Motivated by both the lack of research on the value relevance of accounting
information in emerging markets and Kuwait’s unique institutional setting, this
study has three specific objectives. The first objective is to investigate the extent to
which firms listed on the KSE comply with the IFRS. More specifically, determine
the level of IFRS compliance and the factors that influence compliance levels. The
second objective is to examine the value relevance of accounting information
produced by KSE-listed companies and the changes in value relevance over time.
The third objective of this study is to explore the association between the IFRS
compliance level and the value relevance of accounting information to market
participants, thus linking the first two objectives.
Based on these objectives, this study addresses the following research questions:
1. To what extent do KSE-listed companies comply with IFRS disclosure
requirements?
2. What factors explain the differences in KSE-listed company compliance
levels, and how important is the auditor-quality factor?
3. Was accounting information—earnings and book value—value relevant
to KSE participants during the 1995–2006 period?
4. Did the value relevance of accounting information—earnings and book
value— change during the 1995–2006 period?
5. To what extent do compliance levels affect the value relevance of
accounting information?
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1.3 Theoretical Framework and Hypotheses
Following a review of the literature on value relevance and IFRS compliance, a
research framework is developed. The quality of accounting information is expected
to be influenced by the quality of the accounting standards being used. The effective
enforcement of accounting standards is also expected to influence the quality of
accounting information. Thus, drawing on this framework and accounting for firm-
specific characteristics, this thesis investigates the value relevance of IFRS-based
accounting information to market participants and the influence of the compliance
level on value relevance. In the assessment of the IFRS compliance level, the
influence of the enforcement of accounting standards is also considered. Figure 1.1
shows the links among the quality of accounting information, enforcement of
accounting standards and value relevance of financial statements.
Within this framework, 13 research hypotheses are developed and tested to
comprehensively address the study’s objectives and research questions. Seven
hypotheses address the influence of firm-specific attributes on the level of
compliance with IFRS disclosures, while four hypotheses address the value
relevance of accounting earnings and book values to KSE investors during the
1995–2006 period. The remaining two hypotheses address the link between
compliance with IFRS requirements and the value relevance of accounting earnings
and book values to Kuwait Stock Exchange participants.
9
Figure 1.1.The link between the quality of accounting information, enforcement of accounting standards, and the value relevance of financial statements information
Quality of Accounting Information
Quality of Accounting Standards
Value Relevance of Financial Statements
Information
Enforcement of Accounting Standards
External Governance: Regulatory - Legal system and enforcement laws - Regulatory body; proactive monitoring - Regulatory body; reactive monitoring
- Regulatory oversight of external auditor
- Nature of punishment External auditor and audit quality
- Big-4 / non Big-4 audit firms
Internal Governance: Board of directors characteristics
- Board composition - Role duality - Independence
Internal control role
10
1.4 Research Design
Due to the small number of firms listed on the KSE, the study's sample for testing
the hypotheses consists of all companies listed on the KSE.
The primary data source used to test the compliance with IFRS hypotheses is
composed of the annual reports of KSE-listed firms. Due to the need for manual data
collection and the difficulty of obtaining annual reports for earlier years, the study
period is limited to 2006, which was the most recent data available for KSE-listed
firms.4 Of the 39 IASs/IFRSs issued by the end of 2006, only 27 standards were
relevant and applicable to the investigation of compliance.
Consistent with prior compliance research (Cooke, 1989b, 1991, 1992; Tower et al.,
1999; Street and Bryant, 2000; Street and Gray, 2001; Glaum and Street, 2003; and
Al-Shammari et al., 2008), the extent of IFRS compliance among KSE-listed firms
is measured using a self-constructed, item-based compliance index (CINDEX).
To investigate the relationship between the level of compliance with IFRS
mandatory disclosures and attributes that explain compliance differences, the level
of compliance (CINDEX) is used as the dependent variable. Company attributes,
including age, liquidity, leverage, size, profitability, auditing quality and industry
category are used as independent variables.
To investigate the effect of corporate attributes (independent) on the IFRS
compliance level (dependent), a Multivariate Ordinary Least Squares (OLS)
regression model is used. The compliance multivariate regression model specifies
the level of IFRS compliance as a function of a company’s age, liquidity, leverage,
size, profitability, audit quality and industry category.
4 The 2006 year may not be atypical of earlier years because, as Botosan (1997) argues, unlike voluntary disclosures, mandatory disclosure practices have remained relatively constant over time.
11
A 12-year period from 1995 to 2006 is examined to test the value relevance
hypotheses. This period is used because the KSE experienced significant regulatory
improvement and a pronounced increase in the number of listed companies and
market participants during this time. The data required to investigate the value
relevance of accounting information includes stock prices, the book values of
equities, net income, dividends, total assets, total liabilities and common shares
outstanding. This data is collected manually from companies’ financial statements.
The main source for stock price data is the historical database of the KSE Public
Relations Department. The primary source for the other data is the companies’
financial statements, which are available from the KSE Auto Documentation and
Archival Department.
To provide comprehensive insights into the value relevance of accounting
information to investors, two valuation models are used: the price model and the
returns model. The price model is used to examine links among stock prices,
earnings and book values, as in Ohlson (1995). The returns model is used to
examine the links between stock returns and the levels and changes of accounting
earnings, as in Easton and Harris (1991). To explore the extent to which IFRS
compliance can be associated with the value relevance of accounting information,
the standardised compliance score obtained from the self-constructed index is used
as an additional explanatory variable (CINDEX) in the price and returns models.
1.5 Summary of Major Findings
The study findings reveal that the mean level of compliance with all applicable
IFRS-mandated disclosures for all KSE-listed firms during 2006 was 72.6%, ranging
from 49% to 92%. The results show that most KSE-listed firms have complied with
most IFRS-mandated disclosures, though no firm has fully complied with such
disclosures.
The results show wide variations in the level of compliance with the 27 applicable
IAS/IFRS. High levels of compliance with some standards can be attributed to those
standards having requirements that are relatively easy to meet. The medium level of
12
compliance with some standards seemed to be determined by firm-specific
characteristics. And where standards had low levels of compliance, contributing
factors appeared to be proprietary costs, difficulty in adherence, the sensitive nature
of the disclosure requirement and inexperience. Comparing these results with
previous compliance studies shows that the compliance level among KSE-listed
firms is lower than for firms in other developed and developing countries.
The results also suggest a positive links between firm age, leverage, size,
profitability and level of compliance with IFRS disclosures among KSE-listed firms.
In contrast, liquidity was not found to be a significant factor explaining variations in
compliance levels. The findings show significant differences in compliance levels
across the five industry categories in the Kuwait Stock Exchange. Moreover, the
findings highlight the importance of the external auditor’s quality and rigour in
promoting compliance with IFRS requirements. Several robustness tests were
conducted to ensure that the regression results were not sensitive to alternative
measures of the dependent and independent variables, and that the tests confirmed
the results obtained in the primary model.
The results based on the price and returns models show that earnings and book
values were significant factors in firm valuation on the Kuwait Stock Exchange
during the 1995–2006 period. They also show that the value relevance of earnings
and book values declined significantly during this period. The price model results
confirm the impact of profitability, industry categories and firm size on the value
relevance of earnings and book values. However, the returns models confirm the
influence of only profitability on the value relevance of earnings, not industry
category or firm size.
Both the price and returns model demonstrate a significant association between the
IFRS compliance level and the value relevance of earnings and book values to KSE
investors. These results are likely to suggest that greater compliance with IFRS is
valued by market participants, as compliance seems to represent additional
information that investors incorporate into their valuation models.
13
1.6 Contributions of the Study
This study assesses the value relevance of accounting information, IFRS compliance
levels among KSE-listed companies, and the factors that influence the extent of
compliance. The study findings provide several contributions. First, the findings
provide empirical evidence of widespread non-compliance with mandatory IFRS
requirements among KSE-listed firms. These findings raise questions about the
effectiveness of the enforcement bodies responsible for monitoring IFRS
compliance. In addition, the findings confirm past criticism of the currently enforced
securities law, which described it as weak and outdated. Consequently, the study
findings have important implications for standard setters and their current reviews.
In particular, the findings support the ongoing regulatory debate about the need for a
more rigorous regulatory framework, as well as adequate mechanisms to both
address the weaknesses observed in the currently enforced securities law and ensure
compliance with accounting standards.
Second, this study examines the implications of two external auditors on the extent
of IFRS compliance. Since 1995, KSE-listed companies have been required to be
audited by two different external auditing firms. This requirement distinguishes the
Kuwaiti accounting environment from that of countries with more developed
economies, where only one external auditor is required. However, the existing
literature and studies on Kuwait do not examine the effects of two external auditors
on IFRS compliance, which this present study does. Another contribution of this
study is that it explores the implications of two external auditors assessing
regulatory compliance. In this study, the external auditors of all 163 KSE-listed
firms attest to full IFRS compliance. However, in reality, none of these firms
actually fully comply with all the standards. This finding raises serious questions
about how effective the two-auditor requirement is in promoting compliance with
laws and regulations, as well as the associated cost–benefit of this requirement for
KSE-listed firms.
14
Finally, there is no known research that empirically examines the association
between the quality of accounting information and the existence and enforcement of
effective laws that ensure IFRS compliance. Therefore, this study contributes to the
literature by providing the first known empirical evidence on the links between the
level of IFRS compliance and the value relevance of financial statements to market
participants. Price and returns model results show a significant association between
firm value and the level of IFRS compliance. These results offer empirical evidence
to support a theoretical expectation of the association between the level of
compliance with IFRS and the value relevance of accounting information to market
participants.
Consequently, the findings of this study have important implications for standard
setters. In particular, the finding that moving towards stricter IFRS compliance is
likely to improve the value relevance of financial statement information to KSE
participants highlights the effectiveness of greater IFRS compliance and the benefits
to market participants of high-quality, value relevant financial statement
information.
1.7 Organisation of the Study
The remainder of this thesis is organised as follows. Chapter 2 discusses the
regulatory framework of accounting and securities trading in Kuwait, and its impact
on KSE-listed firms. Chapter 3 provides a review of current literature concerning the
value relevance of accounting information and IFRS compliance that is relevant to
this study.
Chapter 4 develops the theoretical framework, including the research model and
related hypotheses. Chapter 5 describes the research design, including descriptions
of variables, study period, data collection and the statistical analysis performed.
Chapter 6 presents the results of IFRS compliance, while Chapter 7 presents the
results of the value relevance of accounting information. The thesis concludes in
Chapter 8 with a summary and discussion of the results, and an outline of the study’s
major contributions, limitations, and implications.
15
CHAPTER 2
Regulatory Framework of Accounting and Securities Trading in Kuwait
Accounting regulations are designed to ensure fair and honest transactions. These
regulations have become particularly important with the rise of corporations, and the
separation of management and ownership, wherein proper accounting attests to the
credibility of financial data. Standard reporting systems provide transparency for
investors, creditors, managers and governments. Thus, regulations and their effective
enforcement give investors a degree of security, and help ensure that capital markets
operate efficiently (Hellstrom, 2006).
In Kuwait, the evolution of corporate financial reporting began in the early 1960s
with growth of the business sector and the establishment of public corporations. The
Kuwaiti government is fully responsible for formulating business regulations, and
managing and running enforcement agencies, to ensure adherence to these
regulations. Accordingly, several laws exist to regulate accounting and securities
trading in Kuwait, two of which are directly relevant to firms listed on the Kuwait
Stock Exchange (KSE):
The Law of Commercial Companies
The Kuwait Stock Exchange Regulations
This chapter discusses the regulations that govern the securities trading and
accounting environment of KSE-listed companies. In addition, the chapter addresses
how important sections of the regulations apply to listed companies. Section 2.1 of
this chapter provides brief background to the Kuwait Stock Exchange. Section 2.2
then presents an overview of the Law of Commercial Companies. Finally, Section
2.3 discusses the Kuwait Stock Exchange Regulations.
16
2.1 Background of the Kuwait Stock Exchange
Formally opened in August 1983, the Kuwait Stock Exchange is relatively young
compared to other developed stock markets (KSE, 2005a). Since then the KSE has
significantly expanded, which has caught the attention of both domestic and
international investors, particularly in recent years.
Table 2.1 below shows the number of companies that were listed on the KSE from
1995 to 2006. The 2006 Kuwait Stock Exchange Investor Guide states that by the
end of 2006 there were 163 Kuwaiti companies on the KSE. The KSE
administration divides all listed companies into seven sectors: banking, insurance,
investment, real estate, industry, service and food. Table 2.2 below shows the
number of KSE-listed companies in each sector in 2006.
The KSE has recently experienced remarkable growth. In 2005, the KSE market
index rose 78.6% after increasing by 33.8% in 2004, by 101.7 % in 2003, and by
39% in 2002 (see Table 2.3). By the end of 2006, the KSE’s market capitalisation
value was $105 billion, an increase of 41.4% over 2005 when the KSE’s market
capitalisation value had been only $74 billion. In addition to market capitalisation,
the number of KSE market participants has increased since 2001 when the Ministry
of Commerce passed a law allowing foreign investors to invest in KSE-listed
companies. Table 2.4 below presents a summary of the KSE’s trading activities from
2001 to 2006.
Several factors have contributed to the KSE’s growth, including the increased profits
of listed companies, growth of capital inflows from domestic and international
sources, higher oil prices, political stability in the area, the Kuwaiti government’s
economic reforms and the privatisation of some of the country’s state-owned
enterprises (KSE, 2005b).
17
Table 2.1: Kuwait Stock Exchange—Number of Listed Companies 1995–2006
One of the most significant laws governing accounting in Kuwait is the Law of
Commercial Companies No. 15/1960. The Ministry of Commerce and Industry
(MCI) issued the law on 19 October 1960 to organise the formation of new
companies and regulate the administration of existing companies. This law has been
amended numerous times over forty years. Although several laws now regulate
Kuwait’s accounting and auditing profession to various degrees, the Law of
Commercial Companies is still considered the primary law governing the accounting
and auditing functions of listed companies in Kuwait (Al-Qahtani, 2005).
Before 2001, Article 68 of the Law of Commercial Companies was a major factor
limiting the growth and development of KSE-listed companies. Article 68 restricted
foreign investment in the Kuwait Stock Exchange to Gulf Cooperation Council
(GCC) nationals, including Bahrain, Oman, Kuwait, Qatar, Saudi Arabia and the
United Arab Emirates.
To encourage foreign investment, an amendment was approved in 2001 that allowed
all foreign investors to acquire up to 49% ownership of a KSE-listed company. Also
under the new law, foreign investors could seek approval from the Minister of
Commerce and Industry to acquire up to 100% of a company’s outstanding shares.
19
As a result, the number of listed companies and market participants on the KSE has
since expanded significantly (KSE, 2005b).
2.2.1 Accounting and Financial Reporting Requirements
Article 93 of the MCI law requires companies to provide annual, audited balance
sheets, and profit and loss statements, to the MCI and all shareholders. Within two
months of the date on which a company’s general shareholders meeting approves its
statements, directors are required to publish their financial statements for the
previous financial year and a list providing the names of the directors and auditors in
the official gazette. However, the law does not provide guidelines for preparing
these statements, other than stating that they be prepared in accordance with
‘generally accepted accounting standards’ to reflect a ‘true and fair view’ of the
company’s position, and that a proper book of accounts must be maintained. Further,
the law does not define ‘generally accepted accounting standards’ or ‘true and fair
view’.
In addition to these annual financial statements, the law requires companies to report
the following information monthly to the Companies Department of the MCI:
transactions volume
company securities traded
highest and lowest sales and purchases of company stock.
Because of the ambiguity that the law creates by not specifying a set of accounting
standards or a definition of ‘true and fair view’, major differences have emerged in
the disclosures that Kuwaiti companies provide in their financial statements. In an
effort to follow generally accepted accounting procedures, and provide a true and
fair view of company positions, differences in disclosure methods arose as
companies adopted the accounting standards of other countries, such as the United
States, the United Kingdom, or the neighbouring Arab countries (Shuaib, 1987).
In 1983, to respond to these discrepancies and in an attempt to standardise
accounting practices in Kuwait, the MCI began to issue memorandums and
20
resolutions that gave guidelines for preparing financial statements. In 1986, the MCI
issued Ministerial Resolution No. 10, which offered guidelines for preparing
financial statements that covered only the following issues:
investment in land and real estate
investment in securities
differences in land and real estate evaluations
receivables, debtors and loans
amortization of deferred losses.
In 1987, the MCI issued Resolution No. 4 to establish a Permanent Technical
Committee with the primary objective of establishing local accounting standards. In
its working methods and procedures, the Permanent Technical Committee (PTC)
states that it would use the accounting standards of developed countries as a guide,
whenever appropriate, for setting accounting standards in Kuwait.
In 1987, the PTC issued the following three accounting standards, which KSE-listed
companies were then required to follow:
Standard No. 1: Financial Statements concerns the information to be
disclosed in financial statements, which to some extent is analogous
to International Accounting Standard No. 5, Information to Be
Disclosed in Financial Statements.
Standard No. 2: Accounting for Investments concerns accounting
for securities investments. This standard is partially in line with the
International Accounting Standard No. 25, Accounting for
Investments.
Standard No. 3: Accounting for Real Estate concerns real estate and,
to some extent, is similar to the International Accounting Standard
No. 25, Accounting for Investments.
21
Although the PTC’s objective was to establish local accounting standards that
incorporated practices relevant to Kuwaiti companies and reflected its economic
environment, the standards received widespread criticism from accountants,
auditors, investors and others for their ambiguity, insufficiency and overall poor
quality (Shuaib, 1998).
After ongoing criticism, the PTC reviewed the effectiveness of the standards with an
eye towards compliance, as well as updating or adding new standards. As part of its
review, the PTC studied current trends in financial reporting and considered
feedback from accountants and auditors. Subsequently, the PTC strongly
recommended that Kuwaiti companies adopt the International Accounting Standards
(IAS). Accordingly, on 17 April 1990, the MCI issued Resolution No. 18, which
mandated that all companies operating in Kuwait and listed on the Kuwait Stock
Exchange adopt the International Accounting Standards for financial periods
beginning 1 January 1991 (MCI, 2000).
2.2.2 Compliance with and Enforcement of Accounting Standards
Article 93 of the Law of Commercial Companies requires that KSE-listed companies
submit their annual financial statements to the MCI registrar and distribute them to
company shareholders. They must submit their annual, audited financial statements
to the MCI within 90 days of the close of the financial year, and at least two weeks
before their annual shareholder meeting. Timely submission of financial statements
is the only MCI requirement for the renewal of a company’s licence.
However, as will be discussed later, the KSE also governs the financial reporting of
its listed companies. In contrast to the MCI rule, the KSE requires all listed
companies to submit reviewed quarterly financial statements within 45 days of the
end of each quarter, in addition to annual, audited financial statements.5
5 Listed companies also have to submit their audited, annual financial statements to the KSE within 90 days of the close of the financial year, as well as the MCI.
22
Article 178 of the Law of Commercial Companies states that the MCI’s Control
Department is responsible for ensuring that listed companies comply with prescribed
requirements and regulations. Thus, the Control Department ensures that companies
submit their annual, audited financial statements to the registrar on time. Upon
submission, the Control Department examines the financial statements for
compliance with the Law of Commercial Companies and International Financial
Reporting Standards.
This law requires the Control Department to conduct this examination before
companies distribute their financial statements to shareholders. As mentioned, listed
companies must submit their annual financial statements to the registrar within 90
days of the close of the financial year, and at least two weeks before their annual
shareholders meeting. Therefore, the Control Department has only two weeks to
examine compliance with laws and regulations—a short period within which to
conduct a comprehensive examination. In addition, although the Law of Commercial
Companies requires two external auditors from different auditing firms to audit
annual financial statements, the Control Department conducts its own examination
of the statements to confirm compliance with laws and regulations.
If a Control Department examination finds a violation of the Law of Commercial
Companies or non-compliance with International Financial Reporting Standards, and
the auditors fail to address these violations in their reports, the Control Department
further investigates the matter with the company’s directors and external auditors. If
further investigation confirms that the company has violated the law, the Control
Department reports this violation to the MCI’s Companies Department, which may
arrange a shareholders meeting. If such a meeting is arranged, the MCI presents the
violation to shareholders and allows them to decide what action to take. If
shareholders decide to pursue legal action, the MCI refers the case to a commercial
court for a hearing and appropriate action.
Company directors or officers may be fined but not prosecuted for non-compliance
with International Financial Reporting Standards. However, if a violation relates to
23
specific issues mentioned in the Law of Commercial Companies, then directors,
officers, auditors and anyone who commits these violations can be fined and
prosecuted. Article 246, amended in 1999, states that any person who commits a
violation will receive a minimum fine of 5000 Kuwaiti dinar (US$17,000) to a
maximum of 20,000 (US$68,000) and can be imprisoned for a maximum of three
years.
Some examples of violators include:
anyone who provides misleading company information or
information not in accordance with the law, or anyone who signs or
distributes such documentation
anyone who values company-contributed property at more than its
fair value
any director, manager, or auditor who participates in preparing
financial statements that do not represent the ‘true and fair view’ of
the company position in order to mislead the public.
2.2.3 Role of External Auditor in Promoting Compliance with Accounting Standards
Both the Law of Commercial Companies and External Auditing Law No. 5/1981
govern the preparation of KSE-listed company financial statements. While the Law
of Commercial Companies requires financial statements to be prepared in
accordance with International Financial Reporting Standards (IFRS), the quality of
these standards is not sufficient to guarantee quality financial reporting.
Accounting standards must be effectively enforced (Ball et al., 2003). An
independent audit is one of the most important factors determining the effective
implementation of quality accounting standards (Glaum & Street, 2003). To enforce
the use of International Financial Reporting Standards and promote the credibility of
financial statements, Article 161 of the Commercial Companies Law states that all
annual financial statements must be fully audited and all quarterly financial
24
statements must be reviewed. At least two external auditors from separate firms
must audit and review the financial statements.
Article 161 states that the board should appoint at least one external auditor at the
company’s general shareholders meeting, and the company financial year must align
with the calendar year. This article was amended in August 1994 to require a
company to have at least two external auditors from different auditing firms,
effective for financial statements beginning 1 January 1995.6 This requirement is
considered one of the unique features of financial reporting in Kuwait, as most
countries require only one external auditor. KSE-listed company auditors must be
independent and not, for example, founders or board members. Also, auditors cannot
provide administrative, technical, or consulting support to the company on a
permanent basis.
Article 163 allows auditors to inspect KSE-listed company books at any time and
request any documents they deem necessary. If company management refuses to
comply with an auditor’s request, the auditor must report this to the board of
directors and to attendees at the shareholders meeting. To qualify to audit KSE-listed
company accounts, auditors must register with the MCI. In addition, external
auditors should be appointed and their remuneration determined at a general meeting
of shareholders.
Article 164 states that auditors should attend general shareholders meetings to
discuss their examinations of company accounts. The auditor’s report should:
verify that the company has proper books of accounts
verify that inventory has been taken in accordance with generally
accepted principles
address whether the auditor received all the information needed 6 Although Article 161 of the amended Commercial Companies Law No. 15/1960 states that a company listed in or registered with the KSE shall have no fewer than two external auditors, provided that they are from separate auditing firms, no pronouncements from any regulatory body in Kuwait have prescribed the practices and procedures for the joint audit (Al-Bannay, 2002).
25
address whether the company balance sheet and income statement,
which must be prepared in accordance with company by-laws, the
Law of Commercial Companies, and International Financial
Reporting Standards, present a ‘true and fair view’
address whether the information in the board of director’s report
agrees with the information in the company books
address whether any violations of the company’s by-laws, the Law of
Commercial Companies or the International Financial Reporting
Standards were committed during the year—a condition that might
affect the company’s activities or financial position.
If the company receives a qualified audit report of its financial statements, a
representative from the MCI’s Companies Department must attend the general
meeting of shareholders and call the matter to the attention of shareholders. After
receiving clarification from the auditors, shareholders have the right to take action,
including dismissing members of management, the board of directors, or the firm’s
external auditors (Article 178).
It should be noted that auditors are fully responsible for ascertaining that their
reports are correct. Under the Law of Commercial Companies, auditors are
considered agents of the shareholders, so each shareholder has the right to question
auditor reports and receive a full explanation for any matters raised (Article 165).
2.2.4 Criticisms of the Effectiveness and Enforcement of the Securities Laws
Despite numerous amendments to the Law of Commercial Companies No. 15/1960,
the law has been strongly criticised by investors, accountants, academics, creditors
and others who are concerned with commercial companies in Kuwait (Borsuly,
2007). Such criticism focuses on:
weak and outdated articles that do not mesh with current practices
that govern companies
26
articles that not only contradict each other, but also other regulations
pertaining to the KSE. These contradictions can lead to conflicting
opinions and mixed results, thereby weakening the power of
enforcement
insufficient punishment for those who violate the law.
Borsuly (2007) argues that the laws regulating commercial companies in Kuwait are
not strong enough and are missing many key elements because they are based on
outdated economic conditions. For example, Section 184 of the Law of Commercial
Companies, which deals with insider trading, states that insider trading activities
will be penalised a minimum of 10 Kuwaiti dinar (US$34) and a maximum penalty
of 200 Kuwaiti dinar (US$680). Comparing this punishment with those imposed by
other countries clearly shows the Law of Commercial Companies’ weaknesses and
limitations. This outdated punishment for insider trading activities led to World
Bank criticism in its 2004 report, where it claimed that the Law of Commercial
Companies could no longer control companies. According to the World Bank, a new
law that eliminates contradictions and increases penalties should be established to
improve the market information environment and reduce insider trading (Borsuly,
2007).
Even the Kuwaiti Minister of Commerce and Industry has criticised the Law of
Commercial Companies, stating that a new law must be established to eliminate
perceived regulatory weaknesses. He further stated that the MCI had proposed such
a law eight years ago (Alqabas, 2007) but, due to a lack of cooperation between the
parliament and the government, the proposed law had yet to be placed on the
parliamentary agenda. In response to rising criticism of the law’s internal and
external contradictions, the MCI recently created a team that would eliminate legal
contradictions by establishing a single law—the Monetary Market Authority Law—
to govern KSE-listed companies (Alqabas, 2007).
27
2.3 The Kuwait Stock Exchange Regulations
Although the Kuwait Stock Exchange was officially established in 1983, over-the-
counter trading in Kuwaiti companies has occurred since the late 1960s (KSE,
2001). In August 1983, the Amer of Kuwait passed a decree that officially
established the Kuwait Stock Exchange as an independent financial institution that
was managed by an executive administration and committee.
Article 5 of KSE Regulations states that the exchange shall be managed by the
Market Committee (MC). The MC comprises 11 members, including the president
who is the Minister of Commerce and Industry. The vice president of the committee
is the KSE’s Director General. One member each represents the MCI, the Ministry
of Finance and the Central Bank of Kuwait (CBK). Four members represent the
Kuwait Chamber of Commerce and Industry. Two members are experienced and
competent individuals who are selected by the Council of Ministers on nomination
by the Minister of Commerce and Industry.
Essentially, as noted by Al-Loughani and Chappell (2001), three bodies regulate the
KSE: the MC/KSE, the MCI and the CBK. These bodies regulate and supervise the
Kuwaiti securities market, securities issuers, intermediaries and other institutions
operating in the KSE. Because these bodies often issue conflicting instructions that
can lead to sudden policy changes, stock trading in Kuwait can be highly uncertain.
The Kuwait Stock Exchange Regulations of 1983 assigned the MC and KSE the
responsibility of protecting investors and organizing, developing, and serving the
financial market. The Companies Department at the MCI is responsible for
governing company incorporations and issuing capital shares. Responsibility is
assigned to the Central Bank of Kuwait for supervising, regulating and licensing the
financial institutions and investment companies that operate in the exchange.
28
2.3.1 Criticisms of the Administration of KSE Regulations
The International Monetary Fund (IMF) recently assessed the securities regulatory
system in Kuwait, and noted that the KSE is governed by the three regulatory and
enforcement agencies mentioned above. These institutions’ responsibilities and
regulations often overlap, which results in confusion, and compromises the
effectiveness of the laws and regulations, and their enforcement. The assessment
also found that the securities regulatory powers in Kuwait lack coordination, which
leads to a fragmentation of responsibilities. Principle 1 of the International
Organization of Securities Commissions (IOSCO) states that the regulator’s
responsibilities should be clear and objectively stated. The IMF assessment
concluded that the KSE does not adhere to this principle and suggested that a single,
independent regulatory agency be formed to update the many existing regulations
that lag behind modern best practices (IMF, 2004).
Article 1 of the Amiri Decree grants the MC/KSE independence. However, in
practice it is not independent from external political or commercial interference. For
example, the Minister of Commerce and Industry is the president of the MC, which
can create political conflicts. In addition, six members of the MC represent market
players and the business community, creating a clear conflict of interest that may
interfere with the KSE’s fairness regarding licensed intermediaries (IMF, 2004).
In response to increasing criticism of the regulations that govern the KSE, the MCI
recently created a team that would grant independence to the KSE and eliminate
contradictory regulations by establishing a single regulatory framework—the
Monetary Market Authority Law—to govern listed companies. The main objective
of this redrafted law would be to provide complete independence to the Kuwait
Stock Exchange and eliminate all contradictions that current regulations impose
(Alqabas, 2006).
To create a regulatory framework that reflects current business laws, the MCI has
signed agreements with the U.S. Securities and Exchange Commission (SEC),
Strahota Capital Markets, LLC, and the National Association of Securities Dealers
29
(NASD), who will review the proposed regulatory framework and provide feedback.
The proposed law is expected to adhere to the International Organization of
Securities Commission (IOSCO) standards, which in turn will help Kuwait to
qualify as a member of the International Organization of Securities Commission
(Alqabas, 2006).
2.3.2 Accounting and Financial Reporting Requirements
Unlike the Law of Commercial Companies, which only requires that annual
financial statements be submitted to the MCI, Article 14 of the KSE Regulations of
1983 requires listed companies to provide them within three months after the end of
the financial year. In 1994, an amendment to Article 14 was passed that required
listed companies to further provide semi-annual financial statements by 15 August
each year. In 1998, a further amendment required listed companies to provide
quarterly financial statements within 45 days of the end of each quarter.
KSE-listed companies must submit audited financial statements to the Surveillance
Department at the KSE by the prescribed time. The department does not rely on
independent audit reports for assurance that companies are complying with laws and
regulations. Instead, the department conducts it own examination to determine
compliance with the Law of Commercial Companies, KSE Regulations and the
Central Bank Law, as well as adherence to the International Financial Reporting
Standards. Unlike the MCI, which examines only annual financial statements, the
Surveillance Department conducts a comprehensive examination of annual and
quarterly corporate financial statements. A Surveillance Department examination
involves reviewing a company’s compliance with every International Financial
Reporting Standard. It also analyses and calculates financial ratios to assess the
financial condition of each company (Article 15). If a company is not complying
with these regulations, the KSE Disciplinary Board may impose one of the
following penalties (Article 60):
caution
warning
30
suspension of securities trading for a period not to exceed four
months
cancellation of KSE membership or securities trading licence.
If the Disciplinary Board decides that a violation constitutes a criminal offence, the
case will be prosecuted in a court of law.
The IMF’s assessment report also criticised the KSE sanctioning system. The report
revealed that the regulations provide no pecuniary sanctions and fail to keep the
market in order. The IMF suggested that the KSE impose pecuniary sanctions and a
larger spectrum of sanctions, which should correspond with the seriousness of the
irregularities that market participants commit (IMF, 2004).
Due largely to the lack of penalty, insider trading among KSE investors and
portfolio managers has been a major problem. Al-Saif (1997) argues that KSE
regulators need to control and fine inside traders by passing effective regulations to
increase investor confidence. Al-Hebishy (1997) suggests that insider trading could
be reduced if the available information about listed companies was improved. He
emphasises that information about listed companies should be immediately
disclosed to the public to reduce the possibility of insider trading.
Likewise, the IMF report severely criticised the non-prohibition against insider
trading as a serious defect in the current trading system, and called for
comprehensive rules to address this issue that would be enforced by inspection,
investigation and surveillance systems. According to the IMF, insider trading rules
are a prerequisite for adequate protection for minority shareholders and for wider
participation in the market, particularly wider foreign participation (IMF, 2004).
It should be noted that, under the KSE Regulations, insider trading is neither
prohibited nor penalised provided no trades are based on insider information.
However, as previously discussed, the Law of Commercial Companies, deals with
insider trading activities in a minor way. Article 184 of the Law of Commercial
31
Companies, which concerns insider trading, states that inside traders who base trades
on inside information are subject to a minimum penalty of 10 Kuwaiti dinar
(US$34) and a maximum penalty of 200 Kuwaiti dinar (US$680).
2.3.3 Improvement to the Existing KSE Regulations
To increase market transparency, Article 17 of the KSE Regulations requires listed
companies to immediately disclose to KSE administration any material information
that could affect their business or financial positions. In 1999, an amendment to this
article was passed that required a company and its stockholders to immediately
disclose any single ownership interest once that interest directly or indirectly equals
or exceeds 5% of a company’s capital. The KSE is required to immediately display
this information on trading screens. Stockholders who violate these rules are denied
the right to vote for the extra number of respective stocks for two consecutive
general assembly meetings. Hassan et al. (2003) point out that such new disclosure
rules have gradually improved the KSE’s functioning and efficiency.
To protect the market from sharp price movements, Article 35 of the KSE
Regulations states that the Market Committee shall fix the rate of stock fluctuation
to control volatility and ensure exchange stability. If fixed rates are exceeded, the
KSE may suspend trading operations for a maximum of three days. The KSE fixes
stock fluctuation rates by implementing a price unit system. Under this system, on
any given day, each security has its own market up and down limit. Once the limit is
reached, a security cannot be traded further on that day. The KSE’s set limit is five
units. Therefore, a stock price is allowed to increase or decrease by only five units
on any given day (KSE, 2001).
2.3.4 KSE Listing Requirements
According to Article 4 of the KSE Regulations, listing requirements are established
by the KSE and subject to the Market Committee’s approval. The minimum capital
required for a company to be listed on the KSE is 10 million Kuwaiti dinar (US$34
million). The company must have been operating for at least five years and must
have published audited financial statements for the three financial years prior to the
32
request for listing. In addition, the company must have achieved a net profit in the
previous two years, with a minimum annual net profit of 7.5% of the company’s
capital (KSE, 2007).
According to the Law of Commercial Companies, the MCI, not the KSE, governs
initial public offerings of securities. This requires companies offering securities to
the public to prepare a prospectus that discloses complete and reliable information.
A company’s initial public offering cannot be listed on the exchange until one year
after the publication of its audited financial statements.
Table 2.5 provides a chronological overview of the development of the accounting
environment in Kuwait and its effect on KSE-listed companies.
33
Table: 2.5 Summary of Major Events and Laws that Affected KSE-listed Firms
Year Event
1960 Issue of the Commercial Companies Law, which has been amended several times and is still considered the primary law that governs accounting and auditing of listed companies, in addition to the KSE Regulations.
1983
Establishment of the Kuwait Stock Exchange and issue of KSE Regulations.
1987
Issue of local accounting standards, which receive frequent criticism for their ambiguity and incompleteness.
1991
MCI requirement that all companies that operate in Kuwait and are listed on the KSE must fully comply with the IFRS.
1994
KSE requirement that all KSE-listed firms to provide semi-annual financial statements.
1995
MCI requirement that at least two external auditing firms must audit all annual reports.
1998
KSE requirement that all KSE-listed firms must provide quarterly financial statements in accordance with IAS 34. In addition, that two external auditors must review and approve quarterly reports.
1999
KSE requirement that all KSE-listed companies must immediately disclose any material information that may affect their business or financial positions to KSE administration.
2001
MCI law change to allow foreign investors to invest in the KSE.
2004–2007
Strong criticism of Commercial Companies Law and KSE Regulations by national and international parties for being outdated and insufficient, as well as for the clear overlaps and contradictions that exist between these laws.
2007
MCI acknowledgement of 2004–2007 criticism and its response that it had proposed an improved law eight years before, which had yet to be placed on the parliamentary agenda due to lack of cooperation between the parliament and government.
34
2.4 Conclusion
This chapter provides an overview of the development of the accounting
environment in Kuwait and its effect on KSE-listed companies. The Kuwaiti
government is solely responsible for formulating business regulations, and for
managing and running the enforcement agencies that ensure adherence to these
regulations.
The Law of Commercial Companies and the Kuwait Stock Exchange Regulations
are considered the primary laws that regulate accounting and securities trading in
Kuwait. This chapter addresses how significant sections of these laws affect listed
companies in Kuwait. Despite numerous amendments, investors, accountants,
academics, creditors and others concerned with commercial companies in Kuwait
have strongly criticised these laws for their weak and outdated nature. The
regulatory authority in Kuwait has acknowledged these criticisms and intends to
introduce a more rigorous regulatory framework that will resolve these weaknesses.
However, until such reforms are introduced, it can be assumed that the Kuwaiti
accounting environment has been, in general, loosely regulated. Such environment
provides an interesting context in which to examine compliance with international
accounting standards and the value relevance of accounting information for KSE-
listed companies.
As both regulations and enforcement are costly for regulators and companies, a
potential benefit of this study is that corporate regulators and company managers
may learn to recognise compliance levels and the effect of compliance on the value
relevance of financial statement information. Thus, the outcome of this research will
inform regulators whether moving toward stricter IFRS compliance will necessarily
improve the value relevance of financial statement information in the KSE. Finding
a significant association between IFRS compliance and the value relevance of
accounting statements may provide evidence of the benefits that IFRS compliance
holds for the quality and value relevance of financial statements.
35
While this chapter has considered the Kuwaiti institutional setting in which
accounting regulations operate, the next chapter considers the research background
as it relates to the research questions, and reviews literature pertinent to the value
relevance of accounting information and compliance with International Financial
Reporting Standards in different institutional contexts.
36
CHAPTER 3
Literature Review
Consistent with the research objectives, two major streams of literature are relevant
to this study: the value relevance of accounting information and compliance with
International Financial Reporting Standards (IFRS). This chapter examines both
streams of literature.
The first part of the chapter examines the literature relating to the concept of value
relevance in accounting. This is followed by a review of key studies that examine
both value relevance in mature and emerging financial markets, and institutional
factors associated with differences in value relevance across markets. The second
part of the chapter reviews the literature on compliance with international standards
and factors that influence compliance. Finally, the chapter identifies gaps in both
literature streams, which provides the basis for the theory and hypotheses developed
in Chapter 4.
3.1 Research on the Value Relevance of Accounting Information
The seminal works of Ball and Brown (1968) and Beaver (1968) have been catalysts
for a large number of studies on the value relevance of accounting information.
Their studies represent the first attempts to explore the relationship between
accounting variables and stock prices. The main objective of existing value
relevance research is to investigate whether reported accounting numbers provide
valuable corporate information for investors and other users (Negakis, 2005).
Barth et al. (2001) argue that the key purpose of value relevance research is ‘to
extend our knowledge regarding the relevance and reliability of accounting amounts
as reflected in equity values’ (Barth et al.,2001, p.80). Value relevance research
examines the association between the stock price as a dependent variable and a set
of independent accounting variables. An accounting variable is considered value
37
relevant if it is significantly associated with a dependent variable, such as stock price
(Beaver, 2002).
Barth et al. (2001) claims that value relevance research is not only important for
investors, but it also provides useful insight into accounting matters for standard
setters and other users. Francis et al., (2004) identify seven desirable attributes of
accounting quality: accrual quality, persistence, value relevance, timeliness,
predictability, smoothness and conservatism. This suggests that value relevance,
even if not the only attribute, is one of the most important attributes of accounting
quality.
Beaver (2002) notes that value relevance had been a major area of interest in
empirical accounting research throughout the previous 10 years. However, Beaver
states that ‘as with other research areas, value relevance research is controversial’
(Beaver, 2002, p.460). For example, Holthausen and Watts (2001) assess value
relevance literature’s inferences for standard setting. The authors argue that it is
difficult to draw standard setting inferences from existing literature, and claim that
much of the value relevance research is motivated by an assumption that financial
statements provide inputs to investors’ valuations and that equity investors are the
dominant users of financial reporting. They argue that this is inconsistent with the
view of accounting standard setting regarding the purpose of accounting, which
emphasises all stakeholders. In contrast, Barth et al. (2001) present a different view,
arguing that value relevance research provides useful insights for standard setters.
They contend that although the focus of value relevance research is on investors, the
importance of this research to standard setters should not be underestimated.
The efficient market hypothesis (EMH) provides the theoretical framework and
basis for much of the capital market–based research in accounting (Kothari, 2001).
Value relevance research is part of capital market research, and is based on the
premise that, if accounting information is useful, investors will adjust their
behaviour and the market will respond quickly through a change in stock price.
38
Consequently, information is considered relevant if changes in stock price (or stock
returns) are associated with accounting information.
Scott (2006) explains how security prices respond to the release of accounting
information, which can be used to measure the value relevance of accounting
numbers to investors. He notes that the value relevance of reported net income can
be measured by the extent of security price change around the time the market learns
of the current net income. Scott (2006) rationalises the use of stock price as a
measure of value relevance by noting that rational, informed investors revise their
expectations of future performance and stock returns on the basis of current earnings
information. Revised expectations trigger buy or sell decisions as investors move to
restore the risk–returns tradeoffs in their portfolios to desired levels. If net income
does have information content to investors there would be revision of beliefs upon
receipt, hence triggering buy or sell decisions and associated price changes. Scott
(2006) concludes by noting that accounting information is value relevant if it leads
investors to change their beliefs and actions, and that the extent of a price change
following the release of accounting information is a good measure of the degree of
usefulness to investors.
In capital market research, the market is assumed to be semi-strong efficient.7 The
EMH asserts that, under semi-strong-form efficiency, stock prices adjust rapidly and
accurately in response to all publicly available information (Fama, 1970). This
means that when new information is released, the market will promptly and fully
incorporate it into the price. Since financial statement information is considered a
primary source of publicly available market information, the semi-strong-form
efficiency hypothesis is assumed in value relevance research and thus will be
assumed in this study.
Empirical literature on the value relevance of financial statement information falls
into two major classifications for value relevance research: international
7 Other forms of market efficiency are weak-form market efficiency and strong-form market efficiency (Fama, 1970).
39
comparisons of value relevance research and (2) within country value relevance
research. Given that a major objective of this report is to investigate value relevance
within Kuwait’s capital market setting, this study follows and contributes to the
second category, that is, within country value relevance research.
3.1.1 Interpretation of the Value Relevance Construct
Francis and Schipper (1999) consider four possible interpretations of value
relevance. Under the first interpretation, financial statement information leads
security prices by capturing intrinsic share values, towards which security prices
drift. Value relevance is then measured as the profit generated from implementing
accounting-based trading rules.
Under the second interpretation, financial statement information is considered to be
value relevant if it contains the variables used in a valuation model or predicts those
variables. The valuation model here refers to a discounted dividend valuation model,
a discounted cash flow valuation model or a discounted residual income model.
Under this interpretation, value relevance might be measured by the usefulness of
earnings in predicting future dividends, cash flows, earnings, or book values.
Under the third interpretation, value relevance is indicated by a statistical association
between financial information and stock price or returns, or whether investors
actually use the information to set prices and revise their expectations. Value
relevance is measured by the ability of financial statement information to change the
total mix of information in the market.
This interpretation implies that value relevance is measured in terms of news, and
assumes that value relevant financial information changes security prices because it
causes investors to revise expectations. This interpretation focuses on whether
investors care about the content of financial statements, as well as the timeliness and
predictability of that information. Accordingly, an information content study (a short
window returns study) is adopted to implement this interpretation in an empirical
setting, and consider concerns such as timeliness and expectations formation.
40
Under the fourth interpretation, value relevance is measured by the ‘ability of
financial statement information to capture or summarise information, regardless of
sources, that affects share values’ (Francis and Schipper, 1999, p.326). According to
this interpretation, value relevance is assessed by measuring the statistical
association between accounting information and stock prices or returns over a
relatively long period. It should be noted that, under this interpretation, financial
statement information is not required to be the earliest source of information.
Beaver (2002) notes that value relevance research includes event studies and level
studies. Event studies, the third of Francis and Schipper’s interpretations, examine
stock price reactions over short windows of time that are centred on an
announcement date. Under an event study, the public disclosure date of the item
under study is identified and then the stock price change is examined around the
event date.
Level studies, the fourth of Francis and Schipper’s interpretations, examine the
relationship between stock prices levels and accounting variables. Under level
studies, value drivers that could be reflected in stock price are identified over a
longer time period than used in event studies. According to Beaver (2002), value
relevance research based on level studies is notable because the timeliness of
financial statement information is not an overriding issue. In contrast, the timing of
information is a primary concern in event studies.
This present study examines the value relevance of financial statement information
by testing the statistical association between accounting information (earnings and
book values of equity) and stock prices and returns. Thus, this study follows and
empirically examines value relevance using Francis and Schipper’s fourth
interpretation of value relevance. Hence, the value relevance literature reviewed in
this chapter primarily relates to studies that also use this interpretation.
41
3.1.2 Value Relevance Studies in Mature Financial Markets
Numerous studies are conducted in mature financial markets, such as the United
States, to explore the relationship between accounting numbers and stock prices.
Collins et al. (1997) investigate changes in the value relevance of earnings, book
value, and combined earnings and book value for U.S. firms over a 41-year period.
Their study reveals three primary findings. First, the combined value relevance of
earnings and book value seems to increase slightly over time rather than decline.
Second, the value relevance of earnings appears to decline over the study period but,
at the same time, the value relevance of book value increases. Third, the shift in
value relevance from earnings to book value appears to be due to an increase in the
incidence and significance of one-time items, changes in average firm size and
intangible intensity level over the study period, and an increased frequency of
negative earnings.
Similar to Collins et al. (1997), Francis and Schipper (1999) examine the value
relevance of earnings and book value for U.S. firms from 1952 to 1994. Their results
indicate that the explanatory power of earnings, and changes in earnings,
significantly decreased over time. Conversely, their test of the explanatory power of
book values showed no evidence of decline.
In contrast to Collins et al. (1997) and Francis and Schipper (1999), Brown et al.
(1999) and Lev and Zarowin (1999) both report a decline in the value relevance of
the book value of equity and earnings over time for U.S. firms. Brown et al. (1999)
state that the results of prior studies that investigate the value relevance of
accounting numbers over time do not control for scale effects and can be misleading.
In particular, the authors argue that the documented increase in the value relevance
of accounting information relates to increases in the coefficient variation of the scale
factor. They find a decline in the value relevance of earnings and book value as
measured by R² after controlling for these effects.
42
Motivated by the anecdotal concerns of financial analysts, accounting regulators and
U.S.centric academic research papers that conclude that the relevance of financial
accounting information has declined over time, Brimble and Hodgson (2007)
examine whether the relevance of accounting earnings for valuation declined in
Australia between 1973 and 2001. The study undertakes methodological refinements
that involve controlling for transitory items using nonlinear regressions and
adjusting for possible stock market inefficiencies. After controlling for nonlinearities
and stock price inefficiencies, the results show that the value relevance of
accounting earnings did not decline during this period.
Using returns and price models, Lev and Zarowin (1999) examine the value
relevance of financial information (earnings, book values, and cash flows) compared
to the total information available in the marketplace between 1977 and 1996.
Contrary to Collins et al. (1997) and Francis and Schipper (1999), Lev and Zarowin
note a systematic decline in the association between capital market values and key
financial variables (book value, earnings, and cash flow) for U.S. firms during the
1980s and 1990s. They argue that this decline in the usefulness of financial
information was due primarily to business change, whether driven by innovation,
competition or deregulation. The authors note that the current reporting system does
not sufficiently capture either the impact of change on a firm’s operations or
economic conditions, which creates a mismatch between revenues and costs. To
remedy this asymmetry, Lev and Zarowin (1999) suggest that the current financial
reporting system be revised to incorporate business changes, either through
comprehensive capitalisation of intangible investments or systematic restatement of
financial reports.
Burgstahler and Dichev (1997) explore the role of earnings and book value as
complementary, fundamental determinants of market values. The authors argue that,
under the complete and perfect markets assumption, measures of book value and
earnings are redundant alternatives for equity valuation. However, in a more realistic
setting with market imperfections, measures of book value and earnings are
complementary, rather than redundant, components of equity valuation. Thus, in
43
imperfect markets, equity valuation is a function of the firm’s current resources
(book value) and how well such resources are utilised (earnings).
Accordingly, Burgstahler and Dichev (1997) argue and find evidence showing that
markets give more weight to book value for firms with low earnings levels and more
weight to earnings for firms with high earnings levels. Burgstahler and Dichev’s
(1997) analyses are consistent with Collins et al. (1999) in that the authors find that
book value becomes a more important indicator of market value for firms with low
earnings or losses.
Similar to Burgstahler and Dichev (1997), Collins et al. (1999) explore the role of
book value in equity valuation to show that the book value of equity is more value
relevant than earnings for firms that report losses. To investigate why the book value
of equity is more value relevant, the authors examine loss firms in detail and explore
whether book value substitutes for expected future earnings or liquidation value.
Collins et al. (1999) find that book value provides information about future earnings
for loss firms. In addition, the authors find that book value serves as a value relevant
proxy for liquidation value in the case of loss firms that are most likely to cease
operations and liquidate.
Barth et al. (1998) study the relative valuation roles of book value and net income
with respect to a firm’s financial health. Upon examining U.S. firms from 1974 to
1993, they conclude that the explanatory power of earnings is positively associated
with a firm’s financial health. In contrast, the explanatory power of book value is
negatively associated with a firm’s financial health. They suggest that investors
place more valuation weight on equity book value or net income, depending on firm
differences in financial health, which supports the argument that the balance sheet
and income statement fulfill different roles.
Chang (1999) investigates changes in the value relevance of earnings and book
value, as well as the factors associated with those changes, for U.S. firms from 1953
to 1996. Using the residual income valuation approach, he develops three measures
44
of value relevance: variation measures, portfolio return measures and valuation lag
measures.
Chang’s results for variation measures indicate that the value relevance of book
value and earnings decline over time. For portfolio return measures, the results
indicate that the value relevance of both book value and earnings decline over the
period. However, the returns from earnings-based portfolios had not changed over
the period. Results for valuation lag measures indicate that valuation lag changes
nonlinearly over time. Chang’s study then investigates factors associated with
changes in the value relevance of book value and earnings. The results show that
growth difference, intangible asset intensity and nonrecurring items are all inversely
associated with the value relevance of earnings and book value.
Existing literature on value relevance also documents the value relevance of non-
financial information and suggests that an important complementary relationship
exists between traditional financial variables (earnings, book value, and cash flow)
and non-financial variables in the context of high-tech sectors.
Amir and Lev (1996) investigate the value relevance of wireless communication
companies’ financial information (earnings, book values, and cash flows) and non-
financial information (the total of population in a company’s service area (POPS) as
a growth proxy, and the ratio of subscribers to POPS, or penetration rate as an
operating performance measure) of wireless communication companies using price
and returns models. Their study reveals two key findings. First, financial variables in
this sector are value relevant only when combined with non-financial variables in
regression models. This result demonstrates the complementary relationship between
financial and non-financial information. Second, the value relevance of non-
financial information in the wireless communications industry overwhelms the value
relevance of traditional, financial indicators. Similar results are expected in other
science-based, high-growth sectors. The authors believe that this shows how
important it is to significantly expand the range of fundamental variables examined
to include non-financial variables.
45
Using returns and price models, Ely and Waymire (1999) examine the time series
behavior of the relationship between earnings and stock returns for yearly samples
of New York Stock Exchange (NYSE) firms between 1927 and 1997. The study
hypothesises that earnings relevance became materially greater after: (a) the
empowerment of the Committee on Accounting Procedure (CAP) in 1993 as the first
U.S. standard-setting body and (b) the subsequent reorganisations of the standards-
setting process, which led to the creation of the Accounting Principle Board (APB)
in 1959 and the Financial Accounting Standard Board (FASB) in 1973.
Ely and Waymire find weak evidence to support the hypothesis that earnings
relevance became greater following the empowerment of U.S. accounting standard-
setting bodies. However, they note that the study is based entirely on a broad test of
association and casual interference about economic issues, and they do not offer
causes for these weak findings.
The purpose of this brief overview is to provide a summary of previous value
relevance research that has been conducted in mature financial markets. The overall
empirical results of the studies suggest that both balance sheet information (book
values) and income statements (earnings) are value relevant in mature financial
markets, though, in the U.S. market, their valuation importance has declined over
time. In addition, previous research notes the importance of incorporating non-
financial information to complement financial information in equity valuation.
Overall, an extensive body of research has found that a broad range of information is
value relevant to investors in mature markets.
3.1.3 Value Relevance Studies in Emerging Financial Markets
While many studies are conducted in mature financial markets to explore the
relationship between stock prices (or returns) and accounting variables (earnings and
book value), more recent research shows some interest in the value relevance of
accounting information in an international context (Lopes, 2002). However, even
with the recent interest in international markets, emerging financial market research
46
has been somewhat neglected. Nevertheless, some interesting findings have arisen
from a small number of studies.
Graham et al. (2000) examine the value relevance of accounting information in
Thailand before and after the 1997 devaluation of the baht. The authors address two
primary questions. First, what is the relationship between accounting information
(earnings and book value) and stock prices in Thai companies? Second, what effect
did the 1997 economic crisis have on the association between accounting
information and stock prices?
To analyse the change in value relevance before and after the 1997 crisis, the study
covers the period from 1992 to 1998. The authors find that the earnings and book
values produced by Thai firms were value relevant; but the association between
accounting information and stock prices changed over the study period. Specifically,
the value relevance of earnings alone and book value alone declined over the sample
period. Such a deterioration of earnings’ value relevance would have been expected
after the baht devaluation. Interestingly, the study also shows that the explanatory
power of book value increased both during and after the 1997 economic crisis.
Using a returns and price model, Chen et al. (2001) examine the relationship
between accounting information, earnings and book value, and stock price in the
Chinese stock market from 1991 to 1998. Their findings show that accounting
information is value relevant according to both pooled cross-section and time series
regressions. These results are consistent across both returns and price models.
In addition, the study explores four factors that are likely to affect the degree of
value relevance: positive versus negative earnings, firm size, earnings persistence
and stock liquidity. The results also indicate that earnings are value relevant for
firms with positive earnings, whereas firms with negative earnings show no
evidence of value relevance. The returns model shows that the earnings of smaller
firms are more value relevant. However, the price model shows that the earnings of
larger firms are more value relevant. With respect to earnings persistence, the results
47
indicate that Chinese stock prices do not appear sensitive to earnings persistence in a
manner similar to that exhibited in mature financial markets. As for stock liquidity,
the study findings support the hypothesis that accounting information is more value
relevant for companies whose stock are more liquid, as measured by greater
percentage of public shareholding.
Jermakowicz and Gornik-Tomaszewski (1998) explore the association between
stock returns and annual earnings, based on the Polish accounting standards of firms
listed on the Warsaw Stock Exchange (WSE). The study’s sample comprises 52
WSE-listed firms from 1995 to 1997. The authors employ the returns model
developed by Easton and Harris (1991) to measure value relevance. The study’s
results show that, with regard to Polish firms, annual earnings is an important
element of equity valuation in the WSE. In addition, Jermakowicz and Gornik-
Tomaszewski (1998) argue that their results are generally consistent with those
obtained by Easton and Harris (1991), who assess the association between earnings
and returns for U.S. firms. From these results, the authors conclude that earnings
produced by Polish firms play a valuation role similar to those in mature financial
markets, particularly in other European markets.
Ragab and Omran (2006) investigate the value relevance of accounting information
from 1998 to 2002, based on Egyptian Accounting Standards, for a sample
consisting of 56–59 firms per year. Their study employs the returns model of Easton
and Harris (1991) and the price model of Ohlson (1995). Empirical results show
that, based on both returns and price models, accounting information, earnings and
book value are all relevant in the Egyptian market and, except for a non-significant
relation between earnings changes and stock returns, the results are consistent with
other literature on value relevance in mature markets. Ragab and Omran rationalise
the exception by stating that Egyptian investors might have a very short-term
horizon and thus focus on earnings levels rather than earnings changes when valuing
stocks.
48
Ragab and Omran note that an important finding is that the value relevance of
Egyptian financial accounting information is relatively greater than information in
more mature financial markets. They justify this finding by arguing that competing
information sources, such as earnings forecasts, management conference calls and
financial analyst reports are less prevalent in Egypt than more mature financial
markets.
Bae and Jeong (2007) examine the value relevance of earnings and book value
produced by companies that belong to Korean business groups known as the
chaebol, where controlling power is heavily concentrated in a single family. In
addition, the study explores the extent to which governance mechanisms affect the
value relevance of accounting information. The study sample consists of industrial
firms listed on the Korean Stock Exchange between 1987 and 1998.
Employing the price model of Ohlson (1995), the findings show that the value
relevance of book value and earnings is significantly smaller for chaebol-affiliated
firms. While company size is positively associated with value relevance, the authors
find that chaebol companies, which are generally larger in size, are less value
relevant than non-chaebol-affiliated firms.
Additionally, Bae and Jeong (2007) find that foreign equity ownership, as a proxy
for the monitoring effect, is positively associated with value relevance. However, in
contrast, they find that cross-equity ownership, as a proxy for cash flow–control
divergence, is negatively associated with value relevance. The authors argue that the
current literature on value relevance generally assumes that it is homogeneous across
firms within a country. This study’s important contribution is showing that this
assumption is invalid. Bae and Jeong (2007) argue that significant differences exist
in the degrees of value relevance among companies within a country, and that a
company’s governance structure is a primary determinant of value relevance.
Most relevant to this study, Elshamy and Kayed (2005) investigate the value
relevance of earnings and book value for Kuwaiti firms. Their study employs the
49
Ohlson (1995) valuation model, which expresses a firm’s stock price as a function of
both earnings and book value. Using a sample of 31–75 firms per year, they estimate
yearly cross-sectional regressions for the 1992–2001 period and use the R² metric to
measure value relevance. In addition, the study compares the explanatory power of
earnings and book value for share prices.
Elshamy and Kayed’s findings (2005) show that adjusted R² for the pooled cross-
sectional, time series regression indicates that earnings and book value jointly
explain about 75% of the cross-sectional variation in securities prices, which
indicates that earnings and book value are positively and significantly associated
with stock price. In addition, earnings and book value individually explain a
significant portion of the variation in stock prices each year and for all years.
The adjusted R² for the pooled cross-sectional, time series regression shows that
earnings alone explains about 72% of the cross-sectional variation in stock prices,
while book value alone explains about 62% of the cross-sectional variation in stock
prices. In the combined model, the results show that the incremental information
content of earnings is relatively high at 13%, while the incremental information
content of book value is only 3%. This finding is inconsistent with U.S. studies
(Collins et al., 1997; Francis and Schipper, 1998), which find that book value
explains more than earnings.
To gain insight into the association between earnings or book value and stock prices,
Elshamy and Kayed (2005) partition the total sample into sub-samples based on firm
profitability. Using profit–loss firm classifications, the study reveals that earnings
for profit firms add more to the overall explanatory power of the valuation model
than book value. In contrast, earnings for loss firms do not add any value to the
overall explanatory power of the valuation model. Book value is only a marginally
significant explanatory variable. In conclusion, Elshamy and Kayed argue that their
study findings are similar to those obtained in U.S. and other developed markets,
except the finding that the incremental information content of earnings is greater
than that of book value.
50
Elshamy and Kayed’s (2005) study has a number of limitations. First, it examines
the value relevance of earnings and book value based only on the price valuation
model provided by Ohlson (1995). Kothari and Zimmerman (1995) argue that the
price model is better specified economically because the estimated slope coefficients
of the price model are less biased than those of the returns model. However, the
returns model has fewer serious econometrical problems than the price model. To
provide comprehensive insights into value relevance of accounting information,
Kothari and Zimmerman (1995) and Ota (2003) suggest using both price and returns
models in value relevance studies rather than just one model.
The second limitation is that their study assumes that the ‘Kuwaiti accounting
system assures a complete compliance with the International Accounting Standards’
(Elshamy and Kayed, 2005, p68). However, Al-Shammari et al. (2008) use a sample
of GCC companies to demonstrate a significant variation in compliance among
KSE-listed companies.
The present study will attempt to overcome the limitations of Elshamy and Kayed’s
study. It focuses on the value relevance of financial statement information and the
influence of the IFRS compliance level on value relevance. Furthermore, the
economic environment in Kuwait, in general, and the KSE in particular, has
significantly progressed over the last five years, especially since the 2001 reform
allowing foreigners to invest in the KSE. Further, this study covers a larger sample
than Elshamy and Kayed examined in terms of companies and market participants.
In summary, value relevance studies that are undertaken in emerging financial
markets use similar models to those used in studies of the value relevance of
financial statements in mature financial markets. While the findings of research into
value relevance in emerging markets are generally consistent with those of mature
markets, some inconsistencies are evident and warrant further investigation. Also,
the issue of accounting standard compliance and its impact on accounting quality
has not been investigated.
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3.1.4 The Influence of Institutional Factors on Financial Statement Value Relevance
Beaver (2002) reviews five major areas of capital market research that he believes
have made the greatest contribution to existing knowledge over the past ten years:
market efficiency, Feltham-Ohlson modelling, value relevance research, analyst
behaviours and discretionary behaviours. Beaver adds that more than any of the four
areas that are reviewed, value relevance research requires in-depth knowledge of
accounting institutions, accounting standards, and the particular characteristics of the
reported numbers. Hellstrom (2006) argues that this feature of value relevance
research supports research based on case country studies, rather than large
comparative studies where the researcher has a limited possibility of understanding
the accounting institutions and standards of all researched countries.
As well as the importance of accounting institutions for value relevance research,
prior research finds significant differences in the properties of accounting
information across countries due to differences in institutional and legal settings. For
example, Bushman and Piotroski (2006) highlight the importance of institutional
factors in shaping accounting numbers, stating that a country’s legal system,
securities laws and regulations, political, economy and tax systems create incentives
that influence the behaviour of corporate managers, regulators, investors and other
market participants. These incentives shape the characteristics of reported
accounting numbers through a complex interaction of accounting standards; legal,
regulatory, market and political pressures; and reporting discretions exercised by
managers. Thus, a complete understanding of the properties of accounting numbers
must incorporate the influence of financial reporting incentives that the existing
institutions generate.
Ali and Hwang (2000) use data from 16 countries over the 1986–1995 period to
explore relationships between measures of value relevance of accounting
information, earnings and book value of equity, and several country-specific factors.
They demonstrate that value relevance of financial statement information is sensitive
to several country-specific factors.
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Specifically, Ali and Hwang reveal four primary findings. First, value relevance is
lower for countries with bank-oriented financial systems than those with market-
oriented systems. The authors justify this finding by noting that, in bank-oriented
financial systems, only a few banks supply most business capital needs, as opposed
to market-oriented systems in which several diverse investors provide financing.
Because of the low number of financial providers in bank-oriented systems, the
demand for accounting information is lower because banks have direct access to
company information.
Ali and Hwang’s second finding is that value relevance is lower for countries where
private sector bodies are not involved in the standard-setting process. The
rationalisation is that government bodies establish financial accounting rules to
satisfy regulatory needs instead of investors’ information needs, such as computing
income taxes.
The third finding is that value relevance is lower when tax regulations significantly
influence financial accounting measures. This finding is drawn from the fact that tax
regulations are influenced by social, political and economic objectives rather than
the investors’ information needs. The fourth finding is that value relevance is greater
when more is spent on external auditing services. This finding suggests that
resources committed to auditing reflect the importance and value of financial
accounting information to investors.
Hellstorm (2006) explores value relevance in a unique institutional setting. The
focus of her study is the Czech Republic’s transitional economy during its switch
from a centrally planned economy to an open economy. The study identifies five
institutional factors that influence the extent of and changes in value relevance: the
development of accounting laws and regulations, control mechanisms, business
climate changes, economic development and industry structure, and
internationalisation and the business cycle. The study shows that the degree of value
relevance can be expressed as a function of all of these institutional factors.
53
The above review of the literature on the influence of institutional factors
demonstrates the importance of understanding the factors uniquely associated with
each country’s accounting information value relevance. Until recently, many studies
have been conducted in countries with highly developed markets, such as the U.S.,
while little attention has been paid to other international markets (Richards, 1996).
However, more recently, studies conducted in a broader international context have
been the focus of some accounting information literature. The motivations for this
vary, but generally relate to these countries’ unique accounting, reporting, standard
setting and other institutional factors. These differences create a need for an
improved understanding of the influence of institutional factors on the value
relevance of accounting information (Lopes, 2002).
3.2 Compliance with International Financial Reporting Standards (IFRS) Literature
This section reviews existing literature that is relevant to studies of IFRS
compliance. Section 3.2.1 explores existing theories on the motivation for
compliance with IFRS disclosures. Section 3.2.2 then examines existing literature on
IFRS compliance. Finally, Section 3.2.3 discusses the corporate determinants of
compliance with IFRS disclosure requirements.
3.2.1 Motivation for Compliance with IFRS Disclosures
The influential works of Grossman (1981) and Milgrom (1981) explain possible
motives for firms to provide full disclosure to investors. The authors argue that, in
the absence of disclosure, investors must obtain and analyse data from other sources,
and they incur costs while doing so. Due to a lack of information, investors discount
the price they are willing to pay to purchase a firm’s stock. Firms are then motivated
to disclose all relevant information to mitigate undervaluation. Thus, firms find it
more beneficial to disclose additional information to investors.
This argument is based on the notion that information asymmetry is created between
firms and investors when firms do not fully disclose information (Petersen and
Plenborg, 2006). According to economic theory, information asymmetry can
54
increase a firm’s capital cost because imperfect information can lead to ‘adverse
selection’ between buyers and sellers of a firm’s securities. This adverse selection
tends to reduce the liquidity of a firm’s securities (Copeland and Galai, 1983;
Glosten and Milgrom, 1985).
In contrast, increased disclosure improves comparability and permits potential
investors to recognise more efficient firms for investment purposes. Thus, in the
absence of full disclosure, firms must discount share issues to provide extra
compensation to potential investors who may be hesitant to hold shares in firms that
offer limited liquidity. Because of the discount, the firm receives less capital from
the issue of equity, ultimately increasing the firm’s capital cost. By increasing their
disclosure, firms are likely to mitigate information asymmetry between firms and
investors, which should reduce capital costs (Diamond and Verrecchia, 1991). The
reduction in capital costs motivates firms to disclose information in their reports to
attract investors and maintain low capital costs.
Botosan (1997) presents an empirical assessment of the quantifiable benefits of
increased disclosure. Using a sample of U.S. firms, Botosan (1997) examines the
association between disclosure level and the cost of equity capital. Botosan regresses
firm-specific estimates of the cost of equity capital on market beta, firm size and a
self-constructed measure of disclosure level. This measure of disclosure level is
based on the amount of voluntary disclosure that 122 U.S. manufacturing firms
provided in their 1990 annual reports. The findings show that greater disclosure is
associated with lower equity capital costs. However, the study finds this statistically
significant, negative relationship only for firms with limited analyst following. For
firms with extensive analyst following, no evidence of association is evident.
Botosan attributes the lack of evidence on the relationship between disclosure and
equity cost to the disclosure measure she uses in her study. She notes that this
disclosure measure is limited to information in the firms’ annual reports, which
might not provide a powerful proxy for the overall disclosure level when analysts
play a significant role in the communication process.
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Similar to Botosan (1997), Botosan and Plumlee (2002) explore the association
between disclosure and equity cost. They confirm Botosan’s 1997 findings, and
provide evidence that firms with greater disclosure in their annual reports experience
lower equity capital costs. This disclosure benefit also extends to reducing the cost
of debt capital (Sengupta, 1998).
Although previous studies demonstrate the benefit associated with greater
disclosure, such as reducing equity capital and debt costs, Verrecchia (1983) argues
that disclosure is limited by a ‘proprietary cost’. Scott (1994) defines proprietary
cost as any possible reduction in future cash flows that are attributable to disclosure.
Verrecchia (1983) argues that the release of greater information about a firm, either
favourable or unfavourable, is useful to competitors, investors or employees in a
way that could threaten the firm’s prospects and competition position. This could
cause reductions in future cash flows. This potential threat associated with
disclosure may cause firms to limit their disclosure levels when proprietary costs
arise. Healy and Palepu (2001) document that, when proprietary costs arise,
companies have an incentive not to disclose information that will reduce their
competitive position, even if doing so increases the cost of raising additional equity,
i.e. there is a cost–benefit trade-off.
As well as the capital needs theory, previous studies have also used the signalling
and agency theories to explain manager incentives to disclose (Jensen and Meckling,
1976; Morris, 1987). The signalling theory addresses problems of information
asymmetry in markets and explains how this asymmetry can be reduced if the party
with more information signals it to others. This theory assumes that companies have
information that investors do not. If investors have no information about a specific
company but do have general perceptions, investors will value all companies at the
same price, which is a weighted average of their general perception. Managers of
greater quality companies incur an opportunity loss by doing so because their
company might be valued at a higher price if investors know about the company’s
superior quality, while managers of lower-quality companies have an opportunity
gain.
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High-quality companies have an incentive to leave the market unless they can
communicate their superior qualities to investors and increase the share price. This
communication is done by signalling (disclosure). As better quality companies
signal, investors consider all the remaining companies to be of poorer quality, so
their average price is reassessed downward. The best of the remaining firms then try
to distinguish themselves. The process of signalling continues as long as companies
obtain an increase in price that exceeds signalling costs. To be effective, firms
should use credible signals (Morris, 1987).
Hughes (1986) views disclosure as a signal of corporate values when there is high
information asymmetry between investors and a firm. She argues that firm managers
can use disclosure to signal the firm’s value to investors. These signals are credible
to investors because a firm’s quality can be easily observed later, and firms that send
fraudulent disclosures are penalised. Hughes’ study shows that information
asymmetry gives managers an incentive to signal their firm’s value through
disclosure to differentiate their firm from those of poorer quality.
In addition to signalling theory, disclosure literature uses agency theory to explain
managers’ disclosure incentives (Morris, 1987). Agency theory concerns the
behaviour of principals (shareholders) and agents (managers) in the separation of
ownership and firm control. The theory explains problems that arise when
shareholders rely on managers to provide services on their behalf, due to the
separation of ownership and control (Jensen and Meckling, 1976). If parties act in
self-interest, the conflict of interest between shareholders and managers increases.
Due to these interest conflicts, agency costs rise. Managers have an incentive to
reduce these agency costs, and one way to do so is disclose more accounting
information (Morris, 1987).
In summary, the existing theoretical literature on disclosure has used the capital need
theory, agency theory and signalling theory, to provide possible motives for firms to
provide financial reporting disclosure, and explain variations in the level of financial
reporting disclosure across firms. In general, these studies show that firms might
57
benefit from giving investors additional accounting information to exploit the
disclosure benefits that exceed disclosure costs, such as lower capital or debt cost.
Given these benefits, it is reasonable to assume that managers will be motivated to
exploit the discretion offered in accounting standards to maximise reporting and
disclosure benefits.
3.2.2 Research on the Extent of IFRS Compliance
Over recent years, International Financial Reporting Standards (IFRS) have
increasingly become the global accounting standards. According to the International
Accounting Standard Board (IASB), almost 100 countries have adopted or made a
commitment to adopt IFRS (IASB, 2008). However, questions are raised as to
whether companies that claim to be IFRS compliant are, in fact, complying with all
IFRS requirements (Glaum & Street, 2003). Indeed the IASB and the president of
the International Federation of Accountants (IFAC) have criticised auditors who
assert that financial statements fully comply with International Accounting
Standards (IAS) when the accounting policies and notes indicate otherwise (Cairns,
1997).
Street et al. (1999) investigate this issue by empirically examining the accounting
policies and disclosures of firms from various countries that claimed to comply with
IAS in the financial year of 1996. Their study reveals significant IAS non-
compliance, and that the degree of compliance by companies that claim to comply
with IAS is mixed and selective. Thus, the findings of Street et al. support the
IFAC’s view that auditors often assert that financial statements comply with IAS,
when, in fact, the accounting policy footnotes and other notes indicate otherwise.
Their results show that, while many firms are anxious to seek the international
investment status that comes with adopting IAS, they are not always willing to fulfill
all of the requirements and obligations that are required in order to do so.
58
In response to the concern that companies frequently note in their annual reports that
they fully comply with IAS, despite obvious exceptions to IAS guidelines, the IASC
revised IAS 18:
An enterprise whose financial statements comply with International Accounting Standards should disclose that fact. Financial statements should not be described as complying with International Accounting Standards unless they comply with all requirements of each applicable Standard and each applicable Interpretation of the Standing Interpretations Committee. Inappropriate accounting treatments are not rectified either by disclosure of the accounting policies used or by notes or explanatory material (IAS 1 Revised, 1997, para. 11 & 12).
Glaum and Street (2003) investigate IAS compliance after the revised IAS 1 is
passed. Glaum and Street investigate the compliance level of companies listed on
Germany’s New Market with both IAS and U.S. Generally Accepted Accounting
Principles (GAAP) disclosure requirements, with regard to their year 2000 financial
statements. Their findings reveal that compliance levels range from 41.6% to 100%,
with an average of 83.7%. Both univariate comparison and analysis that controls
other firm characteristics indicate that the average compliance level is significantly
lower for companies that apply IAS than those that apply U.S. GAAP. The authors
argue that this result partially supports critics who claim that the system of IAS is
weaker and less rigorously applied than U.S. GAAP.
Tower et al. (1999) investigate the extent of IAS compliance across six countries in
the Asia Pacific region: Australia, Hong Kong, Malaysia, Philippines, Singapore and
Thailand. They analyse the 1997 annual reports of 10 listed companies’ in each of
the six countries. The analysis comprehensively compares IASC rules with company
annual report disclosures. In doing so, the authors find that many IAS are not
applicable to some companies and so use two compliance index ratios. Ratio 1
assumes that a firm’s non-disclosure of an item means that it is a non-applicable
item. Ratio 2 has a stricter interpretation and assumes that a firm’s non-disclosure
8 The IASC revised IAS 1, ‘Presentation of Financial Statements’ in 1997, effective for financial statements covering a period beginning on or after 1 July 1998. Further revisions to IAS 1 were made in 2003.
59
means that the firm does not comply with the rule. The results show that the overall
compliance mean is 90.68% for Ratio 1 and 42.2% for Ratio 2. Australia has the
highest level of compliance (Ratio 1 = 94% and Ratio 2 = 54%) while the
Philippines has lowest level of compliance (Ratio 1 = 88% and Ratio 2 = 28%).
Using a worldwide sample, Street and Gray (2001) examine the extent of IAS
compliance among 279 firms from 32 countries. They use the financial statements
and footnotes of 1998 accounts to analyse compliance levels. The findings show that
significant IAS non-compliance, especially in the case of IAS disclosure
requirements. Extending Street and Gray (2001), Morris and Gray (2009) use a
sample of 519 firms from 12 Asian countries in 2002 to examine whether country-
level explanatory variables more than firm-level variables explain variations in IFRS
compliance levels. The results show that both country-level and firm-level variables
influence the extent of IFRS compliance, but that country-level variables are more
influential.
While numerous studies have examined compliance with international accounting
standards in specific countries, only a few that have examined corporate compliance
in Middle Eastern countries. A recent study by Al-Shammari et al. (2008) examines
the extent of IAS compliance by companies in the Gulf Cooperation Council (GCC)
countries (Bahrain, Oman, Kuwait, Qatar, Saudi Arabia and United Arab Emirates)
from 1996 to 2002.
In contrast to Abdelrahim et al. (1997), who use a questionnaire to measure IAS
compliance, Al-Shammari et al. analyse company financial statements using a
compliance checklist for 14 IASs.9 Al-Shammari et al. (2008) suggest that
examining company financial statements, rather than obtaining views and opinions
of chief financial officers via questionnaires and interviews, provides more reliable
evidence of compliance levels. Importantly, this study reveals a significant variation
in compliance levels among GCC countries and between companies. The average
compliance level for all GCC companies during the study period was 75% and there
9 The 14 IASs are IAS 1, 10, 14, 16, 18, 21, 23, 24, 27, 28, 30, 32, 33 and 37.
60
was an increase in compliance over time from 68% in 1996 to 82% in 2002. This
finding reveals that non-compliance is widespread and is probably greater than
among developed countries.
An earlier study also examined IAS compliance by Kuwaiti companies. Using a
small sample of 22 KSE-listed companies, Abdelrahim et al. (1997) examine their
compliance with mandatory IAS requirements in 1995 financial statements. The
study investigates three IAS that relate to fixed assets: IAS 16 (accounting for
property, plant and equipment), IAS 20 (accounting for government grants and
disclosure of government assistance) and IAS 23 (borrowing costs). The data
required for the study is obtained from a questionnaire, and interviews with financial
managers and accountants. The study findings show that companies fully complied
with some requirements but not with other requirements For example, some
mandatory requirements had less than 20% compliance.
Abdelrahim et al. (1997) indicate that, based on their sample, no KSE-listed
company is fully compliant with all the mandatory requirements of the three
investigated standards. They stress the importance of further training for accountants
who are responsible for applying IAS in Kuwaiti companies to promote compliance
with the required IAS.
3.2.3 Corporate Determinants of Compliance with IFRS Disclosure Requirements
In addition to determining the extent of IFRS compliance, several compliance
studies explore the relationship between the extent of IFRS compliance and several
institutional and corporate characteristics, such as industry, size, profitability,
liquidity, ownership diffusion, audit quality, leverage, internationality and age.
Generally, these studies reveal that firm size and listing status are significantly
associated with the degree of compliance. However, findings on the relationship
between the extent of compliance and other company attributes are mixed (Glaum
and Street, 2003). In general, the purpose of exploring the association between the
level of compliance and company attributes is to understand the factors associated
61
with compliance, and explain differences in the extent of compliance across
companies and countries.
Glaum and Street (2003) investigate the effect of several corporate characteristics on
the level of compliance with IAS and U.S. GAAP disclosure requirements in the
year 2000 financial statements of companies listed on Germany’s New Market. The
corporate characteristics are firm size, audit quality, reference to the use of ISA or
U.S. Generally Accepted Auditing Standards (GAAS) in the audit opinion, listing
status, country of domicile, industry, profitability, internationality, ownership
structure, maturity and rate of growth.
Using a sample of 100 firms that apply IAS and 100 that apply U.S. GAAP, the
study reveals that the level of IAS and U.S. GAAP disclosure compliance is
positively and significantly associated with firms being audited by ‘Big-5’ auditing
firms and with cross-listing on U.S. exchanges. The results also show that
compliance levels are associated with reference to the use of ISA or U.S. GAAS in
the audit opinion. The study shows that none of the other attributes significantly
explains the level of IAS and U.S. GAAP disclosure compliance . Glaum and Street
(2003) argue that the corporate characteristic that most determines the level of IAS
and U.S. GAAP compliance is being audited by a Big-5 audit firm. The authors
show that, on average and with all other things being equal, a switch from a non-
Big-5 to a Big-5 audit firm results in a 10.8% increase in compliance level. In
addition, the study shows that two of the Big-5 firms outperform the others in
influencing client compliance levels.10
In their study of the extent of IAS compliance among Gulf Cooperation Council
(GCC) countries, Al-Shammari et al. (2008) investigate factors associated with the
level of IAS compliance. Nine company attributes are examined: company size,
leverage, internationality, ownership diffusion, auditing firm, company age, industry
10 Gallery et al. (2008) similarly show that when Australian companies adopted IFRS in 2005, disclosure quality differed according to the Big-4 audit firms that companies engaged to conduct the external audit.
62
category, liquidity and profitability. Based on a sample of 137 GCC companies, the
results show that, between 1996 and 2002, compliance was statistically and
significantly associated with a company’s size, leverage, internationality and
industry. However, company profitability, liquidity, ownership diffusion and
whether the audit is conducted by a Big-5 audit firm are not significantly associated
with the compliance level. Al-Shammari et al. (2008) note that their results differ
from those found in developed countries, suggesting that corporate characteristics
associated with IAS compliance may differ between developed and developing
countries.
As well as institutional differences between developed countries and GCC countries,
Al-Shammari et al. (2008) find variations in the relative influence of corporate
characteristics across GCC countries. Size is the most influential factor in every state
except Bahrain, while a company’s age is significantly associated with the
compliance level in Bahrain, Oman and Kuwait. Leverage and internationality are
statistically significant in Oman and Kuwait, while a company’s industry category is
significant only in Kuwait. Profitability is positively and significantly related to the
level of compliance in Qatar, while liquidity is negatively associated with the level
of compliance in Saudi Arabia. Other company attributes are not significant in any
GCC country. Al-Shammari et al. (2008) argue that variations in the relationship
between compliance levels and company attributes in GCC countries suggest that
the influence of company attributes may differ between countries, even when these
countries are in one region and have strong economic and cultural ties.
In summary, the literature on IFRS compliance provides substantial evidence of
non-compliance by companies that claim to comply with the standards. In addition,
these studies document a significant variation in compliance across countries.
Moreover, variation in compliance also occurs between companies, based on
corporate characteristics such as industry, internationality, leverage, size,
profitability, and the quality and rigor of audit (Tower et al., 1999; Street and
Bryant, 2000; Street and Gray, 2001; Glaum and Street, 2003; Al-Shammari et al.,
2008).
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3.3 Conclusion
Most of the previous literature on the value relevance of accounting information has
a prominent characteristic—an inability to distinguish between accounting standards
used and the actual implementation of those standards. Hellstrom (2006) states that
companies cannot expect their accounting information to have higher value
relevance simply because they adopt high-quality accounting standards, whether
domestic or international. She notes that high-quality accounting standards will not
be effective or produce value relevant information unless effective control
mechanisms ensure that the standards are actually implemented and complied with.
Hellstrom (2006) encourages future value relevance research to address this issue,
and to distinguish between accounting standards and the level of compliance with
those standards.
Although many previous studies have investigated the value relevance of accounting
numbers in the U.S. and internationally (Amir et al., 1993; Barth & Clinch, 1996;
Collins et al., 1997; Francis & Schipper, 1999; Bao and Chow, 1999; Chen et al.,
2001), no known research explores the association between the extent of IFRS
compliance and the value relevance of accounting numbers. Thus, there is room for
research that examines this issue.
As mentioned previously, a recent study by Al-Shammari et al. (2008) finds a
significant variation in the extent of IFRS compliance among GCC companies.
Therefore, the Kuwaiti stock market provides an ideal setting for investigating this
issue further and exploring the relationship between compliance levels and the value
relevance of accounting information. The next chapter pursues this further,
developing the theoretical framework and the research hypotheses to address the
study’s research objectives and questions.
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CHAPTER 4
Theoretical Framework and Hypotheses Development
The literature review in Chapter 3 highlights the effects of institutional factors on
accounting numbers. Previous studies have documented the effect of a country’s
legal system, securities laws and regulations, political, economy and tax system on
the value relevance of accounting numbers. The literature on IFRS compliance
highlights the effects of firm-specific characteristics on a firm’s compliance level.
Based on these studies, this chapter is divided into four sections. Section 4.1
develops a research framework to demonstrate the relationships among the quality of
accounting information, the enforcement of accounting standards and the value
relevance of financial statement information. Section 4.2 presents testable
hypotheses regarding the relationship between firm attributes and the level of
compliance with IFRS-required disclosures. Section 4.3 presents a set of hypotheses
regarding the value relevance of earnings and book values. Finally, Section 4.4
presents hypotheses regarding the links between compliance with IFRS-required
disclosures and the value relevance of accounting earnings and book values.
4.1 The Value Relevance–Information Quality Framework
Chapter 3 discussed the motivation for firms to provide complete disclosures to
investors. In addition to those motivations, external and internal governance factors
also influence levels of IFRS compliance.
4.1.1 External Governance
One external factor that influences the level of IFRS compliance is the effectiveness
of an enforcement body’s monitoring of financial statements. Al-Shammari (2005)
discusses two types of financial statement monitoring that promote IFRS
compliance: proactive and reactive monitoring. Proactive financial statement
monitoring refers to the process of monitoring company compliance with IFRS and
other accounting regulations to detect non-compliance.
65
In contrast, reactive financial statement monitoring refers to the process of
examining company compliance with IFRS and other accounting regulations after
the enforcement body receives a complaint that the company has failed to comply
with prescribed standards. The level of the regulatory monitoring system’s
effectiveness is likely to influence IFRS compliance. In addition, both regulatory
oversight of external auditors and the nature of sanctions imposed for compliance
violations also influence the level of compliance.
External audits also play an important role in promoting IFRS compliance. Glaum
and Street (2003) note that the external auditing firm’s role in examining financial
statements is one of the most influential determinants of effective compliance with
accounting standards. As well as external audit involvement in promoting
compliance levels, Glaum and Street note the importance of audit quality in
promoting compliance. Their empirical results demonstrate that, on average, a
switch from a non-Big-5 audit firm to a Big-5 audit firm results in an approximately
11% increase in the level of IAS compliance.
4.1.2 Internal Governance
In addition to external governance, previous studies discuss the influence of internal
governance on the extent of financial disclosure. For example, Haniffa and Cooke
(2002) examine whether the extent of disclosure in annual reports can be associated
with internal governance. The authors use board composition, family members
sitting on the board, role duality, non-executive chairpersons and cross-directorship
by board members as indicators of internal governance. Their results indicate that
only family members sitting on a board and non-executive chairmen are
significantly associated with the extent of disclosure in annual reports. The board’s
role as a key internal governance mechanism is further emphasised in Gibbins et al.
(1990), who note that boards of directors are formally responsible for disclosing
information in the annual reports. As such, the nature of the board of directors and
related internal governance mechanisms are likely to have an important influence on
the extent of disclosure.
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4.1.3 Components of the Framework
Based on a review of the literature on value relevance and IFRS compliance, this
study develops a framework showing the relationships between the quality of
accounting information, enforcement of accounting standards and the value
relevance of financial statement information (see Figure 4.1 below). The quality of
accounting information is influenced by the quality of accounting standards used and
the effectiveness of their enforcement. As previously mentioned, Kothari (2000)
supports this relationship by noting that the quality of accounting information is a
function of both the quality of accounting standards and the enforcement of those
standards.
Figure 4.1 further demonstrates that the quality of accounting information that a firm
produces would influence the value relevance of financial statement information to
market participants. Francis et al. (2004) note that value relevance of accounting
information—even if not the only attribute—is one of the most important attributes
of accounting quality. The findings of Barth et al. (2005) support the relationship
between the quality of accounting information and value relevance by providing
empirical evidence that adopting higher quality accounting standards results in an
improvement in the quality of financial reporting. As a result of the improved
financial statement quality, value relevance increases for both earnings and book
value.
As well as the effect of the quality of accounting standards on the quality of
accounting information, Figure 4.1 also illustrates that the enforcement of
accounting standards can affect the quality of accounting information. As previously
discussed, Barth et al. (2005) note that lax enforcement of accounting standards may
result in limited compliance, which undermines the ability of these standards to
produce high-quality information. Similarly, Hellstrom (2006) argues that merely
adopting high-quality accounting standards is insufficient to increase the quality of
accounting information. Hellstrom argues that effective regulations and enforcement
67
mechanisms are also necessary to ensure that companies follow and comply with
these standards.
Previous literature identifies external and internal factors that can affect the
enforcement of accounting standards. As Figure 4.1 shows, the effectiveness of
accounting standards enforcement can be expressed as a function of both external
governance and internal governance. External governance refers to the effectiveness
of the regulatory body and the external auditor in ensuring corporate compliance
with accounting regulations. As the board of directors is formally responsible for the
information disclosed in annual reports (Gibbins et al., 1990), companies’ internal
governance is also expected to influence the enforcement of accounting standards.
68
Figure 4.1. The Value Relevance–Information Quality Framework
Quality of Accounting Information
Quality of Accounting Standards
Value relevance of financial statements
information
Enforcement of Accounting Standards
External Governance: Regulatory
- Legal system and enforcement laws - Regulatory body; proactive monitoring - Regulatory body; reactive monitoring - Regulatory oversight of external auditor - Nature of punishment External auditor and audit quality
- Big-4 / non-Big-4 audit firms
Internal Governance: Board of directors characteristics
- Board composition - Role duality - Independence
Internal control role
69
Drawing on this framework and accounting for firm-specific characteristics, this
study examines five research questions with respect to KSE-listed companies:
1. To what extent do KSE-listed companies comply with IFRS?
2. What factors explain the differences in KSE-firm compliance levels, and
how important is the auditor-quality factor?
3. Was accounting information—earnings and book value—value relevant
to KSE participants during the 1995–2006 period?
4. Did the value relevance of accounting information—earnings and book
value—change during the 1995–2006 period?
5. To what extent do levels of compliance affect the value relevance of
accounting information?
When monitoring company financial statements, Kuwait’s enforcement body applies
the same rules to all KSE-listed companies. Thus, no variation in the effect of
regulatory monitoring on the enforcement of accounting standards is expected across
KSE companies. In addition, internal governance practice is somewhat similar across
KSE-listed firms due to the cultural and business environment in Kuwait. Thus, little
variation is expected in the effect of internal governance on the enforcement of
accounting standards.
External audit quality is expected to be the most important factor affecting the
enforcement of accounting standards. In Kuwait, corporate law requires each
company to appoint at least two external auditors from separate auditing firms. The
combination of audit firms that companies may use varies based on the unique
combination of auditors the company appoints. Therefore, audit quality may vary
from company to company and, consequently, variations are expected to exist related
to the influence of audit quality on the enforcement of accounting standards, and the
level of IFRS compliance across KSE-listed companies.
70
In summary, the value relevance of accounting information is expected to be
influenced by the level of IFRS compliance. In assessing the level of IFRS
compliance, the influence of the enforcement of accounting standards on the extent
of compliance should be considered. Audit quality is expected to be a key factor that
influences the enforcement of IFRS and, as a result, the level of compliance.
4.2 Firm-Attribute Hypotheses
The first research question aims to determine the extent to which KSE-listed firms
comply with IFRS-required disclosures. The second research question aims to clarify
which factors contribute to the varying compliance levels of KSE-listed firms. KSE
regulations require listed firms to be audited by at least two external auditing firms.
Therefore, part of the second question specifically examines the impact of auditor
quality on compliance levels. As such, the first set of hypotheses concern the level of
firm compliance with IFRS regulations and the factors that explain differences in
compliance.
As discussed, previous studies on IFRS compliance provide substantial evidence of
non-compliance among firms that claim to comply. Such studies find significant
variations in compliance across countries and firms. The variations in compliance
among firms can be linked to a range of firm attributes, including age, liquidity,
leverage, size, profitability, industry type, and audit quality and rigour (Tower et al.,
1999; Street and Bryant, 2000; Street and Gray, 2001; Glaum and Street, 2003; Al-
Shammari et al., 2008; Gallery et al., 2008).
To investigate the factors behind variations in IFRS compliance among KSE-listed
firms, the current study examines the seven firm attributes noted above, which
previous studies identified as significant factors that affect compliance levels.
Because KSE requires firms to be audited by two external auditing firms, this study
gives close attention to the effect of the audit quality on compliance levels. The
following discussion examines the seven firm attributes and their related hypotheses.
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4.2.1 Firm Age
Firm age, or the number of years since a firm’s foundation, may affect a firm’s level
of compliance with IFRS-required disclosures. Although the KSE was established in
1983, some KSE-listed firms were founded as far back as 1952, while others were
founded as recently as 2005.
In comparing older and younger firms, Glaum and Street (2003) argue that younger
firms tend to concentrate on product and market development when establishing their
businesses, rather than accounting. In addition, managers of younger firms tend to be
less experienced in running a listed corporation and complying with regulatory
requirements. Consequently, Glaum and Street (2003) contend that younger firms’
accounting systems tend to be inadequate, resulting in lower quality accounting and
disclosures. In contrast, older firms tend to have well-established accounting
systems, and experienced managers and staff, resulting in higher quality accounting
and disclosures.
In general, the findings regarding the relationship between firm age and extent of
IFRS compliance are mixed. Owusu-Ansah (1998) finds that firm age has a
significant positive effect on mandatory disclosure among listed firms in Zimbabwe.
However, Glaum and Street (2003) find no evidence of such a relationship among
Germany’s New Market firms. Al-Sammari et al. (2008) reveal that, although firm
age does not significantly affect the level of IFRS compliance among a full GCC
sample, it does significantly affect compliance among a sub-sample of 50 KSE-listed
firms.
Based on these findings, and due to the large variation in the ages of KSE-listed
firms,11 it is expected that older KSE firms will be more likely to comply with IFRS-
required disclosures than younger KSE firms. Two justifications support this
prediction:
11 Some firms have been in existence for more than 55 years, while others for as few as 2.
72
First, owing to their maturity and associated learning experience, older firms are
more likely to have well-established accounting systems and qualified, experienced
staff. These characteristics will likely lead to reduced costs and increased ease in
gathering, processing and disseminating the information needed to comply with
required disclosures. Therefore, older firms are more likely to disclose much more
information in their annual reports than younger firms (Owusu-Ansah, 1998; Glaum
and Street, 2003).
Second, a possible competitive disadvantage exists for younger firms who disclose
certain information, such as capital expenditures, research and development
expenditures, and new products. This disadvantage would arise if competitors were
to use disclosed information to the detriment of younger firms. In contrast, older
firms might be more motivated to disclose such information because it would be less
likely to harm their competitive positions (Owusu-Ansah, 1998; Al-Sammari, 2005).
Therefore, this study hypothesises that:
H1: The level of compliance with IFRS disclosure requirements is positively
associated with a firm’s age.
4.2.2 Firm Liquidity
Researchers generally agree that a firm with a lower liquidity ratio will have a
greater need to allay the fears of investors and lenders. It will also need to meet their
informational needs regarding the firm’s ability to meet short-term financial
obligations without liquidating long-term assets or ceasing operations. To do this, a
firm with lower liquidity tends to provide more detail in its annual reports than a firm
with higher liquidity (Wallace and Naser, 1995).
Regulatory authorities are also interested in a firm’s ability to meet its short-term
financial obligations, as this might affect the firm’s future solvency (Wallace and
Naser, 1995). Thus, firms with a lower liquidity would be expected to disclose more
information and achieve a higher level of compliance with IFRS disclosures than
73
higher liquidity firms. However, Belkaoui and Kahl (1978) argue that a higher-
liquidity firm will have greater disclosure because managers of financially strong
firms have nothing to hide from users of financial statements and, hence, will be
more likely to disclose more information than a firm with lower liquidity.
In examining the corporate characteristics likely to explain the level of disclosures
among Spanish firms, Wallace et al. (1994) find a significant negative association
between disclosure levels and liquidity ratios. In contrast, Belkaoui and Kahl (1978)
show a positive relationship between disclosures and liquidity ratios, although the
results are statistically insignificant. Wallace and Naser (1995), Owusu-Ansah
(1998), Owusu-Ansah and Yeoh (2005), and Al-Sammari et al. (2008) find no
association between disclosures and liquidity ratios.
Despite these mixed results regarding the association between disclosure levels and
liquidity ratios, it is expected that KSE firms with lower liquidity ratios will be more
likely to disclose financial information than firms with higher liquidity ratios. Two
justifications support this prediction:
First, as previously explained, three agencies regulate and supervise the KSE: the
KSE administration, the Ministry of Commerce and Industry, and the Central Bank
of Kuwait. KSE-listed firms must submit their annual reports to the Surveillance
Department of each agency. Article 13 of the KSE Regulations12 states that the
KSE’s Surveillance Department is responsible for calculating and analysing financial
ratios to assess each listed firm’s financial condition. Thus, enforcement agencies
would be likely to closer scrutinise firms with lower liquidity ratios. Lower liquidity
firms would likely provide more detailed information, thereby achieving a higher
level of compliance with IFRS-required disclosures.
Second, Lower liquidity firms are more likely to use bank funding than higher
liquidity firms (Wallace and Naser, 1995). By disclosing more detailed information,
12 The Kuwait Stock Exchange Regulations of 1983.
74
firms with lower liquidity can signal to outsiders that, despite a lower liquidity ratio,
their financial condition is sufficient to meet their short-term obligations.
Accordingly, this study hypothesises that:
H2: The level of compliance with IFRS requirements is negatively associated with a
firm’s liquidity ratio.
4.2.3 Firm Leverage
Several previous studies have explored the relationship between disclosure levels
and firm leverage. Firms with high leverage are generally expected to disclose more
information to satisfy creditors (Alsaeed, 2006). In disclosure literature, the ‘agency
theory’ is used to explain the incentive for managers of high-leverage firms to
provide more disclosure (Morris, 1987). Alsaeed (2006) argues that firms with
proportionally higher levels of debt in their capital structure are prone to higher
agency costs. Therefore, managers have an incentive to reduce these agency costs.
One method is to disclose more accounting information to satisfy the needs of
debenture holders (Morris, 1987). In addition, by disclosing more information,
highly leveraged firms can assure creditors that they are less likely to bypass their
covenant claims (Ali et al., 2004).
Similarly, Wallace et al. (1994) argue that high-leverage firms have a greater
obligation to satisfy the informational needs of their long-term creditors and, thus,
may provide more detailed information in their annual reports than low-leverage
firms. Consequently, based on the disclosure literature, a positive relationship likely
exists between a firm’s disclosure level and its indebtedness.
In examining the association between disclosure levels in annual reports and various
firm characteristics, Ahmed and Courtis (1999) find a statistically significant positive
association between firm leverage and disclosure level. Similar to Ahmed and
Courtis (1999), Al-Shammari et al. (2008) report a significant positive association
between compliance with IFRS-required disclosures and firm leverage. In contrast,
75
Wallace et al. (1994), Wallace and Naser (1995), Inchausti (1997), Tower et al.
(1999), Ali et al. (2004), and Gallery et al. (2008) find no significant association
between disclosure level and firm indebtedness.
Banks play a significant role in the Kuwaiti economy (Al-Shammari, 2005). KSE-
listed firms commonly rely on the banking system to provide funding (IMF, 2004).
Thus, KSE-listed firms seeking debt financing would be expected to provide detailed
information to lower the cost of debt and satisfy the informational needs of debenture
holders. These potential disclosure benefits are likely to motivate KSE firms to
comply more fully with IFRS disclosures.
Consequently, this study hypothesises that:
H3: The level of compliance with IFRS requirements is positively associated with a
firm’s leverage.
4.2.4 Firm Size
Numerous previous disclosure studies have suggested that larger firms tend to
disclose more information in annual reports than smaller firms (Wallace et al., 1994;
Wallace and Naser, 1995; Joshi and Al-Mudhahki, 2001; Ali et al., 2004; Owusu-
Ansah and Yeoh, 2005; Chavent et al., 2006; Alsaeed, 2006; Al-Shammari et al.,
2008; Gallery et al., 2008).
The literature provides several reasons why larger firms tend to provide more
detailed information. In their review of disclosure and determinants studies, Chavent
et al. (2006) identify three reasons for a positive relationship between firm size and
disclosure level. First, larger firms are more politically visible than smaller firms. As
a result, they are exposed to more litigation and government intervention. Therefore,
larger firms are more willing to disclose information to reduce political costs, and
mitigate litigation and government intervention. Second, the cost of accumulating
information is lower for larger firms because of their extensive internal reporting
76
systems. Third, because full disclosure may jeopardise their competitive positions,
smaller firms are more likely to conceal sensitive information.
Watts and Zimmerman (1983) argue that agency costs are higher for larger firms due
to the larger number of shareholders. As a result, managers of large firms have an
incentive to reduce potential agency costs. One way is by disclosing more accounting
information. Ahmed and Nicholls (1994) argue that larger firms rely heavily on
financial markets to raise funds. Botosan (1997) shows that greater disclosure is
associated with lower equity capital cost. Not only does greater disclosure reduce the
cost of equity, but it also reduces the cost of debt (Sengupta, 1998). Consequently,
larger firms would probably benefit from providing additional accounting
information to investors.
Mixed results have emerged regarding the association between firm size and IFRS
disclosure level. Joshi and Al-Mudhahki (2001), Al-Shammari et al. (2008) and
Gallery et al. (2008) find a positive significant association between firm size and
IFRS disclosure. In contrast, Tower et al. (1999), Street and Bryent (2000), Street
and Gray (2001) and Glaum and Street (2003) report no evidence of any association
between firm size and IFRS disclosure.
Although IFRS disclosure literature offers mixed results on the association between
firm size and IFRS disclosure, KSE-listed firms would be expected to derive
potential benefits from more disclosure. These benefits, such as lower capital or debt
costs, are more likely to motivate larger firms to disclose than smaller firms.
Thus, this study hypothesises that:
H4: The level of compliance with IFRS requirements is positively associated with a
firm’s size.
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4.2.5 Firm Profitability
Previous disclosure research has determined that profitability influences a firm’s
disclosure level (Singhvi and Desai, 1971; Wallace et al., 1994; Wallace and Naser,
1995; Inchausti, 1997; Owusu-Ansah 1998; Ali et al., 2004; Gallery et al., 2008).
Singhvi and Desai (1971) claim that managers are more likely to disclose detailed
information when profitability is high to signal their ability to maximise
shareholders’ value, increase the security of their positions and justify their
compensation. In addition, managers of profitable firms may feel proud of their
success and disclose more information to the public to promote a positive impression
of their performance (Alsaeed, 2006). On the other hand, a firm may disclose less
information when profitability is low to hide the various reasons for declining
profitability or even losses. Thus, firms with high profitability would be expected to
disclose more information than firms with low profitability (Singhvi and Desai,
1971).
Using agency and signalling theories, Inchausti (1997) claims that when managers
possess ‘good news’ due to better performance, they disclose more detailed
information to the market than when they possess ‘bad news’ to prevent their shares
being undervalued.
The empirical findings of prior research on the association between firm profitability
and disclosure level are mixed. For example, Owusu-Ansah (1998), Ali et al. (2004)
and Gallery et al. (2008) provide evidence of a significant positive association
between profitability and disclosure. In contrast, Street and Bryant (2000), Street and
Gray (2001), Glaum and Street (2003) and Al-Shammari et al. (2008) find no
significant association between profitability and disclosure.
Despite these mixed results, KSE firms with high profitability would be more likely
to disclose detailed information to signal their ability to maximise shareholders’
78
value, increase their positional security and justify their compensation than firms
with low profitability.
Consequently, this study hypothesises that:
H5: The level of compliance with IFRS requirements is positively associated with a firm’s profitability. 4.2.6 Size of Firm’s External Auditor
The relationship between a firm’s disclosure level and the size of its external
auditing firms13 is well established in the literature (Palmer, 2008). A positive
relationship between disclosure level and the quality of external audit has been
reported in several studies.
The literature has provided several justifications for this association. DeAngelo
(1981) argues that larger auditing firms have well-established reputations and,
therefore, have more to lose if they fail to report a discovered breach or make errors
or misrepresentations in their clients’ corporate reports. Thus, DeAngelo claims that
larger auditing firms have a greater incentive to maintain independence from their
clients and report non-compliance with rules and regulations.
Malone et al. (1993) argue that smaller auditing firms are sensitive to their clients’
demands because of the economic consequences of losing a client. Wallace and
Naser (1995) claim that, due to this sensitivity phenomena, larger auditing firms are
less likely to depend on one or a few clients. The apparent lack of bonding with
clients enables larger auditing firms to demand greater disclosure in their clients’
corporate annual reports (Wallace and Naser, 1995).
Wallace et al. (1994) argue that firms audited by internationally affiliated auditing
firms (Big-4) are more likely to provide more detailed information than firms audited
by local auditing firms. The rationale is that internationally affiliated auditing firms
tend to be larger and offer more expertise than local auditing firms.
13 External auditing firms are divided into larger (Big-4) and smaller (non-Big-4) firms (Alsaeed, 2006).
79
Several studies examine the empirical findings of prior research on the association
between disclosure level and external audit quality. For example, in their meta-
analysis of 23 separate studies on the association between corporate characteristics
and disclosure levels in annual reports, Ahmed and Courtis (1999) find that the
external auditor’s size has a significant positive association with the firm’s disclosure
level. Street and Gray (2001) use a worldwide sample, and find a significant positive
association between the level of compliance with IAS-required disclosures and
audits by one of the Big-5 auditing firms.
For firms listed on Germany’s New Market, Glaum and Street (2003) report a
positive association between IAS-required disclosures and audits by one of the Big-5
auditing firms. Gallery et al. (2008) and Palmer (2008) show that firms audited by
the Big-4 auditing firms disclose better quality information about the effect of
adopting Australian Equivalents of International Financial Reporting Standards
(AIFRS) than firms audited by non-Big-4 auditing firms.
Based on previous studies, the level of compliance with IFRS-required disclosures
among KSE-listed firms would probably vary between those firms audited by Big-4
auditors and non-Big-4 auditors. Firms audited by the international Big-4 auditing
firms would also be expected to have a higher level of compliance than those audited
by the non-Big-4. In Kuwait, where regulations require that each listed firm be
audited by two external auditors (Big-4, non-Big-4 or a combination of both), it is
expected that the level of compliance would increase with more frequent use of Big-
4 auditing firms.
Accordingly, this study hypothesises that:
H6: The level of compliance with IFRS requirements is positively associated with the
number of Big-4 auditing firms that audit a firm’s financial statements.
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4.2.7 Firm Industry
Owusu-Ansah (1998) argues that firms’ mandatory disclosure practices are likely to
vary across different industry types. Owusu-Ansah suggests that the nature or
importance of an industry type to either investors or the country might explain
expected differences in mandatory disclosure levels across industries. For example,
certain industry types are highly regulated due to their overall contribution to the
national income. These industry types might be subject to more rigorous regulations.
Consequently, rigorous regulations might affect the disclosure practices of firms
operating in these industry types.
Gallery et al. (2008) note that differences in disclosure levels across industries are
expected because some standards are more common within certain industry types.
For example, the banking industry is expected to comply with IAS 30 (Banks and
Financial Institutions Disclosures) because this standard is more applicable to
banking activities.
Glaum and Street (2003) argue that no clear relationship exists between industry type
and disclosure level, as prior research has yielded mixed results regarding this
association. Glaum and Street (2003) find that, for firms listed on Germany’s New
Market, industry type has no significant effect on IAS-mandatory disclosures. Street
and Bryant (2000) also find no evidence of an association between industry type and
the IAS compliance level. However, in contrast to Street and Bryant (2000) and
Glaum and Street (2003), Street and Gray (2001) report a positive association
between IAS compliance and being in the commerce and transportation industry. In
addition, Gallery et al. (2008) find that firms in the mining and energy industry, and
the biotechnology and technology industry, have higher quality AIFRS disclosures
than firms in other industries.
Because some standards are more common within certain industries, firms in those
industries will probably comply more fully with IFRS requirements that are more
relevant to their operations.
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As a consequence, this study hypothesises that:
H7: The level of compliance with IFRS requirements varies according to a firm’s
industry type.
4.3 Hypotheses on the Value Relevance of Accounting Information
The third and fourth questions of this study address the value relevance of IFRS-
based financial statements to KSE participants, and the change in the value relevance
over time. These questions consider: the increase in the number of listed firms, the
increase in the number of market participants, resulting from foreign investors being
allowed to invest in the KSE, and the substantial improvement in the KSE
informational environment due to the adoption of IFRS standards, quarterly financial
reporting, and the requirement to immediately disclose any financial information that
might affect a firm’s business or financial position.
Therefore, this study develops four hypotheses to address how value relevant
accounting earnings and book value were to KSE investors during the 1995–2006
period.
Gjerde et al. (2005) argue that a greater focus on the informational needs of investors
in accounting and standard setting should improve the value relevance of accounting
numbers because better informed inventors can determine value more precisely.
More broadly, Hellstrom (2006) claims that accounting information must be useful
and timely to be relevant to investors. As discussed in Chapter 3, several studies
examine the value relevance of the book value of equity and earnings over time.
Some studies show that the value relevance of accounting information has increased
(Collins et al., 1997 and Francis and Schipper 1999) while others indicate the
opposite (Brown et al., 1999 and Lev and Zarowin, 1999).
The continuous improvement in the KSE’s regulatory and informational environment
between 1995 and 2006 suggests that timely financial information became more
available to investors during this period. This potentially improved the value
82
relevance of accounting information to KSE investors. The substantial increase in the
number of listed firms and market participants in the KSE over those 12 years would
also have improved the informational environment so it could better meet current
investor needs and attract more investors.
Therefore, the information that KSE-listed firms produced between 1995 and 2006
regarding earnings and book value is expected to be value relevant to KSE
participants. Additionally, the value relevance of accounting earnings and book value
is expected to increase over time due to an increase in the accounting information
available to investors.
Thus, this study hypothesises that:
H8: Book values of KSE-listed firms were value relevant to KSE participants during
the 1995–2006 period.
H9: Earnings of KSE-listed firms were value relevant to KSE participants during the
1995–2006 period.
H10: The value relevance of the book values of KSE-listed firms increased during
the 1995–2006 period.
H11: The value relevance of the earnings of KSE-listed firms increased during the
1995–2006 period.
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4.4 Hypotheses on the Value Relevance of Accounting Information and IFRS Compliance
The final question of this study asks whether a positive association exists between
the level of IFRS compliance and the value relevance of accounting information
provided to investors of KSE-listed firms. Therefore, the final two hypotheses
concern the association between the level of compliance with IFRS requirements and
the value relevance of accounting earnings and book value for KSE participants.
Using a large sample of firms from various countries, Barth et al. (2005) compare
the accounting information characteristics of firms that have adopted IAS with a
sample of firms that have not adopted IAS. Barth et al. investigate whether reporting
under IAS is associated with predictable differences in accounting quality.
Their overall results suggest that IAS improve accounting quality consistent with the
objective of the IASB.14 In addition, the study finds that the financial statement
information that IAS-adopting firms produce provides more value relevant earnings
and book values than firms that do not adopt IAS, based on both price and returns
models. Similarly, Bartov et al. (2002) use a sample of German firms to show that
earnings based on IAS are more value relevant than those based on German
accounting standards.
Although it might seem that IFRS adoption is associated with a predictable
improvement in accounting quality and value relevance, Barth et al. (2005) argue
that lax enforcement of these high-quality standards may result in limited
compliance, which undermines the effectiveness of these standards in producing
high-quality information. Consequently, it cannot be assumed that adopting the IFRS
will necessarily lead to more value-relevant financial statement information in all
jurisdictions.
14 The International Accounting Standards Board (IASB), the issuers of the IFRS, notes that its objective is to produce a single set of high-quality global standards (IASB, 2003).
84
Kothari (2000) similarly argues that the quality of accounting information is not only
influenced by the quality of accounting standards, but also by the existence and
enforcement of effective laws governing accounting standards. Kothari (2000)
defines the quality of financial information as a function of both the quality of
accounting standards and the enforcement of those standards. Thus, if enforcement is
weak, the quality of accounting information is likely to be poor, regardless of the
quality of accounting standards (Kothari, 2000).
The literature on IFRS compliance provides substantial evidence of non-compliance
among firms that claim to comply. These studies also document significant
variations in compliance across industry, internationality, leverage, firm size, and
audit quality and rigour (Tower et al., 1999; Street and Bryant, 2000; Street and
Gray, 2001; Glaum and Street, 2003; Al-Shammari et al., 2008).
Despite the extensive literature on value relevance, Hellstrom, (2006) notes that the
research fails to distinguish between accounting regulations and the actual
implementation of accounting standards. Although the literature on value relevance
theoretically links the quality of accounting information to the enforcement and
effective implementation of accounting standards (Kothari, 2000; Barth et al., 2005),
no known empirical research explores the association between compliance with
accounting standards and the value relevance of accounting information.
Considering the potential improvement in value relevance to be gained from
adopting the IFRS, and the potential for non-compliance to undermine this
improvement, greater IFRS compliance by KSE-listed companies is expected to be
associated with an increased value relevance of earnings and book value to investors.
85
Therefore, this study hypothesises that:
H12: The higher the level of compliance with IFRS requirements, the greater the
value relevance of book values.
H13: The higher the level of compliance with IFRS requirements, the greater the
value relevance of earnings.
Table 4.1 summarises this study’s research questions and their corresponding
hypotheses.
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Table 4.1: Research Questions and Corresponding Hypotheses
Research Questions Hypotheses
1. To what extent do KSE-listed
firms comply with IFRS?
2. What factors explain the differences in KSE-firm compliance levels, and how important is the auditor- quality factor?
H1: The level of compliance with IFRS requirements is positively associated with a firm’s age.
H2: The level of compliance with IFRS requirements is negatively associated with a firm’s liquidity ratio.
H3: The level of compliance with IFRS requirements is positively associated with a firm’s leverage.
H4: The level of compliance with IFRS requirements is positively associated with a firm’s size.
H5: The level of compliance with IFRS requirements is positively associated with a firm’s profitability.
H6: The level of compliance with IFRS requirements is positively associated with the number of Big-4 auditing firms that audit a firm’s financial statements. H7: The level of compliance with IFRS requirements varies according to a firm’s industry type.
3. Was accounting information—
earnings and book value—value relevant to KSE participants during the 1995–2006 period?
H8: Book values of KSE-listed firms were value relevant to KSE participants during the 1995–2006 period.
H9: Earnings of KSE-listed firms were value relevant to KSE participants during the 1995–2006 period.
4. Did the value relevance of
accounting information—earnings and book value—change during the 1995–2006 period?
H10: The value relevance of the book values of KSE-listed firms increased during the 1995–2006 period. H11: The value relevance of the earnings of KSE-listed firms increased during the 1995–2006 period.
5. To what extent do levels of
compliance affect the value relevance of accounting information?
H12: The higher the level of compliance with IFRS requirements, the greater the value relevance of book values. H13: The higher the level of compliance with IFRS requirements, the greater the value relevance of earnings.
87
4.5 Conclusion
In conclusion, this chapter develops the research framework and hypotheses to
address the study’s objectives and research questions. The value relevance of
accounting information is expected to be influenced by the level of compliance with
IFRS. Lax enforcement of accounting standards may result in limited compliance,
undermining the effectiveness of high-quality accounting standards in producing
high-quality information. In assessing the level of IFRS compliance, the effect of
accounting standards enforcement on the extent of compliance is considered.
Seven hypotheses address the influence of firm-specific attributes on the level of
compliance with IFRS disclosures. Four hypotheses address the value relevance of
accounting earnings and book value to KSE investors between 1995 and 2006. The
two remaining hypotheses address the association between IFRS compliance and the
value relevance of accounting earnings and book value to investors.
Regarding IFRS compliance, this study hypothesises that the level of compliance
increases with firm age (H1), leverage (H3), size (H4), profitability (H5) and the
number of Big-4 auditing firms that audit a firm’s financial statements (H6). It is
predicted that the level of compliance will decrease with a higher liquidity ratio
(H2). In addition, the level of IFRS compliance is expected to vary according to
industry type (H7).
Regarding the value relevance of accounting information, book values (H8) and
earnings (H9) are expected to be value relevant to KSE participants. In addition, the
value relevance of KSE-listed firms’ book values (H10) and earnings (H11)
increased during the 1995–2006 period. Also, the higher the level of IFRS
compliance, the greater the value relevance of book value (H12) and earnings (H13).
Chapter 5 presents the research design developed to test the hypotheses formulated
in this chapter.
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CHAPTER 5
Data and Research Methods for IFRS Compliance and the Value Relevance of Accounting Information
This chapter develops and explains the data and research methods used to test the
research hypotheses. The resulting research models adopt an integrated design based
on well-established research methods applied in capital market–based accounting
research. Section 5.1 details the data collection and research methodology related to
IFRS compliance. Section 5.2 discusses research designs that address the value
relevance of accounting information to investors in the Kuwait Stock Exchange
(KSE). Section 5.3 details and describes the research method used to test the
association between the value relevance of accounting information and IFRS
compliance.
5.1 Data and Methods for Testing Compliance Hypotheses
This section describes the data collection and research methodology relevant to the
first research objective and the associated hypotheses (H1–H7): investigating the
extent to which KSE-listed firms comply with mandatory IFRS disclosures. First,
the section presents an overview of the data collection approach and the time period.
The second part examines IFRS and justifies their selection. The process for
constructing, validating, weighting and scoring the disclosure compliance index is
then explained. Finally, this section discusses the company attributes used and
statistical method employed.
5.1.1 Data Collection
The primary data source for investigating both the extent to which KSE-listed firms
comply with mandatory IFRS disclosures and the factors that affect these
compliance levels is the companies’ consolidated financial statements. All the
required consolidated financial statements for KSE-listed companies were purchased
from the Auto Documentation and Archival Department at the KSE.
89
5.1.2 Time Period
In a study exploring the association between disclosure level and equity capital cost,
practices seem to have remained relatively constant over time. Because the
compliance level is expected to be relatively constant over time, and the data
requires hand collection, this investigation of the compliance level of KSE firms is
limited to one year.
The year 2006 is selected as the focus year for this study for the following reasons:
1. At the time of data collection for this study, the 2006 annual reports were the
most recent reports available from the KSE Auto Documentation and Archival
Department.
2. In their investigation of the IAS compliance of Gulf Cooperation Council
(GCC) countries, Al-Shammari et al. (2008) determined the compliance level of
a sample of KSE-listed firms for 1996, 1999 and 2002. This study’s focus on
2006 provides an opportunity to compare this study’s results with those of Al-
Shammari et al.
3. One of this study’s objectives is to explore the association between IFRS
compliance level and the value relevance of accounting information to market
participants. Since 2006 is the most recent year of the full study period, it is
likely to be the year with the highest compliance level. Therefore, it is
considered the best year to examine the value relevance of compliance.
5.1.3 Selection of KSE-listed Companies
The KSE’s Investor Guide for 2006 shows that, by the end of 2006, the KSE listed
163 Kuwaiti companies. KSE administration divides KSE-listed companies into
seven sectors. Table 5.1 shows the number of companies in each sector at the end of
2006 and the percentage of total firms of each sector.
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Table 5.1: KSE Investment Sector and Number of Firms at the End of 2006
Sector Number of
Firms Percentage
Banks 9 6
Investment 43 26
Insurance 7 4
Real Estate 29 18
Industrial 25 15
Services 45 28
Food 5 3
Total 163 100
Source: Kuwait Stock Exchange, 2006.
All companies operating on the KSE must comply with IFRS disclosures in
accordance with Resolution No. 18 of 1990. Due to the relatively small number of
KSE-listed firms, the sample for measuring IFRS compliance consists of all the
companies listed in the KSE in 2006.
5.1.4 Measuring the Extent of IFRS Compliance
To test the compliance hypotheses, a measure of the extent of IFRS compliance
must first be established. Marston and Shrives (1991) state that a well-constructed
compliance index is a reliable device for measuring corporate compliance.
Consequently, several studies have used a compliance index to measure compliance
(Street and Bryant, 2000; Street and Gray, 2001; Glaum and Street, 2003; Al-
Shammari et al., 2008). The self-constructed compliance index is developed based
on the applicable and relevant IAS and IFRS for the Kuwaiti financial reporting
environment and the study period.
By the end of 2006, the International Accounting Standards Board (IASB) had
issued 41 IAS/IFRS. However, the IASB replaced, amended or superseded some of
these. As a result, by the end of 2006, there were 39 IAS/IFRS (IASB, 2007). Table
A1 in Appendix A presents the current status of the IAS/IFRS and their effective
dates.
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Selection of International Financial Reporting Standards (IFRS)
Marston and Shrives (1991), Wallace et al. (1994) and Barako et al. (2006) argue
that there is no one theory that offers guidance on the number and selection of
standards for inclusion in the compliance index. However, Wallace et al. (1994)
argue that the selection of standards for inclusion would usually be determined by
the focus of the research.
Since all KSE-listed companies are legally required to comply with IFRS, the focus
here is on all the mandatory IFRS disclosures required in the financial statements
and footnotes. However, it should be noted that not all the IFRS issued at the end of
2006 were applicable at that date, and, therefore, some standards are not relevant to
this study. In addition, some standards are not applicable to the Kuwaiti financial
reporting environment. Thus, the selection of IFRS for inclusion in the constructed
compliance index is based on the following criteria:
1. Applicability to the fiscal year ending 31 December 2006.
2. Relevance to the study focus.
3. Applicability and relevance to the Kuwaiti financial environment and the
companies’ practices.
Applicability and Relevance to the Fiscal Year Ending 31 December 2006
IFRS 7 (Financial Instruments: Disclosures) became effective in January 2007,
while IFRS 8 (Operating Segments) became effective in January 2009. Thus these
two standards are not applicable for the study period and are excluded from the
constructed compliance index. Since the focus of this study is on annual reports, IAS
34 (Interim Financial Reporting) is also not relevant and is excluded.
Applicability and Relevance to the Kuwaiti Financial Environment
The IASB notes that its main objective is to produce a single set of high-quality
global standards (IASB, 2006). The IFRS are global in nature and not specifically
92
designed for the Kuwaiti financial environment. Therefore, some of these qualifying
standards will be irrelevant to the Kuwaiti financial environment and the practices of
KSE-listed companies.
Three procedures are used to determine the applicability and relevance of each IFRS
to the Kuwaiti financial environment:
1. The researcher reviews studies that address the implementation of IFRS and
their applicability to the Kuwaiti financial environment.
2. The researcher contacts academic experts and practicing professionals to
determine the applicability of each IFRS to the Kuwaiti environment.
3. To confirm and validate the identification of inapplicable standards obtained
in steps 1 and 2, the researcher examines all annual reports for any disclosures
relating to these inapplicable standards.
The process used to determine each IFRS’ applicability and relevance to the Kuwaiti
financial environment reveals that IAS 12, IAS 19, IAS 26 and IAS 29 are
inapplicable.
IAS 12 (Income Tax) is not applicable to the Kuwaiti financial environment because
income taxes are not levied on the income of KSE-listed companies.15 IAS 19
(Employee Benefits) and IAS 26 (Accounting and Reporting by Retirement Benefit
Plans) are not applicable because KSE-listed firms are obligated to follow the local
labour and social security laws. IAS 29 (Financial Reporting in Hyperinflationary
Economies) is not applicable because the inflation rate ranged from 1 to 2% during
the 2004–2006 period (CBK, 2006).16
15 Although KSE-listed firms are not subject to income tax, all KSE-listed firms are required to pay a National Labour Support Tax at 2.5% of their profit in accordance with the Ministry of Finance Resolution No. 26 of 2001. 16 IAS 29 does not establish an absolute rate at which hyperinflation is deemed to exist. However, it suggests that hyperinflation is deemed to have occurred if the cumulative inflation rate over three years approaches or exceeds 100% (IASB, 2006).
93
In addition to identifying the above standards as not applicable to the Kuwaiti
environment, the researcher noticed four IFRS/IAS that are not technically
The regression equation tested in the regression analysis is specified as:
iiiiii
iiiiii
SERVINDINDUSINDINVSTINDFTINDAUDIT
PROFITSIZELEVERAGELIQUIDITYAGECINDEX
____ 109876
543210
(1)
where:
CINDEX = compliance score
0 = constant term
AGE = number of years that have passed since being founded to the end of 2006
LIQUIDITY = the ratio of current assets to current liabilities at the end of 2006
LEVERAGE = the ratio of total debt to total shareholders’ equity at the end of 2006
SIZE = total assets at the end of 2006
PROFIT = the return on equity (ROE) at the end of 2006, which is the ratio of net income to average common shareholders’ equity
AUDIT = coded 2 if two Big-4 audit firms audit the company’s financial statements, 1 if one Big-4 audit firm audits the company’s financial statements and 0 otherwise
IND_FT = a dummy variable that equals 1 for firms in the financial institutions category and 0 otherwise
IND_INVST = a dummy variable that equals 1 for firms in the investment category and 0 otherwise
IND_INDUS = a dummy variable that equals 1 for firms in the industrial category and 0 otherwise
IND_SERV = a dummy variable that equals 1 for firms in the service category and 0 otherwise
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5.1.8 Determinants of Compliance with IFRS Disclosures (Independent Variables)
The definition, measurement and justification for including each company attribute
are discussed below:
Age
The company’s age is measured as the number of years that have passed since the
company was founded through the end of 2006. This measure is consistent with
prior compliance studies (Owusu-Ansah, 1998; Glaum and Street, 2003; Al-
Shammari et al., 2008). Alternatively, the natural logarithm of age is used in the
sensitivity analysis.
Liquidity
Liquidity is measured by the ratio of current assets to current liabilities at the end of
2006. This measure has been commonly used in prior compliance studies (Wallace
et al., 1994; Wallace and Naser, 1995; Owusu-Ansah and Yeoh, 2005; Al-Shammari
et al., 2008).
Leverage
Leverage is measured by the ratio of total debt to total shareholders’ equity at the
end of 2006. This measure is consistent with several prior studies (Wallace et al.,
1994; Wallace and Naser, 1995; Haniffa and Cooke, 2002; Al-Shammari et al.,
2008; Gallery et al., 2008). Also consistent with prior research, the ratio of book
value of total debt to market value of equity plus book value of total debt is used as
an alternative measure in the sensitivity analysis.
Size
The company’s total assets at the end of 2006 are used as a proxy for firm’s size.
This measure is consistent with prior studies (Cooke, 1991; Haniffa and Cooke,
2002; Palmer, 2008; Gallery et al., 2008). Both market capitalisation (Wallace and
Naser, 1995; Owusu-Ansah, 1998) and net sales (Cooke, 1989a) are used as
alternative size measures to test robustness.
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Profitability
Consistent with Wallace et al. (1994), Wallace and Naser (1995), Glaum and Street
(2003), Al-Shammari et al. (2008) and Palmer (2008), profitability is measured
using the return on equity (ROE) at the end of 2006, which is the ratio of net income
to average common shareholders’ equity. Alternatively, return on assets (ROA),
which is the ratio of net income to average total assets, is used in the sensitivity
analysis.
Auditor Quality
The number of Big-4 audit firms represented on the firm’s audit team is used as a
proxy for auditor quality. A variable is coded two (2) if the firm was audited by two
Big-4 audit firms, one (1) if audited by one Big-4 audit firm and zero (0) otherwise.
To test robustness, the auditor quality dummy variable is coded as one (1) if the firm
was audited by Big-4 audit firms and zero (0) otherwise.
Industry Category
The KSE administrator has divided the KSE-listed firms into seven sectors: banking,
insurance, service, food, industry, investment and real estate. However, due to the
similarities among some KSE-sector operations, and to avoid categories with a small
number of firms, this study combines some of these sectors into one category. The
banking and insurance sectors are combined into one financial institutions category,
and the food and industry sectors are combined into one industrial category. Four
dummy variables are used to explore the influence of industry category on the level
of compliance with IFRS mandatory disclosures.
5.2 Data and Research Methods for Testing Value Relevance Hypotheses
This section describes the data collection and explains the empirical valuation
models used to test the value relevance hypotheses. Initially, it provides an overview
of the sample criteria and the collection methods, and a description of the empirical
valuation models used. Thereafter, the section details the methods used to assess
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value relevance and changes in the value relevance over time. Finally, this section
discusses factors that influence the value relevance of earnings and book value.
5.2.1 Time Period, Sample and Data Description
This study covers a 12-year period from 1995 to 2006. This time frame is used for
four reasons. First, the KSE experienced major regulatory improvements and a large
increase in the number of listed companies during this period. Second, a law was
passed in 2001 to allow foreign investors to invest in KSE-listed companies, which
increased the number of market participants. Third, from 1995 the KSE required
listed companies to be audited by at least two external auditors from separate firms.
Therefore, the financial statements from 1995 onwards are likely to be of greater
quality and more reliable than those issued in earlier years. Fourth, the KSE started
to computerise its data in 1995, which affected the availability of data prior to this
period.
The data needed to investigate the value relevance of accounting information
includes stock prices, book values of equities, net income, dividends, total assets,
total liabilities and common shares outstanding. The main source of stock price data
is the database in the KSE’s Public Relations Department. The main source of other
data is company financial statements, which can be obtained from the KSE’s Auto
Documentation and Archival Department.
Stock prices, accounting information and dividends are all presented in the Kuwaiti
dinar (KD), the domestic currency.18 Consistent with the recommendations of Barth
et al. (1992) and Kothari and Zimmerman (1995), this study uses the per-share value
of price and earnings to reduce heteroscedastic disturbances and scaling effects. To
ensure the accuracy of per-share information, all data was checked to confirm the
treatment of any capital adjustment.
18 The official currency in Kuwait is the Kuwait dinar (KD), which is divided into 1000 fils. The average exchange rate with the U.S. dollar is approximately 1KD : US$ 3.00.
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The KSE’s 2006 investor guide shows that, by the end of 2006, the KSE listed 163
Kuwaiti companies. Table 5.3 shows the number of companies listed on the KSE
between 1995 and 2006.
Table 5.3: Number of KSE-Listed Companies 1995–2006
Year Number of firms Percentage
1995 45 4.3
1996 53 5.0
1997 65 6.1
1998 69 6.5
1999 76 7.2
2000 75 7.1
2001 76 7.2
2002 84 7.9
2003 96 9.1
2004 113 10.8
2005 142 13.4
2006 163 15.4
Total 1,057 100.0
Source: Kuwait Stock Exchange, 2006
Due to the relatively small number of firms listed on the KSE during this period, this
study uses the all of the KSE-listed firms. However, data availability resulted in the
use of the following sample selection criteria:
1. Essential financial statement information (book value, net income, dividends,
stock splits and common stock shares outstanding) must be available for the year
concerned.
2. Firm stock prices must be available for the whole year concerned.
After employing these criteria to the entire population, the price model sample
consists of 1057 firm-year observations for the entire period, ranging from 45 in
1995 to 163 in 2006. The returns model sample consists of 928 firm-year
observations for the entire period, ranging from 45 in 1995 to 141 in 2006.
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Companies listed on the KSE are divided into seven sectors19. Table 5.4 below
classifies the sample observations included in the study according to these sectors
for both the price and returns models.
Table 5.4: Price and Returns Model Sample Observations Based on Industry Type
Type
Price Model Sample Returns Model Sample
Number of Observations
PercentageNumber of
Observations Percentage
Bank 97 9.2 96 10.3
Investment 267 25.3 229 24.7
Insurance 57 5.4 54 5.8
Real Estate 170 16.1 144 15.5
Industrial 203 19.2 184 19.8
Service 212 20.0 171 18.4
Food 51 4.8 50 5.5
Total 1,057 100 928 100
5.2.2 Empirical Valuation Models Assessing Value Relevance
Four study hypotheses (H8–H11) address the value relevance of accounting earnings
and book values to KSE investors over the 1995–2006 period. Value relevance
research examines the association between stock price (or stock returns) and a set of
accounting variables (Beaver, 2002). The value relevance theory pertains to the role
that accounting information plays in equity valuation, i.e. how much of a firm’s
value can be explained by or attributed to accounting information (Al-Hogail, 2004).
Thus, value relevance research aims to provide empirical information showing the
extent to which accounting information contributes incrementally to equity valuation
to assess its usefulness to investors for economic decision making.
To assess the value relevance of financial statement information, stock prices (or
stock returns) are usually regressed on book value of equity and earnings for each 19 However, due to the similarities among KSE-sector operations, and to avoid categories with a small number of firms, the banking and insurance sectors are combined into one financial institutions category, and the food and industry sectors are combined into one industrial category.
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year to explain variations in stock prices. Yearly cross-sectional analysis of the
statistical association (R²) between accounting information, book value and earnings,
and stock price is then subject to time-series analysis to assess the significant and
trend changes of value relevance over time. Finding significant statistical association
(R²) between these variables indicates that the financial statement information is
value relevant to market participants.
Two valuation models used to examine accounting value relevance dominate the
literature: the price model and the returns model. The price model examines the
association between stock price and earnings and book value, as in Ohlson (1995).
The returns model examines the association between stock returns and the levels and
changes of accounting earnings, as in Easton and Harris (1991). These two models
are based on two bottom-line accounting items: accounting book value and earnings.
Researchers are interested in these items because they assume that the items proxy
the content of financial information, as they present reasonable summaries of two
fundamental financial statements: the balance sheet and the income statement.
Researchers are interested in information from these key items because book value
of equity embodies capital input and past performance, while current earnings proxy
for future performance. In addition, consistent with Ohlson’s ‘information
dynamics’ theory, other information can be used beyond book value and earnings
information.
Because selection of either the price or returns model is contentious in the literature
(Barth et al., 2001; Holthausen and Watts, 2001), a number of comparative studies
have resulted. For example, Kothari and Zimmerman (1995) show that the price
model’s earnings response coefficients are less biased, but the returns model has
fewer serious econometrics problems. Comparative studies suggest that, in the
absence of a clear preference between the two models, using both to conduct value
relevance studies will provide more comprehensive insights on the value relevance
of accounting information (Kothari & Zimmerman, 1995; Ota, 2003). Consequently,
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this study uses both models to examine the value relevance of accounting
information in the Kuwaiti context.
Price Model
Ohlson (1995) develops a model that links a firm’s market value to earnings and
book value. In this model, current earnings are considered a proxy for abnormal
earnings, while book value is considered a proxy for the present value of expected
future normal earnings. Ohlson’s 1995 model expresses a firm’s market value as a
linear function of earnings, book values and other value relevant information. The
model has many appealing properties and provides a useful benchmark for
conceptualising how market value relates to accounting data and other information
(Ohlson, 1995).
Ohlson’s model is based on three analytically straightforward assumptions. First, the
present value of expected dividends determines the market value. Second,
accounting data and dividends satisfy the clean surplus relation, and the dividends
reduce book value without affecting current earnings. The clean surplus is
considered satisfied when ending book value equals beginning book value plus
income minus dividends (Lundholm, 1995). Third, a linear model frames the
stochastic time-series behaviour of abnormal earnings. The variable of abnormal
earnings is defined as current earnings minus the risk-free rate times the book value
at the beginning of the period; that is, earnings minus a charge for the use of capital.
These assumptions result in a linear, closed-form valuation model in which value
equals book value plus a linear function of current abnormal earnings and the scalar
variable representing other information (Ohlson, 1995). Bernard (1995) argues that
Ohlson’s model is important because it provides a theoretical link between financial
statement data and firm value. Thus it provides a framework that can be used to
study the relationship between market value and accounting data.
Researchers have extensively used Ohlson’s theoretical model to empirically
examine the value relevance of accounting earnings and book value (Collins et al.,
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1997; Barth et al., 1998; Collins et al., 1999; Francis and Schipper, 1999; Lev and
Zarowin, 1999; Gjerde et al., 2005; Hellstrom, 2006; Bae and Jeong, 2007).
The model is specified as follows:
Pit = 0 + 1 EPSit + 2 BVSit + it (2)
Consistent with Collins et al. (1999), to investigate the relative explanatory power
that earnings and book value individually have for stock prices, the following two
equations are used:
Pit = b0+ b1EPSit + it (3)
Pit = c0+ c1 BVSit+ it (4)
where
Pit = stock price per share for firm i at time t, three months after the fiscal year’s end of time t
EPSit = the earnings per share of firm i at time t
BVSit = the book value per share of firm i at time t
t = 1995,…, 2006, corresponding to the years 1995–2006
it = other value relevant information
The statistical association between stock price and both earnings and book value is
the primary metric used to measure the value relevance of accounting numbers. If
accounting variables (earnings and book value) are value relevant to investors, then
an association will exist between stock price and earnings and book value, and the
coefficients of earnings and book value will be statistically significant. The
explanatory power (R²) of the regression model measures this association. To
investigate value relevance over the 1995–2006 period, the yearly association
between stock price, earnings and book value, as measured by R², is used to examine
changes in the value relevance to investors during the period.
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Returns Model
The price model in this study provides insight into how accounting earnings and
book value can explain variations in stock prices. It also creates the foundation for
analysing the dynamics of stock prices. However, the price model itself cannot
provide any evidence of how changes in the price model’s independent variables
(earnings and book value) determine stock market returns (Xu, 2003). To provide
this evidence and further test the value relevance of accounting information, the
returns model is also used in this study.
Previous studies that empirically examine the returns–earnings relationship are
based on a theoretical model that expresses stock price as a multiple of earnings.
This model is generally used to motivate empirical studies of the relationship
between securities returns and the change in earnings, or between abnormal returns
and unexpected earnings (Beaver et al., 1980; Collins and Kothari, 1989; and Easton
and Harris, 1991). In addition to earnings changes, Easton and Harris (1991) argue
that including earnings levels in the returns model, scaled by opening stock price,
can also provide a relevant explanatory variable for returns. Easton and Harris
(1991) suggest that the role of the earnings levels might be related to the presence of
transitory components in a previous period’s earnings.
Ali and Zarowin (1992) argue that using earnings changes as a proxy for unexpected
earnings in the presence of transitory components of earnings could understate
earnings response coefficients and negatively, cross-sectionally correlate estimation
error with persistence. Thus, including earnings levels in the returns model is
important for capturing the transitory components of earnings beyond the permanent
components of earnings that are captured in the earnings changes (Ali and Zarowin,
1992). Similar to Ali and Zarowin (1992), Ohlson and Shroff (1992) suggest that
including scaled earnings levels in the returns model can help reduce measurement
error in unexpected earnings.
Consequently, as suggested by prior research and employed in Easton and Harris
(1991), both earnings levels and earnings changes, scaled by opening stock prices,
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are included in the returns model in this study. Easton and Harris (1991) express the
value relevance of accounting earnings as a function of earnings levels, earnings
changes and other unspecified factors.
Thus, the basic returns model used in this study is:
itititititit PEPSPEPSR 12110 // (5)
Consistent with Easton and Harris (1991), the following two equations are used to
investigate the relative explanatory power that earnings levels and earnings changes
individually have for stock returns:
Rit = b0+ b1EPSit / Pit -1 + it (6)
Rit = c0+ c1 ∆EPSit / Pit -1 + it (7)
where:
Rit =
the return over the 12 months that is computed as the price per share three months after the fiscal year’s end plus net dividends per share minus the price per share nine months before the fiscal year’s end divided by the price nine months before the fiscal year’s end20
Pit-1 = the share price nine months before the fiscal year’s end
EPSit / Pit- = the earnings per share of firm i at time t deflated by the share price of firm i at time t-1
∆EPSit / Pit-1 = the change in earnings per share from time t-1 to time t deflated by the share price of firm i at time t-1
t = 1995, . . . , 2006, corresponding to the years 1995–2006
it = other value relevant information
Accounting earnings are considered value relevant if there is an association between
the returns, the earnings levels and changes, and whether the coefficients of the
earnings levels and changes are statistically significant. To investigate value
relevance over 1995–2006, the yearly association between stock returns and
20 KSE-listed companies are required to release their financial statements within three months after the end of the fiscal year.
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earnings, as measured by R², is used to examine the value relevance of earnings
levels and changes over the period.
5.2.3 Changes in Value Relevance of Earnings and Book Value
To investigate whether the value relevance of earnings and book value changed over
the period, two approaches are used:
1. Splitting the study period into sub-periods. A comparison of the adjusted R²
obtained from the sub-period models can be used as a tool to investigate the
change in value relevance over time (Lev and Zarowin, 1999; Hellstrom, 2006).
The study period is divided into two six-year sub-periods, specifically the 1995–
2000 period and the 2001–2006 period. In 2001, the KSE allowed all foreign
investors to invest in KSE-listed companies.21 As a result, the KSE has
experienced significant expansion in the number of listed companies and market
participants. Another result was that media attention and interest from financial
advisors noticeably increased, which also increased the amount of publicly
available information about KSE-listed firms. Consequently, the rationale for
splitting the study period into pre-2001 and post-2001 periods is to investigate
the changes in the value relevance of earnings and book value after these events.
To further investigate pre-2001 and post-2001 changes, a dummy variable is
incorporated into the price and returns models that equals one (1) for the years
after 2001 and zero (0) otherwise. The interaction between earnings, book value
and the post-2001 dummy variable is examined to investigate pre-2001 and post-
2001 changes in the value relevance of earnings and book value.
2. Regressing the adjusted R² obtained from yearly, cross-sectional regressions
of the price and returns models on a time-trend variable (Collins et al., 1997;
Francis and Schipper, 1999), as shown below:
21 Prior to this amendment, foreign investment in the KSE was restricted to Gulf Co-Operation Council (GCC) nationals, namely, Bahrain, Oman, Kuwait, Qatar, Saudi Arabia, and the United Arab Emirates.
112
R²T = a0 + a1 TIMEt + t (8)
where:
R²T is the adjusted R² values obtained from the price and returns models,
and TIME = 1,…,12, corresponding to the years 1995–2006.
The value relevance of earnings and book value is assumed to have increased
(decreased) over time if the estimated time coefficient (a1TIMEt) is significantly
positive (negative) at conventional significance levels. According to Francis and
Schipper (1999), the sign of the coefficient estimates in regressions of value
relevance metrics on time metrics can provide evidence about changes in the value
relevance of accounting variables over time. Significant positive coefficient
estimates would provide evidence consistent with an increase in value relevance
over time , while significant negative coefficient estimates would provide evidence
consistent with a decline in value relevance over time (Collins et al., 1997; Francis
and Schipper, 1999; Blacconiere et al., 2000; Gjerde et al., 2005).
5.2.4 Factors Influencing Value Relevance of Earnings and Book Value
As discussed in Chapter 3, several studies have documented that several factors can
influence the value relevance of earnings and book value. These can include the
earnings sign (positive or negative) (Collins et al., 1997; Barth et al., 1998; Collins
et al., 1999), industry categories (Barth et al., 1998; Francis and Schipper, 1999;
Ballas and Hevas, 2004; Hellstrom, 2006), and firm size (Collins et al., 1997; Barth
et al., 1998; Babalyan, 2001). These factors and their likely influences are
considered below.
Value Relevance and the Effect of Profitability
To investigate whether a firm’s profitability influences the value relevance of
earnings and book value, the sample is partitioned into two sub-samples: profit firms
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and loss firms. In addition, a profitability indicator variable is incorporated into the
extended price and returns models as a control variable to capture its expected value
relevance influence.
Value Relevance and the Effect of Industry Category
To examine the influence of industry categories on earnings and book value, the
sample is partitioned according to industry sectors. The KSE administrator has
divided the KSE-listed firms into seven sectors: banking, insurance, service, food,
industry, investment and real estate. However, due to the similarities among some
KSE-sector operations, and to avoid categories with a small number of firms, this
study combines some of these sectors into one category.
The banking and insurance sectors are combined into one financial institutions
category, and the food and industry sectors are combined into one industrial
category. Therefore, the entire sample is partitioned into five industrial categories.
As well as these categories, dummy variables for industry categories are
incorporated into the extended price and returns models as control variables to
capture their expected value relevance influences.
Value Relevance and the Effect of Firm Size
To examine the impact of firm size, the sample is partitioned into small and large
firms. The median22 of the logarithm of a firm’s total assets is used as a relative size
measure (Barth et al., 1998; Bae and Jeong, 2007). Firms with total assets higher
than the median are classified as large firms, while the remaining firms are classified
as small firms. The natural logarithm of total assets is also used as a continuous
measure in the extended price and returns models to capture the expected influence
of size on value relevance.
22 Babalyan (2001) suggests using the median as a relative size measure rather than the average size. The average size might not be a useful estimate when very large firms exist in the sample population.
114
5.2.5 Extended Price and Returns Models
The extended price and returns models that incorporate profitability, industry
categories and firm size as control variables are as follows:
Pit =stock price per share for firm i at time t, three months after the fiscal year’s end of time t
|EPSit| = the absolute value of earnings per share of firm i at time t
BVSit = the book value per share of firm i at time t
Rit =
the returns over the 12 months, which is computed as the price per share three months after the fiscal year’s end plus net dividends per share minus the price per share nine months before the fiscal year’s end divided by the price nine months before the fiscal year’s end
Pit-1 = the share price nine months before the end of the fiscal year
|EPSit| / Pit -1 = the absolute value of the change in earnings per share from time t-1 to time t deflated by the share price of firm i at time t-1
∆|EPSit| / Pit -1 =the absolute value of the change in earnings per share from time t-1 to time t deflated by the share price of firm i at time t-1
LOSSit =dummy variable that equals 1 if the firm achieves negative earnings and 0 otherwise
IND_FIN =dummy variable that equals 1 for firms in the financial institutions category and 0 otherwise
IND_INVEST =dummy variable that equals 1 for firms in the investment category and 0 otherwise
IND_INDUS =dummy variable that equals 1 for firms in the industrial category and 0 otherwise
IND_SERV =dummy variable that equals 1 for firms in the service category and 0 otherwise. The omitted industry category when all categories are zero is the real estate category
SIZE =the natural logarithm of total assets of firm i at time t, where t = 1995,…, 2006, corresponding to the years 1995–2006
t = t = 1995,…, 2006, corresponding to the years 1995–2006
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5.3 Data and Methods for Testing Value Relevance and the Level of Compliance with IFRS Hypotheses
The goal of hypotheses H12 and H13 is to explore whether the extent of IFRS
compliance is associated with the value relevance of accounting information.
Assuming that greater IFRS compliance is valued by investors, then compliance
represents additional information that investors can incorporate into their valuation
models.
To test these hypotheses and examine the effect of compliance levels on the value
relevance of accounting earnings and book value, a compliance level dummy
variable (DCINDEX) is included in the price and returns models. The dummy
variable captures the influence of compliance level on the value relevance of
accounting earnings and book value. It is equal to one (1) if the firm achieves a
compliance level higher than the sample median and zero (0) otherwise.
Since the investigation of firm compliance with mandatory IFRS disclosures is
limited to 2006, the examination of the association between IFRS compliance and
firm value is also limited to 2006. As well as IFRS compliance level, the price and
returns models also use profitability, industry categories and firm size as control
variables to capture their influence.
To further examine the effect of compliance levels on the value relevance of
accounting earnings and book value, the compliance level is collapsed from the
high/low category to high/medium/low category. The percentile rank approach is
used to classify the compliance level into high/medium/low. A compliance level
variable (TCINDEX) is included in the price and returns models to capture the
influence of compliance levels on the value relevance of accounting earnings and
book value. It is equal to two (2) if the firm achieves a compliance level above 75
percentile, one (1) if the firm achieves a compliance level between 75 and 25
percentile, and zero (0) otherwise.
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The level of compliance regression model (model 1), developed earlier in this
chapter, specifies the level of IFRS compliance as a function of firm age, liquidity,
leverage, size, profitability, audit quality, industry category and other unspecified
factors. To incorporate the influence of compliance level, the extended price model
(model 9) specifies a firm’s market value as a function of earnings, book values,
level of IFRS compliance, profitability, industry category, firm size and other value
relevant information. The extended returns model (model 10) specifies a firm’s
value as a function of earnings levels, earnings changes, level of IFRS compliance,
profitability, industry category, firm size and other unspecified factors.
As mentioned, if greater IFRS compliance is valued by investors, then compliance
represents additional information that investors can incorporate into their valuation
models. A significant, positive DCINDEX (or TCINDEX) coefficient indicates that
investors consider greater compliance to be value relevant, which provides support
for H12 and H13. However, an examination of the components of the compliance
regression model (model 1) and the price or returns models (models 9 and 10) that
incorporate compliance level as an explanatory variable shows a possible correlation
between the explanatory variables. In particular, firm size and industry category are
common explanatory variables in both the compliance model and the price or returns
model.
In this situation, it could be argued that the extended price or returns model that
incorporates the DCINDEX (or TCINDEX) might capture only the influence of firm
size and industry category that correlate with compliance level. Consequently,
observing a significant DCINDEX (or TCINDEX) coefficient in the extended price
or returns model might not be considered as having independent explanatory power
in the valuation models. To resolve this situation,23 a two-stage, least squares
regression method is used in which the compliance level (DCINDEX or TCINDEX)
is first regressed on the common explanatory variables (firm size and industry
category) to estimate the portion of DCINDEX (or TCINDEX) that is associated
with the common explanatory variables. 23 See, for instance, Gordon et al. (2004).
The RESIDUAL variable obtained from the above model (model 11) is used as a
proxy for the independent effect of DCINDEX (or TCINDEX). Consequently, the
RESIDUAL variable replaces the DCINDEX (or TCINDEX) in the extended price
and returns models. A significant, positive RESIDUAL coefficient in the valuation
models indicates that greater compliance is considered value relevant to investors,
and indicates support for H12 and H13.
5.4 Conclusion
In conclusion, this study has 13 hypotheses. Seven hypotheses address the influence
of firm-specific attributes on the level of compliance with IFRS disclosures. Four
hypotheses address the value relevance of accounting earnings and book values to
KSE investors over the 1995–2006 period. The remaining two hypotheses address
the association between compliance with IFRS requirements and the value relevance
of accounting earnings and book values to investors. An integrated approach with
well-established research methods for capital market–based accounting is used to
test these hypotheses.
Based on prior research, a self-constructed compliance index is developed to
measure the level of compliance with IFRS-required disclosures. Company
attributes are used to explore why companies vary in compliance levels. To test the
value relevance of the accounting information produced by KSE-listed companies
over the study period, price and returns models are used jointly.
118
The value relevance of accounting information is expected to vary cross-sectionally
according to variations in the quality of the underlying accounting information, as
proxied by IFRS compliance. Hence, before estimating the models, an IFRS
compliance score is derived from the compliance index and incorporated into the
price and returns models as a separate explanatory variable. Additionally, control
variables are incorporated into the models to capture the influence of profitability,
industry category and firm size on the value relevance of accounting information.
This rigorous process of modelling and testing compliance and value relevance
should ensure that this study can definitively answer the research hypotheses and
reach clear conclusions, including conclusions about the implications of the current
financial reporting system for KSE-listed companies.
The results of the statistical procedures developed in this chapter to test the research
hypotheses are discussed in the next two chapters.
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CHAPTER 6
Results of Company Compliance with IFRS-Required Disclosures
This chapter presents the study's findings regarding KSE-listed companies’
compliance with IFRS-required disclosures. Section 6.1 presents descriptive
statistics for dependent and independent variables. Section 6.2 provides the results of
the univariate analysis, followed by an examination of the bivariate relationships
between independent variables in Section 6.3. Section 6.4 presents and discusses the
results of the multivariate regression analysis, which uses models developed in the
previous chapter to test the seven compliance hypotheses. Finally, Section 6.5
assesses the validity and robustness of the results.
6.1 Descriptive Statistics
6.1.1 Dependent Variable (Extent of Compliance with IFRS-Required Disclosures)
As detailed in Chapter 5, this study uses a self-constructed, item-based compliance
index (CINDEX) to measure the extent of KSE-listed firms’ compliance with
applicable, IFRS-required disclosures. The index focuses on mandatory disclosures
in financial statements and footnotes in firms’ 2006 annual reports. The index gives
a ratio of a firm's disclosure score, which is its maximum possible score if the firm
fully complies with all applicable IFRS disclosure requirements. The CINDEX
scores ranges from 0 to 1. Table 6.1 below presents descriptive statistics for
CINDEX.
Table 6.1, Panel A indicates that the mean CINDEX score for all KSE-listed firms in
2006 was 72.6%, while the median was 74%. The minimum score was 49% and the
maximum was 92%. The results show that no KSE-listed firm fully complied with
all the IFRS-required disclosures. Table 6.1, Panel B presents the frequency
distribution of CINDEX scores. It shows that 10% of the firms achieved an IFRS-
compliance score between 49% and 59%. Also, 27% of firms achieved scores
between 60% and 69%, and 38% achieved scores between 70% and 79%. Only 25%
achieved scores above 79%.
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Table 6.1: Descriptive Statistics for the IFRS Compliance Index (CINDEX) in Financial Statements for 2006
Panel A: Descriptive Statistics for CINDEX
Dependent Variable
N Mean Median Standard Deviation
Minimum Maximum Skewness Kurtosis
CINDEX
163
0.726
0.740
0.10
0.49
0.92
–0.208
–0.562
Panel B: Frequency Distribution of CINDEX Scores
CINDEX Range Number of Firms Percentage Cumulative Percentage
= 0.49
1
1
1
0.50–0.59 15 9 10
0.60–0.69 44 27 37
0.70–0.79 63 38 75
0.80–0.89 35 21 96
0.90–0.92 5 4 100
Total 163 100
The frequency distribution of CINDEX scores among the 163 listed firms in 2006
reveals a noticeable variation in IFRS-compliance levels. Three observations can be
made for this. First, the fact that only one firm scored less that 50% (CINDEX =
49%) shows that most firms comply with the majority of IFRS mandatory
disclosures. Second, the fact that no firms fully comply with all IFRS-mandated
disclosures, and more than one-third scored less than 70%, brings into question the
effectiveness of the regulatory body overseeing firm compliance. Third, the large
number of firms with relatively low compliance levels raises concerns about audit
quality because two external auditors must attest to a firm’s full compliance with
IFRS requirements. Interestingly, some KSE firms have reported less than 60% of
121
the required IFRS disclosures but none has received qualified audit opinions
regarding non-compliance with IFRS-required disclosures.24
Although results from previous compliance studies might not provide a valid
comparison, the results of this study compared to previous compliance studies
suggests that compliance among KSE-listed firms is lower than those of other
developed and developing countries. For example, companies listed on the German
New Market had a level of compliance with IAS mandatory disclosures of 81%
(Glaum and Street, 2003). Interestingly, the level of compliance with IFRS
mandatory disclosures among KSE-listed firms was also lower than developed
countries' corporate compliance with voluntary disclosures. For example, Tower et
al. (1999) place the level of voluntary disclosure and measurement compliance
among Australian firms at 94%.
The IFRS compliance level among KSE-listed firms is not only lower than firms in
developed countries but also in some developing countries. For example, Tower et
al. (1999) find the level of compliance with IAS-voluntary disclosure and
measurement to be 93% in Thailand, 90% in Singapore, 90% in Malaysia, 89% in
Hong Kong, and 88% in Philippines.
Comparing this study's finding of a 72.6% compliance level with findings of studies
conducted in the GCC25 market shows that this study's finding is generally in line
with previous studies. For example, in an investigation of disclosure levels in GCC
countries, Al-Shammari et al. (2008) found that the average level of compliance
with IAS-mandated disclosures was 69% between 1996 and 2002, with a minimum
of 28% and a maximum of 97%. They also found an average compliance level of
72% among a sample of 50 KSE-listed companies between 1996 and 2002 period.26
24 All the 163 KSE-listed firms in 2006 received an unqualified audit opinion. 25 The Gulf Cooperation Council (GCC) comprises Bahrain, Oman, Kuwait, Qatar, Saudi Arabia and the United Arab Emirates. 26 For the KSE sample, only the mean level of compliance with IFRS disclosures was reported. No information about the median or the minimum and maximum was reported.
122
However, it should be noted that the current study is more comprehensive than that
of Al-Shammari et al. in terms of the number of IFRS covered, the number of
disclosure items included in the compliance checklist and the number of KSE firms
investigated. While this study includes 419 disclosure items from 27 IFRS, the
disclosure index constructed by Al-Shammari et al. included 185 items to
investigate compliance levels with 14 IFRS among 137 GCC firms, 50 of which
were KSE-listed firms. In the study of Al-Shammari et al., six qualifying standards
were considered to have limited application to the GCC companies during the 1996–
2002 period, and were thus excluded from the disclosure index.27 Due to the
increasing advancement and sophistication of KSE-listed firms operations in recent
years, these standards were found to have significant application to the 163 firms
listed in 2006, which were included in the current study’s disclosure index.
Although these comparisons might give some insight into the compliance level of
one country compared to others, Al-Shammari (2005) argues that such comparisons
may not be valid due to differences in the number of accounting standards
investigated, the checklist items included, the sample sizes selected and the years
covered.
Table 6.2 below gives descriptive statistics for compliance levels with each of the 27
IFRS/IAS-required standards included in this study. The table shows a noticeable
variation in the level of compliance among standards. The mean compliance ranged
from 49% for IAS 17 (Leases) to 91% for IAS 27 (Consolidated and Separate
Financial Statements).
27 These standards were: IAS 11: Construction Contracts, IAS 17: Leases, IAS 22 (superseded by IFRS 3): Business Combinations, IAS 31: Interests in Joint Ventures, IAS 35 (superseded by IFRS 5): Discontinuing Operations and IAS 38: Intangible Assets.
123
Table 6.2: Descriptive Statistics for Compliance Index Scores (CINDEX) by Accounting Standards
Standard Title Mean Min. Max. Number of Disclosures
Requirements High-Level Compliance Group
IAS 1 Presentation of Financial Statements 0.85 0.68 1.00 46 IAS 16 Property, Plant, and Equipment 0.82 0.00 1.00 15 IAS 18 Revenue 0.90 0.20 1.00 7 IAS 27 Consolidated and Separate Financial Statements 0.91 0.00 1.00 11
IAS 30 Disclosures in the Financial Statements of Banks and Similar Financial Institutions
Table 6.3 presents descriptive statistics for all independent continuous variables.
Table 6.4 shows the types of auditors that KSE-listed firms used in 2006, while
Table 6.5 shows the distribution of firms by industry.
127
Table 6.3: Descriptive Statistics for Independent Continuous Variables
Independent
Variable
Mean
Median
Standard Deviation
Minimum
Maximum
AGE 22.00 24.00 12.90 2.00 55.00
LIQUIDITY 4.51 2.83 6.81 0.19 39.63
LEVERGE 1.30 0.70 1.80 0.69 9.20
SIZE 325.23 69.69 952.21 3.50 7898.25
LSIZE 11.26 11.15 1.53 8.15 15.88
PROFIT 0.11 0.13 0.21 –0.92 0.48
AGE is the number of years since foundation to the end of 2006; LIQUIDITY is the ratio of current assets to current liabilities at the end of 2006; LEVERAGE is the ratio of total debt to total shareholders’ equity at the end of 2006; SIZE is the amount of total assets (KD million) at the end of 2006; LSIZE is the natural logarithm of total assets at the end of 2006; and PROFIT is the return on equity (ROE) for the year ended 31 December, which is the ratio of net income to average common shareholders’ equity.
The descriptive statistics presented in Table 6.3 show that the age of KSE-listed
firms ranged from 2 to 55 years, with a mean of 22 years and a median of 24 years.
A noticeable degree of variation exists in the liquidity and leverage ratios among
KSE-listed firms. Liquidity ranged from 0.19 to 39.63, with a mean of 4.51 and a
median of 2.83, while leverage ranged from 0.69 to 9.20 with a mean of 1.30 and a
median of 0.7.
For profitability, the statistics in Table 6.3 show that the mean return on equity for
KSE-listed firms in 2006 was 0.11, and the median was 0.13, ranging from –0.92 to
0.48. The greatest variations in independent variables (firms-specific characteristics)
occurred with size. Firm size varied significantly, ranging from KD 3.50 million to
KD 7898.25 million, with a mean of KD 325.23 million and a median of 69.69.
These statistics show that the firm size mean is significantly greater than the median,
suggesting that the distribution of firm size is positively skewed and non-normally
distributed. The non-normality was largely corrected with the natural logarithm
transformation of the variable (LSIZE).
128
Panel A of Table 6.4 presents the distribution of firms that were audited by either
two Big-4 audit firms, one Big-4 audit firm, or a non-Big-4 audit firm in 2006. Panel
B of Table 6.4 presents the distribution of the Big-4 and non-Big-4 audit firms' share
of KSE-listed companies. Panel A reveals that approximately 51% of KSE-listed
companies had at least one Big-4 audit firm in their audit team combination, while
41% of the companies were audited by non-Big-4 audit firms and 8% were audited
by two Big-4 audit firms. Panel B shows that Ernst & Young had the largest market
share of the Big-4 audit firms in 2006, auditing about 18 % of the KSE-listed firms.
KPMG had the smallest market share of the Big-4 audit firms, auditing only 1% of
the firms.
Table 6.4: Type of Auditor Used by KSE-Listed Firms in 2006
Panel A: Auditor Combination
Combination Frequency Percent
Non-Big-4
67
41
One Big-4
83
51
Two Big-4
13
8
Total 163 100
Panel B: Distribution of Business among Big-4 and Non-Big-4 Audit Firms
Accounting Firm
Frequency (Number of Firms
Audited)
Percent
Deloitte
13
4
Ernst & Young
59
18
KPMG
4
1
PricewaterhouseCoopers
35
11
Non-Big-4
215
66
Total 326 100
Table 6.5 shows the number of companies in each industry category. The table also
presents a cross-tabulation of industry category and auditor combination.
129
Table 6.5: Cross-tabulation of Industry Category and Auditor Combination in 2006
Industry Category
Two Non-Big-
4 One Big-4 &
One Non-Big-4 Two Big-4 Total
Financial Institutions
Count 1 8 7 16
% within Industry Category
6.2% 50.0% 43.8% 100%
% of Total 0.6% 4.9% 4.3% 9.8%
Investment
Count 16 24 3 43
% within Industry
Category 37.2% 55.8% 7.0% 100%
% of Total 9.8% 14.8% 1.8% 26.4%
Real Estate
Count 16 12 1 29
% within Industry
Category 55.2% 41.4% 3.4% 100%
% of Total 9.8% 7.4% 0.6% 17.8%
Industrial
Count 14 16 0 30
% within Industry
Category 46.7% 53.3% 0% 100%
% of Total 8.6% 9.8% 0% 18.4%
Service
Count 20 23 2 45
% within Industry
Category 44.4% 51.2% 4.4% 100%
% of Total 12.3% 14.1% 1.2% 27.6%
Total
Count 67 83 13 163
% of Total 41.1% 50.9% 8.0% 100%
130
Table 6.5 shows that firms audited by two Big-4 audit firms are most likely to be
from the financial institutions category, and least likely to be from the industrial and
real estate categories. Most of the firms in the investment, industrial and service
categories are audited by one Big-4 and one non-Big-4 audit firms, while most firms
in the real estate category are audited by two non-Big-4 audit firms. The result of the
Chi-square test for independence shows significant differences between these
industry categories and auditor combinations (χ2 = 36.96, p < 0.01).
6.2 Analysis of Univariate Results
6.2.1 Continuous Variables
Table 6.6 presents the results of correlation between firm-specific attributes
(continuous variables) and compliance with IFRS disclosure requirements.
Table 6.6: Correlation between Firm-Specific Characteristics (Continuous Variables) and Compliance Index Scores (CINDEX)
Variable
Pearson Correlation Spearman’s Rank Correlation
CINDEX CINDEX
AGE
0.21***
0.22***
LIQUIDITY –0.11 –0.100
LEVERAGE 0.32*** 0.39***
LSIZE 0.62*** 0.60***
PROFIT 0.39*** 0.42***
Notes: *** Correlation is significant at the 0.01 level (2-tailed). Variables are defined as follows: CINDEX is the IFRS-mandated disclosures index score; AGE is the number of years since foundation to the end of 2006; LIQUIDITY is the ratio of current assets to current liabilities at the end of 2006; LEVERAGE is the ratio of total debt to total shareholders’ equity at the end of 2006; LSIZE is the natural logarithm of total assets at the end of 2006; and PROFIT is the return on equity (ROE) for the year ended 31 December 2006, which is the ratio of net income to average common shareholders’ equity.
Correlation between firm-specific characteristics (continuous variables) and
compliance with IFRS disclosure requirements was tested with Pearson Correlation
and Spearman’s Rank Correlation tests. The positive and significant (p <0.01)
131
correlations between firm age, leverage, size, profitability and the level of
compliance with IFRS disclosures are consistent with expectations. However, the
negative association between liquidity and compliance level is not statistically
significant at conventional levels. Thus, these results provide preliminary support for
hypotheses H1, H3, H4 and H5, but not H2.
6.2.2 Categorical Variables (More Than Two Groups)
Audit Quality and Compliance with IFRS Disclosure Requirements
Although firm managers are primarily responsible for preparing financial statements
according to the law, the quality of external auditors plays a major role in promoting
firm compliance with the law. H6 hypothesises that firms audited by an international
Big-4 audit firm have higher IFRS compliance levels than firms audited by non-Big-
4 audit firms. Accordingly, hypothesis H6 predicts that the level of compliance with
IFRS-required disclosures is positively associated with the number of Big-4 audit
firms that audit a firm’s financial statements.
A one-way analysis of variance (ANOVA) test was used to investigate the auditor
effect. Untabulated results reveal significant differences (F = 15.53, p < 0.01) in
compliance scores (CINDEX) across the three possible auditor combinations.
Post-hoc comparisons with Tukey’s Honestly Significant Different (HSD) test
(Table 6.7) further show that the CINDEX mean for firms audited by two Big-4
audit firms (M = 0.85, SD = 0.05) is significantly different (p < 0.05) from the
means of (a) firms audited by one Big-4 and one non-Big-4 firm and (b) firms
audited by two non-Big-4 audit firms. Similar significant differences occur between
firms audited by one Big-4 and one non-Big-4 firm, and between firms audited by
Table 6.9: Bivariate Correlations among the Independent Variables
Independent Variable
AGE LIQUIDITY LEVERAGE LSIZE PROFIT
AGE 1.00 –0.05 0.23** 0.34** –0.08
LIQUIDITY –0.13 1.00 –0.45** –0.30** –0.23**
LEVERAGE 0.31** –0.24** 1.00 0.46** 0.23**
LSIZE 0.38** –0.21** 0.55** 1.00 0.21**
PROFIT –0.03 –0.11 0.16* 0.18* 1.00
*, ** Correlation is significant at ≤ 0.05 and 0.01 levels, respectively (2-tailed). Above the diagonal presents Spearman's correlation and below the diagonal presents Pearson's correlations of the independent variables. Variables are defined as follows: CINDEX is the IFRS-mandated disclosures index score; AGE is the number of years since foundation to the end of 2006; LIQUIDITY is the ratio of current assets to current liabilities at the end of 2006; LEVERAGE is the ratio of total debt to total shareholders’ equity at the end of 2006; LSIZE is the natural logarithm of total assets at the end of 2006; and PROFIT is the return on equity (ROE) at the end of 2006, which is the ratio of net income to average common shareholders’ equity.
Corporate Characteristics Explaining the IFRS Compliance Level Dependent Variable: CINDEX
Variable Predicted
Sign Coefficient t-statistic
Intercept
0.225
4.453***
AGE
+
0.001
1.693++
LIQUIDITY
–
–0.001
–1.166
LEVERAGE
+
0.009
2.024++
LSIZE
+
0.035
7.562+++
PROFIT
+
0.118
3.987+++
AUDIT
+
0.026
2.724+++
IND_FT
?
0.106
3.757***
IND_INVST
?
0.100
6.237***
IND_INDUS
?
0.045
2.581**
IND_SERV
?
0.088
5.376***
N
R²
Adj.R²
F-statistic
p-value (F-statistics)
163 0.616 0.591 24.406 0.000 ++, +++ significant at the 0.05, and 0.01 levels respectively (one-tailed) **, *** significant at the 0.05, and 0.01 levels respectively (two-tailed) CINDEX is the ratio of a firm's actual disclosure score to the maximum score that the firm can achieve if it fully complies with the IFRS mandatory disclosure requirements; AGE is the number of years since foundation to the end of 2006; LIQUIDITY is the ratio of current assets to current liabilities at the end of 2006; LEVERAGE is the ratio of total debt to total shareholders’ equity at the end of 2006; LSIZE is the natural logarithm of total assets at the end of 2006; PROFIT is the return on equity (ROE) at the end of 2006, which is the ratio of net income to average common shareholders’ equity; AUDIT is coded 2 if two Big-4 audit firms audit the company’s financial statements, 1 if one Big-4 audit firm audits the company’s financial statements, and 0 if otherwise; IND_FT is a dummy variable that equals 1 for firms in the financial institutions category, and 0 otherwise; IND_INVST is a dummy variable that equals 1 for firms in the investment category, and 0 otherwise; IND_INDUS is a dummy variable that equals 1 for firms in the industrial category, and 0 otherwise; IND_SERV is a dummy variable that equals 1 for firms in the service category, and 0 otherwise. (The omitted industry category when all categories are zero is the real estate category.)
140
6.4.2 Results of Hypothesis Testing: H2
Hypothesis H2 predicts that the level of compliance with the required IFRS
disclosures is negatively associated with firm liquidity. Contrary to expectation,
Table 6.10 shows that the LIQUIDITY coefficient is negative but not significant in
explaining the variations in IFRS compliance levels. It was argued that a firm with a
lower liquidity ratio has a greater need to allay the information asymmetry concerns
of investors and lenders by providing enhanced disclosures. However, this does not
seem the case for KSE-listed firms with regard to IFRS disclosures. While the
insignificant finding is unexpected, it is consistent with the findings of some
previous studies (Wallace and Naser, 1995; Owusu-Ansah and Yeoh, 2005; Al-
Shammari et al., 2008) and may indicate that firms with lower liquidity find other
means of communicating their financial soundness.
6.4.3 Results of Hypothesis Testing: H3
Hypothesis H3 predicts that the IFRS compliance level is positively associated with
firm leverage. In support of this, Table 6.10 shows that the level of IFRS-required
disclosures is positively and significantly associated with firm leverage (p < 0.05).
In Kuwait, banks are the main source of loans for KSE-listed firms. Therefore, this
result is consistent with the notion that highly geared companies have a greater need
to reduce agency costs and satisfy the information needs of long-term creditors.
Thus they provide more detailed information in their annual reports than lower
geared companies to meet those needs (Morris, 1987; Wallace et al., 1994).
6.4.4 Results of Hypothesis Testing: H4
Hypothesis H4 predicts that the level of compliance with IFRS-required disclosures
is positively associated with firm size. Consistent with this prediction, Table 6.10
shows that firm size (LSIZE) is a significant factor in explaining the variations in the
compliance levels among KSE-listed firms (p < 0.01). This result supports the
argument that larger firms are more willing to disclose information to reduce
political costs, and mitigate litigation and government intervention.
141
In addition, the cost associated with accumulating information is lower for larger
firms because of their extensive internal reporting systems. In comparison, smaller
firms are more likely to conceal sensitive information because full disclosure could
jeopardise their competitive positions (Chavent et al., 2006). This result confirms
prior compliance research that suggests a positive relationship between firm size and
information disclosure (Ali et al., 2004; Chavent et al., 2006; Al-Shammari et al.,
2008; Gallery et al., 2008).
6.4.5 Results of Hypothesis Testing: H5
Hypothesis H5 predicts that the level of compliance with IFRS-required disclosures
is positively associated with firm profitability. Consistent with this hypothesis, Table
6.10 results show that the level of IFRS-required disclosures is positively and
significantly associated with firm profitability (PROFIT), as measured by return on
equity, (p < 0.01). This finding supports the argument that managers are more likely
to disclose detailed information when profitability is high to signal their ability to
maximise shareholders’ value and avoid share undervaluation. This way they
increase the security of their positions and justify their compensation. On the other
hand, firms may disclose less information when profitability is low to hide the
various reasons for declining profitability or losses (Singhvi and Desai, 1971;
Inchausti, 1997). A similar association between profitability and level of disclosure
is reported in Ali et al. (2004) and Gallery et al. (2008).
6.4.6 Results of Hypothesis Testing: H6
Hypothesis H6 predicts that the higher the number of Big-4 auditing firms in a
company's audit team, the higher the IFRS compliance level. As predicted, Table
6.10 results shows that the auditor combination (AUDIT) is a significant factor in
explaining variations in the level of compliance with IFRS-required disclosures (p <
0.01).
Although this is a unique finding in the disclosure literature, it is nevertheless
consistent with the auditor quality argument. Larger international auditing firms
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(Big-4) have well-established reputations and more to lose if they fail to report a
discovered breach, or make errors or misrepresentations in their clients’ corporate
reports. DeAngelo (1981) claims that larger auditing firms have a greater incentive
to maintain independence from their clients and to report non-compliance. In
contrast, smaller local auditing firms (non-Big-4) tend to be sensitive to their clients'
demands because of the economic consequences of losing a client. Thus the apparent
bonding with clients would tend to deter smaller auditing firms from demanding
greater detailed disclosures in clients' corporate annual reports (Malone et al., 1993;
Wallace and Naser, 1995).
6.4.7 Results of Hypothesis Testing: H7
Hypothesis H7 predicts that the level of compliance with IFRS-required disclosure
differs across industry categories. Consistent with this hypothesis, Table 6.10 shows
significant differences in the IFRS compliance level across the five KSE industry
categories. Compliance levels among the categories of financial institution (p <
0.01), investment (IND_INVST, p < 0.01), industrial (IND_INDUS, p < 0.05) and
services (IND_SERV, p < 0.01) vary significantly from levels in the real estate
category. The result confirms that differences in compliance levels occur across the
five KSE industries because certain standards are more common within certain
industry types. This finding is consistent with those of similar research in other
jurisdictions (Street and Gray, 2001 and Gallery et al., 2008).
6.5 Sensitivity Analysis
Several robustness tests were conducted to ensure that the regression results were
not sensitive to alternative measures of dependent and independent variables. Sub-
section 6.5.1 examines the robustness of the results to alternative measures of the
dependent variable (CINDEX). Sub-section 6.5.2 discusses the robustness of the
results to alternative measures of the independent variables (corporate attributes).
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6.5.1 Robustness of the Dependent Variable
Two robustness tests were conducted to ensure that the regression results were not
sensitive to alternative measures of the dependent variable. The first test involved
transforming the dependent variable (CINDEX) by replacing it by its logarithm. The
second robustness test involved re-estimating the primary regression by collapsing
the CINDEX scores (the dependent variable) into three (high, medium and low) sub-
groups.
Replacing the dependent variable by its logarithm did not make any noticeable
difference to the results obtained in the primary model (model 1). In addition, the
results show that collapsing the CINDEX into three sub-groups did not make any
noticeable difference to the magnitude and significance of the explanatory variables
coefficients. These robustness tests confirm the results obtained in the primary
model. Appendix D, Tables D1 and D2, present the detailed results of the robustness
tests.
6.5.2 Robustness of the Independent Variables
As discussed in Chapter 5, firm-specific attributes, such as age, liquidity, leverage,
size, profitability, auditing quality and industry category, were used as independent
variables to investigate the relationship between the IFRS compliance level and
firms attributes, and explain why companies vary in compliance. Prior research has
used alternative measures of these attributes. This sub-section examines the
robustness of the primary model results compared to alternative measures of the
independent variables.
Appendix D, Table D3, presents detailed results of the robustness of the independent
variables. The results confirm the significance of age, leverage, size, profitability,
auditing quality and industry category when using the alternative proxy. Liquidity
yielded mixed results across the alternative models. These results were insignificant
in the primary model (model 1) in the predicted direction (negative) but became
significant in the predicted direction in the alternative models.
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In summary, all the robustness tests confirmed the results obtained in the primary
model.
6.6 Conclusion
The first research question in this study aims to investigate the extent to which KSE-
listed firms comply with IFRS-required disclosures, while the second research
question attempts to clarify which factors cause varying KSE-firm compliance
levels. This chapter aims to provide answers to these research questions by testing
seven related hypotheses. A self-constructed, item-based compliance index,
CINDEX, measured the extent of compliance with 27 IAS/IFRS, focusing on the
mandatory disclosures found in the financial statements and footnotes of KSE firms’
2006 annual reports.
The results of this study reveal that the average level of compliance with all
applicable and relevant IFRS disclosures was 72.6%. The IFRS-compliance level
among KSE-listed firms was found to be not only lower than compliance levels
developed countries, but also in some developing countries. None of the 163 KSE-
listed firms fully complied with all IFRS-required disclosures in 2006.
This finding, and the observed variations in compliance levels across listed firms,
raises concerns about the effectiveness of the enforcement body that oversees
compliance with IFRS-required disclosures in Kuwait, as well as the effectiveness of
external auditing in promoting compliance. Some KSE-listed firms reported less
than 60% of the required IFRS disclosures but none of those firms had received
For the returns model variables (stock returns, earnings levels and earnings
changes), Table 7.1 shows that the mean (median) stock returns of KSE-listed
companies over the 12-year period was 19% (11%), ranging from –0.73 in 1998 to
4.77 in 2004 (Appendix E, Table E1). However, the mean of stock returns tended to
be higher than the median, which indicates that the stock returns distribution was
positively skewed. Both earnings level and earnings changes exhibited similar
differences between the mean and the median.
For the price model variables (stock price per share, book value per share and
earnings per share), Table 7.1 shows that the distribution of the price model
variables was also positively skewed as the means tended to be higher than the
medians. Due to the variation from normality, the stock price and stock returns
* All numbers are in Kuwaiti dinar (KD). Variables are defined as follows: N is the number of observations; Pit is the stock price per share for firm i at time t; EPSit is the earnings per share of firm i at time t; BVSit is the book value per share of firm i at time t; Rit is the return over the 12 months, computed as the price per share three months after the fiscal year’s end plus net dividends per share minus the price per share nine months before the fiscal year’s end divided by the price nine months before the fiscal year’s end; Pit-1 is the share price nine months before the fiscal year’s end; EPSit / Pit-1 is the earnings per share of firm i at time t deflated by the share price of firm i at time t-1; ∆EPSit / Pit-1 is the change in earnings per share from time t-1 to time t deflated by the share price of firm i at time t-1; SIZE is the total assets of firm i at time t (KD million); and t = 1995, . . . , 2006, corresponding to the years 1995–2006.
148
variables were transformed using a natural log transformation. The transformation
process dramatically reduced the skewness and kurtosis in the raw data.28
Table 7.1 shows that firm size varied significantly, ranging from KD 2.65 million to
KD 7898.25 million, with a mean (median) of KD 301.32 (61.50) million. Due to
the variation from normality, the non-normality was corrected with a natural
logarithm transformation of the size variable (LSIZE).29
The total sample was classified by separating net income into two categories: profit
firms and loss firms. Table 7.2 reveals that approximately 93% of the full sample of
KSE-listed firms was profit firms during the study period, while only 7% were loss
firms.
Table 7.2: KSE Profit/Loss Firms 1995–2006
Profitability Frequency Percent
Loss Firms 73 6.9
Profit Firms 984 93.1
Total 1057 100.0
The KSE experienced a significant increase in the number of listed companies
between 1995 and 2006. Table 7.3 presents a year-by-year breakdown of the number
of companies in each industry category during the 1995 to 2006 period. The table
shows that the KSE’s industry composition changed over the study period, with a
proportional decrease in the number of firms in the financial categories and a
28 As the range of stock returns was generally between 0 and 1, with some negative values, the returns variable was transformed using a natural log transformation after adding a constant to bring the smallest value to at least 1 (see Tabachnick and Fidell, 2007). As a result of this procedure, the skewness values of the stock returns variable were substantially reduced from 2.08 to –0.21, and kurtosis from 10.72 to 0.89. For the stock price variable, the transformation reduced skewness from 3.15 to 0.27, and kurtosis from 13.97 to 0.10. 29 The transformation brought the size variable’s mean to 11.22, and median to 11.02, with acceptable skewness and kurtosis ranges.
149
proportional increase in the number of firms in the investment and service
categories.
Table 7.3 KSE-Listed Companies in Industry Categories 1995–2006
Year
Financial (Banks and Insurance)
Investment
Real
Estate
Industrial (Industry and Food)
Service
Total
1995 12
(26.7%) 7
(15.6%) 6
(13.2%) 12
(26.7%) 8
(17.8%) 45
(100%)
1996 12
(22.6%) 12
(22.6%) 6
(11.4%) 14
(26.4%) 9
(17%) 53
(100%)
1997 12
(18.5%) 15
(23.1%) 9
(13.8%) 18
(27.7%) 11
(16.9%) 65
(100%)
1998 12
(17.4%) 16
(23.2%) 10
(14.5%) 20
(29%) 11
(15.9%) 69
(100%)
1999 12
(15.8%) 18
(23.7%) 13
(17.1%) 20
(26.3%) 13
(17.1%) 76
(100%)
2000 12
(16%) 18
(24%) 11
(14.7%) 20
(26.6%) 14
(18.7%) 75
(100%)
2001 12
(15.8%) 19
(25%) 11
(14.5%) 20
(26.3%) 14
(18.4%) 76
(100%)
2002 12
(14.3%) 22
(26.2%) 13
(15.5%) 21
(25%) 16
(19%) 84
(100%)
2003 12
(12.5%) 28
(29.2%) 15
(15.6%) 24
(25%) 17
(17.7%) 96
(100%)
2004 15
(13.3%) 30
(26.5%) 19
(16.8%) 27
(23.9%) 22
(19.5%) 113
(100%)
2005 15
(10.6%) 39
(27.5%) 28
(19.7%) 28
(19.7%) 32
(22.5%) 142
(100%)
2006 16
(9.8%) 43
(26.4%) 29
(17.8%) 30
(18.4%) 45
(27.6%) 163
(100%)
Total
154 (14.6%)
267 (25.3%)
170 (16%)
254 (24%)
212 (20.1%)
1057 (100%)
7.1.2 Bivariate Correlation Results
Table 7.4 present Pearson's correlation and Spearman’s rank correlation among the
variables. As expected, the variables that hypothesised to predict stock price are
positively and significantly correlated to stock price, and each other. The variables
150
that hypothesised to predict stock returns are also positively and significantly
correlated to stock returns.
Table 7.4: Bivariate Correlations among Dependent and Independent Variables for Firm-Year Observations 1995–2006
Notes: *, ** Correlation is significant at ≤ 0.05 and 0.01 levels, respectively (two-tailed). N = 1057 for the price model variables and 928 for the returns model variables. The upper-right diagonal presents Spearman's correlation and the lower-left diagonal presents Pearson's correlation of variables. Variables are defined as follows: Pit is the stock price per share for firm i at time t; EPSit is the earnings per share of firm i at time t;BVSit is the book value per share of firm i at time t; Rit = ((Pit + dit - Pit-1) / Pit-1) is the return over 12 months; dit is the dividends per share of firm i at time t; EPSit / Pit-1 is the earnings per share of firm i at time t deflated by the share price of firm i at time t-1; and ∆EPSit / Pit-1 is the change in earnings per share from time t-1 to time t deflated by the share price of firm i at time t-1. LSIZE is the natural log of the inflation-adjusted total assets of firm i at time t; and t = 1995, . . . , 2006, corresponding to the years 1995–2006.
7.1.3 Checking Assumptions of the Multiple Regression Analysis
To ensure that the multiple regression results are reliable and unbiased, the
assumptions underlying a multiple regression analysis are examined. Consistent with
prior research on the effects of extreme values (Kothari and Zimmerman, 1995;
Collins et al., 1997; Ball et al., 2000), any undue influence of extreme observations
was removed by excluding from the sample the largest and smallest one-half percent
of observations for each regression variable.
151
Examining the correlation matrix of the independent variables of both price and
returns models in Table 7.4 found no pair-wise correlation coefficient in excess of
0.8. This suggests that multicollinearity is not likely to be a serious problem
(Gujarati, 2003). Variance inflation factors (VIF) were also examined and found to
be well within acceptable limits.
To reduce the presence of heteroscedasticity, Kothari and Zimmerman (1995)
recommend the use of White’s (1980) heteroscedasticity-consistent standard errors.
Because this study also involves panel data, observations are not expected to be
independent across years. To correct this problem, the Newey-West
heteroscedasticity and autocorrelation consistent errors corrector was used, which
followed the recommendations of Hill et al. (2008) and was consistent with Kothari
and Zimmerman (1995).
7.2 Empirical Results of Value Relevance of Earnings and Book Value
In accordance with the research methodology (Chapter 5), two valuation models
were employed to investigate the value relevance hypotheses (H8–H11). The price
model assessed the value relevance of earnings and book values of equity, while the
returns model assessed the usefulness of accounting earnings in determining stock
returns. Figure 7.1 outlines the organisation of this section.
152
Figure 7.1. Outline of Empirical Results Presented in Section 7.2
7.2.1 Value Relevance of Earnings and Book Value—Price Model Results (H8 and H9)
This study hypothesises that the information that book value (H8) and earnings (H9)
provide was value relevant to KSE participants between 1995 and 2006. To address
these hypotheses, the price model was used, which expresses firm value as a linear
function of earnings, book value and other value relevant information. Following the
price model that Ohlson (1995) developed and several subsequent empirical studies
applied, this study used the following model to investigate the relationship between
stock price and earnings and book value:
Value Relevance of Earnings and Book Value
7.2.1 Value Relevance of Earnings and
Book Value
7.2.2 Change in the Value Relevance of
Earnings and Book Value
7.2.3 Factors Influencing the Value
Relevance
7.2.6 Value Relevance of Earnings
7.2.7 Change in the Value Relevance of
Earnings
7.2.8 Factors Influencing the Value
Relevance
7.3 Value Relevance and IFRS Compliance
Returns Model Results
Price Model Results
H8 & H9
H10 & H11
H12 & H13
153
Pit = a0+ a1 EPSit + a2 BVSit + it (2)
To investigate the relative explanatory power that earnings and book value
individually have for stock prices, the following two equations were used:
Pit = b0+ b1EPSit + it (3)
Pit = c0+ c1 BVSit+ it (4)
The adjusted R² from models (2)–(4) was the primary indicator of the value
relevance of accounting information. In addition to the adjusted R², the significance
of the explanatory variable coefficients was used as an indicator of the value
relevance of individual explanatory variables.
Table 7.5 presents the pooled and yearly cross-sectional results of the regressing
price on both earnings and book value jointly (model 2) and individually (models 3
and 4).
154
Table 7.5 Pooled and Yearly Cross-Sectional Regressions of Price on Earnings and Book Value 1995–2006
Models: Pit = a0+ a1EPSit + a2BVSit + it (2)
Pit = b0+ b1EPSit + it (3)
Pit = c0+ c1 BVSit+ it (4)
(2)
Pit = a0+ a1EPSit + a2BVSit + it(3)
Pit = b0+ b1EPSit + it
(4) Pit = c0+ c1 BVSit+ it
Year N a1 a2 R²T F
Stat. b1 R²EPS c1 R²BVS
1995 44 14.69
(7.58)*** 5.01
(5.62)*** 0.834 102.67***
25.52 (10.82)***
0.744 9.10
(12.20)*** 0.735
1996 53 7.53
(1.83)* 2.45
(1.70)* 0.599 37.37***
13.03 (5.12)***
0.514 4.18
(3.80)*** 0.517
1997 63 8.48
(3.43)*** 4.19
(4.37)*** 0.694 67.91***
16.83 (10.37)***
0.573 6.49
(8.57)*** 0.627
1998 68 9.92
(2.94)*** 4.96
(4.05)*** 0.613 51.53***
17.80 (7.02)***
0.466 7.35
(9.66)*** 0.524
1999 75 7.83
(2.31)** 4.56
(4.57)*** 0.672 73.59***
17.95 (5.99)***
0.539 6.54
(12.43)*** 0.627
2000 71 11.07
(4.21)*** 3.84
(4.63)*** 0.716 85.67***
21.27 (10.83)***
0.667 6.99
(13.25)*** 0.672
2001 69 10.97
(2.24)** 3.13
(2.50)** 0.633 56.90***
21.57 (9.82)***
0.586 5.56
(8.99)*** 0.595
2002 78 13.65
(3.54)*** 1.99
(2.27)** 0.686 81.78***
18.49 (6.65)***
0.649 5.07
(8.51)*** 0.526
2003 96 6.25
(4.81)*** 1.32
(4.26)*** 0.636 81.18***
8.88 (6.03)***
0.564 2.61
(5.65)*** 0.471
2004 113 8.82
(5.38)*** 1.05
(2.86)*** 0.607 84.95***
11.55 (10.12)***
0.585 3.07
(8.38)*** 0.468
2005 137 4.24
(4.03)*** 1.52
(4.41)*** 0.537 77.77***
7.63 (8.65)***
0.451 2.50
(7.02)*** 0.469
2006 161 6.40
(5.18)*** 1.26
(3.83)*** 0.589 113.27***
9.86 (9.91)***
0.516 2.34
(7.02)*** 0.473
Pooled 1028 7.98
(10.00)*** 1.59
(6.72)*** 0.570
680.37***
11.70
(18.12)*** 0.521
3.35
(13.20)*** 0.453
Fama-MacBeth
Averaging Approach
9.15 (10.33)***
2.94 (6.70)***
15.87
(9.75)***
5.15 (8.04)***
*Significant at the 10% level; **significant at the 5% level; ***significant at the 1% level (two-tailed). Heteroscedasticity in the yearly OLS was corrected by using White’s (1980) heteroscedastic-consistent standard errors; thus figures in parentheses are the corresponding t-statistics. Heteroscedasticity and autocorrelation in the pooled OLS was corrected using Newey-West (1987) heteroscedasticity and autocorrelation consistent standard errors; thus figures in parentheses are the corresponding t-statistics; Pit is the stock price per share for firm i at time t; EPSit is the earnings per share of firm i at time t; BVSit is the book value per share of firm i at time t, and t = 1995,..., 2006, corresponding to the years 1995–2006.
Table 7.5 shows the results of the pooled cross-sectional, time-series regression of
model (2), which indicate that the model was statistically significant (F = 680, p <
0.01). The adjusted R² for the pooled cross-sectional, time-series regression of model
155
(2) shows that earnings and book value jointly explained 57% of the variations in
KSE firms’ stock prices between 1995 and 2006 period.
In addition, the results of the pooled data indicate that the coefficient estimates of
both earnings and book value had a positive and significant (p < 0.01) impact on
stock prices, indicating that earnings and book value were significant factors for
KSE firms’ stock valuation. Furthermore the year-by-year regression results
consistently support the pooled results. The adjusted R² of the yearly cross-sectional
regressions of price on earnings and book value ranged from 54% in 2005 to 83% in
1995, with a mean (median) of 65% (63%). The coefficient estimates for earnings
and book value were positive and significant in each year (p < 0.01). Similar results
were obtained when stock prices were regressed on earnings and book value,
individually (models 3 and 4). All three models showed some evidence of a decline
in adjusted R² over the study period. (This is further investigated in the next sub-
section).
As a robustness check, Fama and MacBeth’s (1973) approach of averaging
coefficients and calculating the t-statistics was conducted. Table 7.5 shows that the
average earnings and book value coefficients were positive and significant across all
models (p < 0.01). Thus, the findings based on the price model strongly support
hypotheses that KSE-listed firms’ book value (H8) and earnings (H9) were value
relevant to KSE participants during the 1995–2006 period.
The results for the price regression (model 2) are consistent with the findings
obtained from developed markets (Collins et al., 1997; Francis and Schipper, 1999;
Hellstrom, 2006). For example, in a study often used as a benchmark in the value
relevance of earnings and book value literature, Collins et al. (1997) use the price
model for a U.S. sample over 1953–1993 to report that earnings and book value
explain 54% of the cross-sectional variation in security prices for their study period.
This current study obtained 57%.
156
The adjusted R² of the yearly cross-sectional regressions of price on earnings and
book value in the study of Collins et al. ranges from 50 to 75%, which is also
consistent with this study, which obtained 54 to 83%. These results suggest that the
KSE-listed firms have earnings and book values that generally display properties
similar to those in developed markets. However, it is interesting to note that the
coefficients on earnings and book values for KSE-listed firms are generally larger
than those reported by Collins et al. Specifically, KSE-listed firms reported
coefficients on earnings and book values of 7.98 and 1.59 respectively, which were
larger than the 3.41 and 0.54 reported by Collins et al.
In addition, when comparing this study's results with those of previous studies in
emerging markets, the earnings and book values of KSE-listed firms appear more
value relevant. For instance, Bae and Jeong (2007) investigate the value relevance of
the Korean firms’ earnings and book values during 1987–1998. Their results show
that earnings and book value explained 34% of Korean firms’ security prices during
this time, which was 23% lower than for KSE-listed firms. Ragab and Omran (2006)
reveal that, in the Egyptian equity market, earnings and book value explained 40%
of the variation in stock prices during 1998–2002.
The value relevance of KSE-listed firms’ earnings and book values is generally
consistent with those of developed markets (Collins et al., 1997; Francis and
Schipper, 1999; Hellstrom, 2006) and higher than some emerging markets (Chen et
al., 2001; Ragab and Omran, 2006; Bae and Jeong, 2007). However, this study’s
results are compared with a prior value relevance study on Kuwait (Elshamy and
Kayed, 2005), the value relevance of earnings and book value reported in this study
is lower than that obtained previously.
In a sample of 31 to 75 KSE-listed firms per year during the 1992 to 2001 period,
Elshamy and Kayed (2005) find that the adjusted R² for the pooled cross-sectional
time-series regression indicates that earnings and book values jointly explain 75% of
the cross-sectional variation in securities prices, which is 18% more than the figure
157
obtained in this study. The adjusted R² of the yearly cross-sectional regressions
ranges from 59% in 1992 to 92% in 1994
Possible reasons for the inconsistency between the studies include that Elshamy and
Kayed examined both a smaller sample and an earlier period. In the last few years,
the Kuwaiti financial market has received significant attention from press and
financial advisories. Bushee et al. (2007) argue that press coverage significantly
affects the information environment of business firms, and greatly increases the
amount of information publicly available about such firms. Consequently, the
sources of useful accounting information for KSE investors have increased in recent
years. This means that KSE investors might use information sources other than
firms’ financial statements, potentially making accounting information less timely
and relevant than a few years ago.
In summary, the findings for the price regression provide convincing evidence that
the earnings and book values that KSE-listed firms reported between 1995 and 2006
played an important role in equity valuation in the KSE. The results correlate closely
with those found in more mature capital markets. Interestingly, the results for the
price regression show that earnings and book value are more value relevant in
Kuwait than other emerging markets. However, comparing this study's results with
those of a previous KSE-based, value relevance study reveals that the explanatory
power of earnings and book value has declined over years. Therefore, the next sub-
section examines the change in the value relevance of earnings and book value over
time.
7.2.2 Changes in the Value Relevance of Earnings and Book Value—Price Model Results (H10 and H11)
As discussed in Chapter 2, the KSE experienced continuous improvement in the
regulatory and informational environment over the 1995–2006 period. The
availability of timely financial information to investors would have increased during
this period, which potentially improved the value relevance of accounting
information to KSE investors. In addition, the substantial increase in the number of
158
listed firms and market participants in the KSE over the 12 years would have
improved the informational environment so it better met current investor needs and
attract more investors. Thus it was predicted that the value relevance of reported
book values (H10) and earnings (H11) would have increased over 1995–2006.
Following the research design (Chapter 5), the change in the value relevance was
assessed using a year dummy variable and by regressing R²s on a time trend.
Comparative Analysis
To investigate changes pre- and post-2001, a dummy variable was created that
equals 1 for post-2001 years and 0 otherwise. The dummy variable was incorporated
into models (2), (3) and (4). The interaction between earnings, book value and the
post-2001 dummy variable was examined. The results presented in Table 7.6
indicate that the coefficients of the interaction terms POST* EPS and POST* BVS
were negative and significant (p < 0.01) in all models. This suggests that the value
relevance of earnings and book value, jointly and individually, have declined post-
2001.30
30 Further, the study period was divided into two six-year sub-periods: 1995–2000 and 2001–2006. Comparing the adjusted R²s obtained by re-estimating the price models based on these sub-periods shows similar results.
159
Table 7.6: Results of Regressions of Price on Earnings and Book Value After Incorporating a Pre- and Post-2001 Dummy Variable
Pit = b0+ b1EPSit + b2 POST + b3 POST* EPSit + it (13)
Pit = c0+ c1 BVSit+ c2 POST + c3 POST* BVSit + it (14)
Variable Model (12) Model (13)
Model (14)
EPS 13.08 (10.52)***
19.66 (22.39)***
_
BVS 2.95 (7.05)***
_ 6.24 (19.94)***
POST 0.72 (10.12)***
0.53 (12.97)***
1.00 (13.71)***
POST* EPS –6.78 (–5.09)***
–10.23 (–10.77)***
_
POST* BVS –1.59 (–3.60)***
_ –3.58 (–10.72)***
***Significant at the 1% level (two-tailed); t-statistics are in parentheses. N= 1028. T-statistics are based on Newey-West (1987) heteroscedasticity and autocorrelation consistent errors. POST is a dummy variable that equals 1 for post-2001 and 0 otherwise.
Time Trends
To further investigate the change in value relevance, the adjusted R²s obtained from
yearly cross-sectional regressions of price on earnings and book value jointly and
individually (models 2 to 4) were regressed on a time-trend variable (TIME). Table
7.7 presents these results.
160
Table 7.7 Regression of the R²T, R²EPS, and R²BVS on a Time-Trend Variable 1995–2006
Models: R²T = a0 + a1 TIMEt + t (15)
R²EPS = b0 + b1 TIMEt + t (16) R²BVS = c0 + c1 TIMEt + t (17)
(15) R²T = a0 + a1 TIMEt + t
(16) R²EPS = b0 + b1 TIMEt + t
(17) R²BVS = c0 + c1 TIMEt + t
a0
a1 TIMEt
R²
b0
b1 TIMEt
R²
c0
c1 TIMEt
R²
0.737
(19.04)***
–0.13
(–2.52)**
0.39
0.622
(12.13)***
–0.008 (–1.13)
0.11
0.674
(16.34)***
–0.018
(–3.16)**
0.50
**Significant at the 5% level; ***significant at the 1% level (two-tailed); t-statistics are in parentheses; t-statistics are based on Newey-West (1987) heteroscedasticity and autocorrelation consistent errors.
Table 7.7 indicates that after estimating joint model (model 15), the TIME
coefficient (a1) was negative and statistically significant (p < 0.05). Accordingly,
this result suggests a decline in the value relevance of earnings and book value
(jointly) in explaining the cross-sectional variation in stock prices over the study
period. Similar results were obtained for the book value model (model 17), but the
TIME coefficient in the earnings model (model 16) was negative but insignificant.
Figure 7.2 illustrates the changes in the value relevance of earnings and book value
jointly, and individually, between 1995 and 2006. A noticeable decline occurred in
the value relevance of earnings and book value, jointly and individually, but the
change in the value relevance of earnings, individually, was not as noticeable. Thus
the decline in overall value relevance was primarily driven by a decline in the value
relevance of book value.
161
Figure 7.2: Changes in the Value Relevance of Earnings and Book Value 1995–2006
This study hypothesised that the value relevance of book value and earnings would
increase over the 1995–2006 period (H10 and H11). Consequently, these findings do
not support H10 and H11. The hypothesised increase was based on the assumption
that the increase in the number of KSE-listed companies and market participants
over the study period improved the informational environment, attracted more
investors and improved the price discovery process. In this environment, it was
expected that financial statement information became more relevant in investors’
valuation decisions.
However, in reality, other factors may have contributed to the decline in the value
relevance of book value and earnings, such as the KSE’s expansion in the number of
listed companies during this time. Table 7.3 presents a year-by-year breakdown of
the number of companies in each industry category between 1995 and 2006. The
table shows noticeable differences in the composition of industry categories across
this period. Hence the change in the number of firms across industry categories
162
could be one explanation for the decline in the value relevance of earnings and book
value.
Another factor could have been the increased attention that the Kuwaiti financial
market received from press and financial advisories after the restriction on foreign
investors was lifted in 2001, which, as discussed, can significantly affect the
information environment of business firms, and increase the amount of publicly
available information about such firms (Bushee et al., 2007). Consequently, the
number of useful non-financial statement sources for KSE investors has increased in
recent years. Therefore, the decline in the value relevance of earnings and book
value could be due to an increase in available information from non-financial
statement sources, potentially making accounting information less timely and
relevant than in the early years of the study period.
This study's results are consistent with previous U.S. value relevance studies of the
value relevance of earnings and book value over time (Chang, 1999; Brown et al.,
1999; Lev and Zarowin, 1999), which conclude that the value relevance of earnings
and book values, jointly and individually, declined over their study periods.
7.2.3 Factors Influencing the Value Relevance of Earnings and Book Value
As discussed in Chapter 3, a number of studies have documented that several factors
can influence the value relevance of earnings and book value, including positive
versus negative earnings (Collins et al., 1997; Barth et al., 1998; Collins et al.,
1999), industry categories (Barth et al., 1998; Francis and Schipper, 1999; Ballas
and Hevas, 2004; Hellstrom, 2006) and firm size (Collins et al., 1997; Barth et al.,
1998; Babalyan, 2001). This sub-section examines these factors to further explain
the value relevance of earnings and book value in the KSE context.
Value Relevance and Profitability
To investigate whether firm profitability influences the value relevance of earnings
and book value, a dummy variable (LOSS) was created that equals 1 if the firm
achieved negative earnings and 0 otherwise. The dummy variable was incorporated
163
into models (2), (3) and (4). Table 7.8 presents the result of regressing stock price on
earnings, book value and the (LOSS) dummy variable.
Table 7.8: Results of Regressions of Price on Earnings and Book Value after Incorporating Profit/Loss as a Dummy Variable
Models: Pit = a0+ a1|EPSit| + a2 BVSit + a3 LOSS + it (18)
Pit = b0+ b1|EPSit| + b2 LOSS + it (19)
Pit = c0+ c1 BVSit+ c2 LOSS + it (20)
Variable
Model (18)
Model (19)
Model (20)
|EPS| 7.45
(9.23)*** 11.48
(17.21)*** __
BVS 1.65
(6.89)*** __
3.21 (13.15)***
LOSS –0.215
(–2.83)*** –0.21
(–6.01)*** –0.53
(–8.68)***
Adj. R2 0.573 0.521 0.483
F-Stat 461.222 560.458 479.109
N 1028 1028 1028
***Significant at the 1% level (two-tailed); t-statistics are in parentheses. T-statistics are based on Newey-West (1987) heteroscedasticity and autocorrelation consistent errors. |EPS| is the absolute value of EPS and
LOSS is a dummy variable that equals 1 if a firm achieved negative earnings and 0 otherwise.
The results show that the LOSS dummy coefficient was significant (p < 0.01) and
negative in the three models, suggesting that the value relevance of earnings and
book value both jointly and individually was lower for loss firms than for profit
firms. Further, untabulated analysis shows that when the models were separately
estimated for the profit and loss sub-samples, the adjusted R2 for profit (loss) firms
was 57% (43%), and the earnings coefficient for profit (loss) firms was 8.47 (–2.40).
The book value coefficients were similar for both sub-samples.
The findings for KSE-listed companies show that earnings had their lowest
information content when they were negative because they tended to be transitory
(Lev and Zarowin, 1999). This confirms the results of previous studies. The findings
also support the literature showing that earnings were a greater determinant of value
when firms were profitable, while book value was more important when losses
existed (Hayn, 1995; Collins et al., 1997; Collins et al., 1999; Chen et al., 2001;
Xiong, 2005; Gjerde et al., 2005).
164
Value Relevance and Industry Category
To explore the influence of industry category on the value relevance of earnings and
book value, the sample was divided into KSE industrial categories. Untabulated
analysis showed that, as demonstrated by the adjusted R², a variation occurred in the
explanatory power of earnings and book value both jointly and individually. In
addition, the results reveal that the estimated coefficients of earnings and book value
varied by industry category, which demonstrates the influence of industry
classification on the value relevance of earnings and book value.
Value Relevance and Firm Size
To examine the effect of firm size, the sample was partitioned into small and large
firms. The median31 of the logarithm of a firm’s inflation-adjusted total assets was
used as a relative size measure (Barth et al., 1998; Bae and Jeong, 2007). Firms with
total assets higher than the median were classified as large firms, while the
remaining firms were classified as small firms.32
Untabulated analysis showed that earnings and book value jointly explained 63% of
the cross-sectional variation in stock prices for large firms. In contrast, earnings and
book value explained only 50% of this variation for small firms.
7.2.4 Extended Price Model
As well as exploring the influence of profitability, industry category and firm size by
partitioning the sample and conducting separate analyses based on each factor, this
study also incorporated these influential factors into the price model (model 2) as
control variables to capture their influence. This is the extended price model that
incorporated profitability, industry category and firm size as control variables:
31 Babalyan (2001) suggests using the median as a relative size measure rather than the average size, as the average size might not be a useful estimate when very large firms are included in the sample population. 32 The natural log of inflation-adjusted total assets was also used as a continuous measure in the extended price model.
**Significant at the 5% level; ***significant at the 1% level (two-tailed). T-statistics are in parentheses. T-statistics are based on Newey-West (1987) heteroscedasticity and autocorrelation consistent errors. Pit is the stock price per share for firm i at time t, three months after the fiscal year’s end of time t; |EPSit| is the absolute value of earnings per share of firm i at time t; BVSit is the book value per share of firm i at time t; LOSS is a dummy variable that equals 1 if firm has achieved negative earnings and 0 otherwise; IND_FIN is a dummy variable that equals 1 for firms in the financial institutions category and 0 otherwise; IND_INVEST is a dummy variable that equals 1 for firms in the investment category and 0 otherwise; IND_INDUS is a dummy variable that equals 1 for firms in the industrial category and 0 otherwise; IND_SERV is a dummy variable that equals 1 for firms in the service category and 0 otherwise (the omitted industry category when all categories are 0 is the real estate category); LSIZE is the natural log of the total assets of firm i at time t; and t = 1995, . . . , 2006, corresponding to the years 1995–2006.
Firm size was also found to be positive and significant (p < 0.05). These results
support the conjecture of Collins et al. (1997) that book value is more important than
earnings in valuing smaller firms, but not larger firms. The study results can be
explained on the grounds that smaller KSE firms are often less mature and more
susceptible to future growth. Consequently, their earnings persistence is lower and
167
may not be a good proxy for future earnings, which leads to the increased
importance of book value relative to earnings in equity valuation.
Additionally, smaller KSE firms are more likely to report losses and face financial
distress. Therefore, investors might place greater weight on book value as a proxy
for abandonment or liquidation value when valuing smaller firms. Overall, the study
findings are consistent with previous studies exploring firm size as a factor in the
value relevance of earnings and book value (Hayn, 1995; Collins et al., 1997;
Collins et al., 1999; Chen et al., 2001; Xiong, 2005; Gjerde et al., 2005).
In summary, these results are consistent with the literature on value relevance, and
confirm the influence of profitability, industry category and firm size on the value
relevance of earnings and book value.
7.2.5 Summary of Price Model Results
Consistent with expectations (H8 and H9), the findings based on the price regression
provide evidence that KSE-listed firms’ reported earnings and book values played an
important role in the equity valuation of KSE-listed firms in each year from 1995 to
2006. The results compare closely with those found in more mature capital markets.
In contrast, the results do not support the change in value relevance hypotheses (H10
and H11). The hypotheses predicted that the substantial improvement in the
regulatory environment over the 12-years period would improve the informational
environment, better meet current investor needs and attract prospective investors.
However, the findings obtained from the price model indicate a significant decline in
the value relevance of earnings and book value between 1995 and 2006.
One reason for the decline in value relevance could be that, during this period, the
KSE experienced expansion in the number of listed companies. In addition, KSE’s
industry composition has significantly changed over the study period. Another
possible reason for the decline in the value relevance could be due to the significant
increase in attention from the press and financial intermediaries that the KSE-listed
companies have received since the market was fully opened up to foreign investors
168
in 2001. The increase in the available information might lead investors to use
sources of information other than firms’ financial statements, thus making
accounting information potentially less timely and relevant than it was in the early
years of the study period.
Consistent with the value relevance literature, the results confirm that profitability,
industry category and firm size were potential factors influencing the value
relevance of earnings and book value. For profitable firms, the results show that
earnings are more likely to determine equity valuation than book value. For loss
firms, the findings reveal that book value is more relevant to equity valuation than
earnings. The results show significant variations in the extent of value relevance
across industry category due to differences in underlying, real economic activity.
Regarding firm size, the results show that book value is more important than
earnings in valuing smaller firms, but not for larger firms.
7.2.6 Value Relevance of Earnings—Returns Model (H9)
As mentioned in Chapter 5, Easton and Harris (1991) provide an alternative returns
model approach for assessing the value relevance of accounting earnings. Kothari &
Zimmerman (1995) and Ota (2003) argue that, to provide more comprehensive
evidence to support the price model approach, it is useful to provide results from this
alternative approach.
Accordingly, Table 7.10 reports the results of the pooled and yearly cross-sectional
regressions of annual security returns on the deflated earnings level and earnings
changes, using the returns model approach (models 5–7). For the pooled data (all
years) presented in Table 7.9, the results of the multivariate regression model (5),
which incorporated the earnings levels and earnings changes, show that the model
was highly significant (F = 161.51, p < 0.01). The results indicate that earnings
levels and earnings changes jointly explained 27% of the variation in annual returns
over the study period. The estimated coefficients of the earnings levels and earnings
changes were positive and significant (p < 0.01) for the pooled data. Similar results
were obtained for the pooled univariate regression models (6 and 7). The robustness
169
of these findings was confirmed in the averaging approach results of Fama and
MacBeth (1973).
Table 7.10: Pooled and Yearly Cross-Sectional Regressions of Annual Security Returns on Earnings Levels and Earnings Changes 1995–2006
Models: Rit = a0+ a1EPSit / Pit -1 + a2 ∆EPSit / Pit -1 + it (5) Rit = b0+ b1EPSit / Pit -1 + it (6) Rit = c0+ c1 ∆EPSit / Pit -1 + it (7)
Model (5) Rit = a0+ a1EPSit / Pit -1 + a2 ∆EPSit / Pit -1 + it
Model (6) Rit = b0+ b1EPSit / Pit -1 +
it
Model (7) Rit = c0+ c1 ∆EPSit / Pit -1 +
it
Year N a1 a2 R²T F. Stat. b1 R²E c1 R²∆E
1995 44 3.50
(5.31)*** 0.46
(0.46) 0.404 13.87***
3.26 (5.61)***
0.398 1.34
(1.03) 0.069
1996 45 0.73
(0.57) 1.03
(0.81) 0.142 3.49**
1.57 (2.77)***
0.132 1.73
(2.74)*** 0.136
1997 51 3.09
(2.45)** –0.44
(–0.59) 0.248 7.93***
2.53 (3.37)***
0.232 0.54
(0.64) 0.042
1998 62 2.81
(3.35)*** 0.23
(0.68) 0.242 9.40***
2.95 (3.62)***
0.236 0.64
(1.07) 0.046
1999 66 3.10
(7.31)*** –0.24
(–1.46) 0.522 34.48***
3.01 (7.12)***
0.516 0.25
(0.58) 0.008
2000 72 2.07
(5.90)*** 0.03
(0.42) 0.386 21.75***
2.09 (6.41)***
0.386 0.45
(1.18) 0.064
2001 74 0.53
(1.21) 0.39
(2.03)** 0.124 5.02***
0.77 (1.76)*
0.075 0.50
(1.90)* 0.094
2002 71 2.00
(6.83)*** 0.33
(2.29)** 0.512 35.63***
2.29 (8.86)***
0.500 1.22
(4.43)*** 0.281
2003 77 1.51
(3.90)*** 0.32
(1.17) 0.261 13.04***
1.76 (5.41)***
0.254 1.16
(3.42)*** 0.157
2004 94 3.11
(4.93)*** 1.03
(1.73)* 0.312 20.68***
3.72 (6.15)***
0.286 2.19
(3.13)*** 0.158
2005 107 2.00
(3.59)*** –0.06
(–0.10) 0.257 18.02***
1.95 (7.49)***
0.257 1.86
(5.97)*** 0.181
2006 138 1.46
(3.98)*** 0.39
(1.74)* 0.226 19.67***
1.85 (5.87)***
0.208 0.88
(2.64)*** 0.142
Pooled
901
2.06 (11.52)***
0.43 (4.06)***
0.265
161.51***
2.41 (15.72)***
0.253
1.21 (7.17)***
0.140
Fama-MacBeth Averaging Approach
2.16 (7.64)***
0.29 (2.26)***
2.31
(9.76)***
1.06 (5.83)***
* Significant at the 10 per cent level; **significant at the 5% level; ***significant at the 1% level (two-tailed). Heteroscedasticity in the yearly OLS was corrected using White’s (1980) heteroscedastic-consistent standard errors, thus figures in parentheses are the corresponding t-statistics. Heteroscedasticity and autocorrelation in the pooled OLS was corrected using Newey-West (1987) heteroscedasticity and autocorrelation consistent standard errors, thus figures in parentheses are the corresponding t-statistics; Rit is the return over the 12 months, which is computed as the price per share three months after the fiscal year’s end plus net dividends per share minus the price per share nine months before the fiscal year’s end divided by the price nine months before the fiscal year’s end; Pit-1 is the share price nine months before the fiscal year’s end; EPSit / Pit-1 is the earnings per share of firm i at time t deflated by the share price of firm i at time t-1; ∆EPSit / Pit-1 is the change in earnings per share from time t-1 to time t deflated by the share price of firm i at time t-1; and t = 1995, . . . , 2006, corresponding to the years 1995–2006.
170
The year-by-year results in Table 7.10 for model (5) support the conclusion based on
the pooled data, which suggests that KSE investors perceived earnings levels to be
value relevant information. The yearly regression results show that, in most years,
the estimated coefficients of the earnings levels (EPS) were positive and significant
(p < 0.01). In contrast, the year-by-year regression results reveal that the estimated
coefficients of earnings changes (∆EPS) were significant (at the 5% and 10% levels)
only in 4 of the 12 years.
Similar to the price model, the findings based on the returns model support
hypothesis H9 that investors considered KSE-listed firms’ earnings to be value
relevant during the 1995–2006 period. Interestingly, the findings for the returns
regression (model 5) are higher than those observed in some developed and
emerging markets (Easton and Harris, 1991; Jermakowicz and Gornik-
Tomaszewski, 1998; Francis and Schipper, 1999; Chen et al., 2001; Gjerde et al.,
2005; Hellstrom, 2006; Ragab and Omran, 2006; Dobija and Klimczak, 2007).
For example, using the returns model for a U.S. sample over the 1968–1986 period,
Easton and Harris (1991) report that earnings levels and changes explained 8% of
the cross-sectional variation in stock returns compared with the 27% obtained in this
current study. The Easton and Harris study is often used as a benchmark in the value
relevance of earnings literature. The adjusted R² of the yearly cross-sectional
regressions in the Easton and Harris study range from 3% to 23%, which is lower
than the 12% to 52% reported here for KSE firms. Also, the coefficients on earnings
levels and changes found for KSE-listed firms were generally larger than those
reported by Easton and Harris. Specifically, KSE-listed firms reported coefficients
on earnings levels and earnings changes of 2.06 and 0.43 respectively, which were
larger than the 0.71 and 0.16 that Easton and Harris reported for US firms.
In other studies, Francis and Schipper (1999) report that for their study of U.S. firms
over 1952–1994, the adjusted R² of the yearly returns model ranged from 5 to 46%,
with the earnings variables explaining 22% of the variation in stock returns. Gjerde
et al. (2005) show that earnings levels and changes explained 5% of the variation in
171
stock returns in Norway during 1965–2004. In the Egyptian equity market, Ragab
and Omran (2006) report that earnings levels and changes explained 4% of stock
returns variations during the 1998–2002 period.
In summary, the returns model provides evidence that annual earnings reported by
KSE-listed firms were significantly associated with stock returns during the 1995–
2006 period, which is consistent with the value relevance of earnings literature.
However, the present study's results tend to be higher in terms of adjusted R² and
earnings coefficients than those reported in other developed and emerging markets.
This result might suggest that KSE investors rely more heavily on earnings than
investors in other markets. Similar to other emerging markets, the KSE has a large
portion of unsophisticated, naïve investors. The financial markets literature has
documented that the likelihood of unsophisticated investors functionally fixating on
earnings information is greater than for sophisticated investors (Hand, 1990). Thus,
the high association between stock returns and earnings could be partially due to the
large proportion of naïve investors in the KSE. Consequently, the value relevance of
earnings is higher in the KSE than other well-developed markets. In addition, it
could be argued that earnings are more value relevant to KSE investors because of
the lack of alternative information sources in Kuwait about prospects.
7.2.7 Changes in the Value Relevance of Earnings—Returns Model (H11)
To investigate whether the value relevance of earnings levels and earnings changes
has changed over the 1995–2006 period, a year dummy variable was incorporated
into the returns models, which was similar to the approaches used in the price
model. The interaction between earnings levels, changes in earnings, and the post-
2001 dummy variable was examined. In addition, the adjusted R² obtained from the
returns models were regressed on a time-trend variable.
Comparative Analysis
To investigate the changes between pre- and post-2001, a dummy variable was
created that equals 1 for years post-2001 and 0 otherwise. It was incorporated into
models (5), (6) and (7). The interaction between earnings levels, changes in
172
earnings, and post-2001 dummy variable was examined. Table 7.11 illustrates that
the coefficient estimates of the interaction between pre-2001 and earnings levels
(POST*EPS) were negative and significant (p < 0.01) in all models, suggesting that
the value relevance of earnings levels decreased post-2001. In contrast, the results
show that the coefficient estimate of the interaction between pre-2001 and changes
in earnings (POST* ∆EPS) was positive and significant (p < 0.05), which suggests
that the value relevance of earnings changes increased post-2001.33
Table 7.11: Results of Regressions of Returns Earnings Levels and Earnings Changes after Incorporating Pre- and Post-2001 as Dummy Variables
Rit = b0+ b1EPSit / Pit -1 + b2POST + b3 POST* EPSit / Pit -1 + it (22)
Rit = c0+ c1 ∆EPSit / Pit -1 + c2 POST + c3 POST*∆EPSit / Pit -1 + it (23)
Variable
Model (21)
Model (22)
Model (23)
EPS 2.75 (11.24)***
2.92 (13.23)***
_
∆EPS 0.22 (3.49)***
_
0.98 (6.77)***
POST 0.07
(1.86)* 0.01
(0.45) 0.02
(0.70)
POST* EPS –1.26 (–3.68)***
–0.77 (–2.71)***
_
POST* ∆EPS 0.48 (2.10)**
_ 0.44 (2.23)**
*, **, *** Significant at the 0.10, 0.05, and 0.01 levels respectively (two-tailed); N = 901. t-statistics are in parentheses. T-statistics are based on Newey-West (1987) heteroscedasticity and autocorrelation consistent errors. POST is a dummy variable that equals 1 for post-2001 and 0 otherwise.
Time Trends
To further investigate the change in the value relevance of earnings over the 1995–
2006 period, the R²s, that were obtained from the multivariate, yearly, cross-
33 Further, the study period was divided into two six-year sub-periods, specifically 1995–2000 and 2001–2006. A comparison of the adjusted R²s obtained from re-estimating the returns models based on these sub-periods showed similar results.
173
sectional regressions of security returns on earnings levels and earnings changes
(model 5), as well as the univariate regression models (models 6 and 7), were
regressed on a time-trend variable.
In Table 7.12, the regression of the yearly R²s, obtained from the multivariate returns
model (model 5), on a time-trend variable shows that the estimated time coefficient
(a1 TIMEt) was negative. However, it was not significant at any conventional levels.
This result implies that although a decline occurred in the combined explanatory
power of earnings levels and earnings changes during the 1995–2006 period, this
decline was not statistically significant. Similar results occurred while regressing the
annual adjusted R²s obtained from the univariate earnings levels model (model 6).
In contrast to these results, the regression of the yearly adjusted R²s of the univariate
earnings changes (model 7) on a time variable indicated that the estimated time
coefficient (c1 TIMEt) was positive and significant (p < 0.10). This result suggests
that a significant increase in the value relevance of earnings changes to KSE
investors occurred during the 1995–2006 period.
Table 7.12: Regression of the R²T, R²E, and R²∆E on a Time-Trend Variable 1995–2006
Models: R²T = a0 + a1 TIMEt + t (24)
R²E = b0 + b1 TIMEt + t (25)
R²∆E = c0 + c1 TIMEt + t (26)
(24) R²T = a0 + a1 TIMEt + t
(25) R²E = b0 + b1 TIMEt + t
(26) R²∆E = c0 + c1 TIMEt + t
a0 a1 TIMEt R² b0 b1 TIMEt R² c0 c1 TIMEt R²
0.318 (3.83)***
–0.002 (–0.21)
0.004 0.309
(3.54)*** –0.003 (–0.25)
0.006
0.037 (0.92)
0.012 (2.19)*
0.323
* Significant at the at the 10% level; **significant at the 5% level; ***significant at the 1% level (two-tailed). T-statistics are in parentheses. T-statistics are based on Newey-West (1987) heteroscedasticity and autocorrelation consistent errors.
Figure 7.3 shows the changes in the value relevance of earnings levels and earnings
changes jointly, and the earnings levels and earnings changes individually, across
174
the 1995–2006 period. It reveals that a clear decline occurred in the value relevance
of earnings levels and changes jointly, and the value relevance of earnings levels
individually, over 1995–2006.
In contrast, the figure shows that the value relevance of earnings changes
individually increased over time. Regressing R²s on a time-trend variable shows that
the observed decline in the value relevance of earnings levels and changes jointly,
and earnings levels individually, were not significant, while the observed increase in
the value relevance of earnings changes individually was significant (p < 0.10).
Figure 7.3: Changes in the Value Relevance of Earnings Levels and Earnings Changes 1995-2006
On the whole, all the approaches used to assess changes in the value relevance of
earnings revealed a decline in the value relevance of earnings levels and earnings
changes jointly, and earnings levels individually, over the study period. In contrast,
the findings show that a steady increase occurred in the value relevance of earnings
175
changes. These results suggest that KSE investor focus on contemporaneous
earnings (earnings levels) decreased, while focus on earnings changes increased.
This focus on earnings changes rather than earnings levels over time might imply
that KSE investors are developing a longer-term horizon when making investment
decisions. In addition, the rapid increase in earnings over the later part of the study
period could also explain these results. Since earnings changed significantly over the
study period, then it is expected that changes in earnings became more value
relevant than earnings levels in predicting future earnings (i.e. a better predictor of
earnings persistence).
The significant development of the KSE over the 12-year was expected to have
improved the information environment and increased the usefulness of accounting
information to KSE investors. Accordingly, H11 predicted that the value relevance
of KSE-listed firms’ earnings would increase over the study period. However, the
results from the returns model provide mixed results. They show that earnings levels
and earnings changes jointly, and earnings levels individually, decreased, while
earnings changes individually increased. As the price model provides significant
evidence of a decrease in earnings over the 1995–2006 period, and in light of the
mixed result obtained from the returns model, the returns model evidence does not
sufficiently support H11.
These findings are consistent with previous studies on the value relevance of
earnings. For example, Francis and Schipper (1999) show a distinct decrease in the
ability of earnings levels and changes to explain annual stock returns. Their
estimated magnitude of this decline was approximately 0.4% per year over 43 years.
Lev and Zarowin (1999) also report that the association between stock returns and
earnings, as measured by R², declined throughout their study period. They regressed
the annual R² on a time variable to show that the decline was statistically significant.
176
7.2.8 Factors Influencing the Value Relevance of Earnings
As discussed earlier, value relevance literature has documented the influence of
profitability, industry category and firm size on the value relevance of accounting
numbers. In this study, to capture the influence of these factors on the value
relevance of earnings, the sample was split according to these three factors and
individual analysis was conducted. These influential factors were also incorporated
into the returns model (model 5) as control variables to capture their influence.
Value Relevance and Profitability
To investigate whether firm profitability influences the value relevance of earnings
and book value, a dummy variable (LOSS) was created that equals 1 if the firm
achieved negative earnings and 0 otherwise. The dummy variable was incorporated
into models (5), (6) and (7). Table 7.13 presents the results of regressing annual
stock returns on earnings levels, earnings changes and the (LOSS) dummy variable.
Table 7.13: Results of Regressions of Annual Returns on Earnings Levels and Earnings Changes After Incorporating Profit and Loss as a Dummy Variable
Models: Rit = a0+ a1|EPSit| / Pit -1 + a2 ∆|EPSit| / Pit -1 + a3 LOSS + it (27) Rit = b0+ b1|EPSit| / Pit -1 + b2 LOSS + it (28) Rit = c0+ c1 ∆|EPSit| / Pit -1 + + c2 LOSS + it (29)
Notes: ***significant at the 1% level (two-tailed); t-statistics are in parentheses. T-statistics are based on Newey-West (1987) heteroscedasticity and autocorrelation consistent errors. |EPS| is the absolute value of EPS; LOSS is a dummy variable that equals 1 if a firm achieved negative earnings and 0 otherwise.
The results show that the coefficient estimate of the LOSS dummy was significant (p
< 0.05) and negative in the three models, suggesting that the value relevance of
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earnings levels and earnings changes jointly, as well as individually, is lower for loss
firms than for profit firms.
Value Relevance and Industry Category
Untabulated analysis shows that all industry categories had positive and significant
earnings levels and changes coefficients. In addition, the explanatory power of
earnings levels and changes (as measured by the R²) ranged from 22 to 30%. This
result is likely to suggest that the explanatory power of earnings levels and changes
is relatively similar across industries, and that industry categories do not have a great
influence on the value relevance of earnings level and earnings changes to KSE
investors.
Value Relevance and Firm Size
Untabulated analysis revealed that the estimated coefficients of both earnings levels
and earnings changes (jointly and individually) were positive and significant (p <
0.01), suggesting a strong association between annual stock returns and earnings
levels and changes, for both large and small firms. The results suggest that both
earnings levels and changes provide value relevant information for investors of large
or small firms.
7.2.9 Extended Returns Model
Similar to the price model, this study included profitability, industry category and
firm size in the returns model (model 5) as control variables to capture the potential
influences of these factors on the value relevance of earnings levels and earnings
changes. This is the extended returns model that incorporated these factors:
*Significant at the 10% level; ***significant at the 1% level (two-tailed). T-statistics are in parentheses. T-statistics are based on Newey-West (1987) heteroscedasticity and autocorrelation consistent errors. Rit is the return over the 12 months, which is computed as the price per share three months after the fiscal year’s end, plus net dividends per share minus the price per share nine months before the fiscal year’s end divided by the price nine months before the fiscal year’s end; Pit-1 is the share price nine months before the fiscal year’s end; |EPSit| / Pit -1 is the absolute value of the earnings per share of firm i at time t deflated by the share price of firm i at time t-1; ∆|EPSit| / Pit -1 is the absolute value of the change in earnings per share from time t-1 to time t deflated by the share price of firm i at time t-1; LOSSit is a dummy variable that equals 1 if the firm achieved negative earnings and 0 otherwise; IND_FIN is a dummy variable that equals 1 for firms in the finance category and 0 otherwise; IND_INVEST is a dummy variable that equals 1 for firms in the investment category and 0 otherwise; IND_INDUS is a dummy variable that equals 1 for firms in the industrial category and 0 otherwise; IND_SERV is a dummy variable that equals 1 for firms in the service category and 0 otherwise (the omitted industry category when all categories are 0 is the real estate category); LSIZE is the natural log of the inflation-adjusted total assets of firm i at time t; and t = 1995, . . . , 2006, corresponding to the years 1995–2006.
7.2.10 Summary of Returns Model Results
Consistent with the price model findings for H9, the returns model results provide
evidence that investors considered the earnings levels reported by KSE firms to be a
significant element in the valuation of these firms. The results show that earnings
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changes were also important for investors in the valuation process, but not as much
as earnings levels.
Consistent with the price model findings but contrary to the H11 prediction, a
significant decline in the combined explanatory power of earnings levels and
earnings changes, as well the explanatory power of earnings levels alone, was
observed across the study period. In contrast, an increase was observed in the
explanatory power of earnings changes during the study period. Further
investigation of the changes in earnings levels and earnings changes over time
revealed that the observed decline in the value relevance of earnings level and
earnings changes jointly, and value relevance of earnings levels individually, were
insignificant. However, the results show that the observed increase in the value
relevance of earnings changes individually was significant.
The mixed result obtained from the returns model means that the returns model
evidence does not sufficiently support H11. The increased investor focus on
earnings changes rather than earnings levels might suggest that KSE investors are
now taking a longer-term view in their investment decisions. In addition, the rapid
increase in earnings over the later part of the study period could also explain these
results. As earnings are changing significantly, changes in earnings would be
expected to become more value relevant than earnings levels in predicting future
earnings (i.e. a better predictor of earnings persistence).
The results of this study’s examination of the influence of profitability, industry
category and firm size on the value relevance of earnings show that only profitability
(positive versus negative earnings firms) influences the value relevance of earnings.
Unlike the price model findings, the results reveal that industry categories and firm
size do not significantly influence the value relevance of earnings level and earnings
changes. The insignificant results could have occurred due to an omitted variable,
such as the omission of book values in the returns model or the omission of earnings
changes in the price model.
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7.3 Value Relevance and the Level of IFRS Compliance (H12 and H13)
As discussed earlier, Hellstrom (2006) argues that value relevance research does not
distinguish between accounting regulations and the actual implementation of
accounting standards, and she encourages future research to address this gap. The
Kuwaiti-context provides an ideal environment for investigating this issue, as is
demonstrated in Chapter 6, which revealed significant variations in IFRS
compliance levels among KSE-listed firms in their 2006 annual reports. This
variation provides an ideal opportunity to explore the association between the value
relevance of IFRS-based accounting information and the level of IFRS compliance.
Based on the potential improvement in the value relevance of accounting
information to market participants that firms could achieve by complying with IFRS
standards, this study predicts that the higher the compliance level, the greater the
value relevance of book value (H12) and earnings (H13). Accordingly, a significant
positive DCINDEX, TCINDEX or RESIDUAL coefficient in the valuation models
would indicate that greater compliance is considered value relevant to investors
7.3.1 Value Relevance and IFRS Compliance—Price Model
Following are the extended price models that incorporate the IFRS compliance level
(DCINDEX, TCINDEX or RESIDUAL), profitability, industry category and firm
+, ++ Significant at the 0.1 and 0.05 levels respectively (one-tailed); *, **, *** significant at the 0.1, 0.05, and 0.01 levels respectively (two-tailed). Heteroscedasticity in the yearly OLS was corrected by using White’s (1980) heteroscedastic-consistent standard errors. Figures in parentheses are the corresponding t-statistics. Pit is the stock price per share for firm i at time t, three months after the fiscal year’s end of time t; |EPSit| is the absolute value of earnings per share of firm i at time t; BVSit is the book value per share of firm i at time t; DCINDEX is a dummy variable that equals 1 if the firm achieves a level of compliance higher than the median level of compliance for all sample firms and 0 otherwise; TCINDEX is a variable that equal 2 if the firm achieves a level of compliance above 75 per cent for all sample firms, 1 if the firm achieves a level of compliance between 75 and 25 per cent and 0 otherwise; RESIDUAL is obtained from a two-stage, least-squares regression method, where the level of compliance (DCINDEX or TCINDEX) is first regressed on the common explanatory variables (firm size and industry category) to estimate the portion of DCINDEX (or TCINDEX) associated with the common explanatory variables; the RESIDUAL variable obtained from these regressions is used as a proxy for the independent effect of DCINDEX (or TCINDEX); LOSS is a dummy variable that equals 1 if the firm achieves negative earnings and 0 otherwise; IND_FIN is a dummy variable that equals 1 for firms in the financial institutions category and 0 otherwise; IND_INVEST is a dummy variable that equals 1 for firms in the investment category and 0 otherwise; IND_INDUS is a dummy variable that equals 1 for firms in the industrial category and 0 otherwise; IND_SERV is a dummy variable that equals 1 for firms in the service category and 0 otherwise (the omitted industry category when all categories are 0 is the real estate category); LSIZE is the natural log of the total assets of firm i at the end of time t; and t =2006.
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This study hypothesises that IFRS mandatory disclosures give all users of financial
statements high-quality and essential information. Thus KSE-listed firms that are
associated with higher levels of IFRS compliance would be more likely to have
greater book value (H12) and earnings (H13) value relevance than firms with
associated with lower compliance levels. These hypotheses are based on the notion
that lax enforcement of IFRS standards may result in limited compliance, which
would undermine the effectiveness of these standards in producing high-quality
information.
The finding of significant coefficient estimates for the compliance variables
(DCINDEX, TCINDEX, and RESIDUAL) support hypotheses H12 and H13. In
addition, this finding provides empirical support to claims by Kothari (2000) and
Barth et al. (2005) that the quality of accounting information is not influenced
simply by the quality of accounting standards, but also the existence and
enforcement of effective laws that ensure compliance with those standards.
7.3.2 Value Relevance and IFRS Compliance—Returns Model
To further investigate the effect of IFRS compliance on the value relevance of
accounting earnings to market participants, the IFRS compliance level (DCINDEX,
TCINDEX or RESIDUAL) was incorporated into the returns model. Following is the
extended returns models that incorporated the IFRS compliance level, profitability,
++ Significant at the 0.05 level (one-tailed); *, **, *** significant at the 0.1, 0.05, and 0.01 levels respectively (two-tailed). Heteroscedasticity in the yearly OLS was corrected by White’s (1980) heteroscedastic-consistent standard errors; figures in parentheses are the corresponding t-statistics. Rit is the return over the 12 months, which is computed as the price per share three months after the fiscal year’s end plus net dividends per share minus the price per share nine months before the fiscal year’s end divided by the price nine months before the fiscal year’s end; Pit-1 is the share price nine months before the fiscal year’s end; |EPSit| / Pit-1 is the absolute value earnings per share of firm i at time t deflated by the share price of firm i at time t-1; ∆|EPSit| / Pit-1 is the change in earnings per share from time t-1 to time t deflated by the share price of firm i at time t-1; DCINDEX is a dummy variable that equals 1 if the firm achieves a level of compliance higher than the median level of compliance for all sample firms and 0 otherwise; TCINDEX is a variable that is equals 2 if the firm achieves a level of compliance above 75 per cent, 1 if the firm achieves a level of compliance between 75 and 25 per cent and 0 otherwise; The RESIDUAL is used as a proxy for the independent effect of DCINDEX (or TCINDEX); LOSS is a dummy variable that equals 1 if firm achieves negative earnings and 0 otherwise; IND_FIN is a dummy variable that equals 1 for firms in the financial institutions category and 0 otherwise; IND_INVEST is a dummy variable that equals 1 for firms in the investment category and 0 otherwise; IND_INDUS is a dummy variable that equals 1 for firms in the industrial category and 0 otherwise; IND_SERV is a dummy variable that equals 1 for firms in the service category and 0 otherwise; LSIZE is the natural log of the total assets of firm i at end of time t; and t =2006.
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The regression results presented in Table 7.16 show that all the regression models
were highly significant (p < 0.01) and that each model explained about 30% of the
association between the dependent variable and the independent variables. The table
indicates that the estimated coefficients of earnings levels were strongly, positively
related with firm value in all models (p < 0.01). In contrast, insignificant positive
association was observed for earnings changes in all models. The insignificant result
regarding the association between earnings changes and stock returns might suggest
that, in 2006, KSE investors had a very short-term horizon as they focused heavily
on contemporaneous earnings (earnings levels) rather than changes in earnings.
The results show that the coefficient estimates of the IFRS compliance level
(DCINDEX, TCINDEX, or RESIDUAL) were positive and significant in all models
(p < 0.05). Consistent with expectations (H12), these findings reveal that greater
IFRS compliance in financial reports is significantly associated with the value
relevance of accounting earnings to market participants. In addition, the findings
confirm the results obtained from the price models, that a significant association (p <
0.05) exists between firm value to market participants and the level of IFRS
compliance.
For control variables, the results show that the estimated coefficients for LOSS,
LSIZE, IND_FIN, IND_INVEST, and IND_SERV variables were not statistically
significant at any conventional level. The insignificance observed for the LOSS
dummy variable could have been due to the small percentage of firms with negative
earnings firms in the 2006 sample, which may result the LOSS variable being a weak
discriminator. For the LSIZE and the industry category variables, the insignificant
association among firm size, industry category and stock returns is not surprising as
a similar insignificant association was found in the pooled regression findings for
1995–2006.
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Summary
It is predicted that KSE-listed firms with greater IFRS compliance are more likely to
have greater book value (H12) and earnings (H13) value relevance than firms with
lower compliance. These hypotheses are based on the assumption that lax
enforcement of IFRS standards may result in limited compliance, which would
undermine the effectiveness of these standards in giving market participants high-
quality information. Taken together, results for both the price and returns models
show a significant association between the IFRS compliance level and the value
relevance of earnings and book value to KSE investors. These results suggest that
compliance represents additional information that investors incorporate into their
valuation models. Accordingly, H12 and H13 are supported by both price and
returns model findings.
Although previous studies have theorised a positive association between the quality
of accounting information and the existence and enforcement of effective laws that
ensure compliance with those standards (Kothari, 2000; Barth et al., 2005), no
known research empirically examines this association. Based on results from the
price and returns models, a significant association can be found between firm value
and IFRS compliance level. These results provide empirical evidence to support the
theoretical expectation of the association between IFRS compliance and the value
relevance of accounting information to market participants. The evidence that
moving towards stricter IFRS compliance is likely to improve the value relevance of
financial statement information clearly highlights the effectiveness of greater IFRS
compliance and the associated benefits for the quality and value relevance of
financial statement information to market participants.
7.4 Conclusion
This chapter reported the results of hypotheses tests that examined the value
relevance of earnings and book value in the KSE during the 1995–2006 period. To
provide comprehensive insights, price and returns models were used to examine the
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value relevance hypotheses. The results provided evidence that earnings and book
value were significant factors in KSE-listed firms’ valuations during the 1995–2006
study period. These findings strongly support hypotheses H8 and H9 that the book
value and earnings of KSE-listed firms are value relevant.
The chapter also investigated changes in the value relevance of earnings and book
value over time. Contrary to expectation (H10 and H11), the findings from the price
and returns models revealed that the value relevance of earnings and book value
significantly declined during the 1995–2006 period
The chapter then investigated the influence of firm profitability, industry category
and firm size on the value relevance of earnings and book value. The price model
results did confirm the effect of profitability, industry category and firm size on the
value relevance of earnings and book value. However, the returns models confirmed
the effect of only profitability on the value relevance of earnings, not industry
category or firm size. The insignificant results observed in the returns model for
industry category and firm size, compared to the price model, could have been due
to an omitted variable, such as the omission of book value in the returns model or
the omission of earnings changes in the price model.
Evidence obtained from estimating the price and returns models shows a significant
association between firm value and IFRS compliance level. These results provide
empirical evidence to support the theoretical expectation of the association between
the IFRS compliance level and the value relevance of accounting information to
KSE market participants. These findings support hypotheses H12 and H13.
The next chapter presents a summary and discussion of the key findings, and the
limitations, implications and major contributions of the study.
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CHAPTER 8
Conclusion
Motivated by both the lack of research on the value relevance of accounting
information in emerging markets and Kuwait’s unique institutional setting, this
study has three specific objectives. The first objective is to investigate the extent to
which firms listed on the Kuwait Stock exchange (KSE) comply with International
Financial Reporting Standards (IFRS). More specifically, determine the level of
IFRS compliance and the factors that influence compliance levels among KSE-listed
firms. The second objective is to examine the value relevance of the accounting
information that KSE-listed companies produce and the changes in value relevance
over time. The study’s third objective is to explore the association between the level
of IFRS compliance and the value relevance of accounting information to market
participants, thus linking the first two objectives.
This chapter summarises the preceding chapters and discusses the key findings in
relation to the research questions. Section 8.1 provides a summary and discussion of
the study findings. Then Section 8.2 presents the study’s major contributions and
implications. The chapter concludes with Section 8.3, which highlights the study’s
limitations and potential areas for future research.
8.1 Summary and Discussion of Findings
Based on its objectives, this study addresses the following research questions:
1. To what extent do KSE-listed companies comply with IFRS disclosure
requirements?
2. What factors explain the differences in KSE-listed company compliance
levels, and how important is the auditor-quality factor?
3. Was accounting information—earnings and book value—value relevant to
KSE participants during the 1995–2006 period?
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4. Did the value relevance of accounting information—earnings and book
value— change during the 1995–2006 period?
5. To what extent do compliance levels affect the value relevance of accounting
information?
Chapter 2 provided an overview of the development of Kuwait’s accounting
environment and its effect on KSE-listed companies. The Law of Commercial
Companies and the Kuwait Stock Exchange Regulations are the primary laws that
regulate accounting and securities trading in Kuwait. The chapter addressed how
significant sections of the laws affect listed companies.
Chapter 3 provided a review of the empirical evidence relating to the value
relevance of accounting information and IFRS compliance. The review of studies on
the value relevance of accounting information revealed a significant number of
studies that investigate the role of fundamental variables in explaining the
relationship between stock price (or stock returns) and the book value of equity and
earnings. Until recently, many of these studies have been conducted in the U.S. and
other countries with highly developed markets, while little attention has been given
to international markets. However, the literature on accounting information has
recently started to show interest in studies with a more international context. The
motivations for this interest vary, but generally relate to the unique accounting,
reporting, standard setting and other institutional factors of these countries. These
differences have prompted a desire to improve general understanding about the
influence of institutional factors on the value relevance of accounting information.
A prominent characteristic of most literature on the value relevance of accounting
information is an ignorance of the ability to distinguish between the accounting
standards being used and the actual implementation of those standards. Accounting
regulations may be of high quality, but the value relevance of reported accounting
information may be of low quality if firms do not fully comply with accounting
regulations or they opportunistically exploit the discretion provided in the
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accounting standards. The review of the literature on IFRS compliance provides
substantial evidence of non-compliance by companies that claim to comply with the
standards.
Chapter 3 highlighted the fact that higher value relevance in accounting information
cannot be expected simply because a company adopts high quality accounting
standards, domestic or international. Such high-quality accounting standards will not
effectively produce value relevant information unless adequate control measures are
in place to ensure the standards are actually implemented and complied with.
Although a substantial number of studies have investigated the value relevance of
accounting numbers in the U.S. and internationally, no known research has explored
the association between the extent of IFRS compliance and the value relevance of
accounting numbers. Thus, a clear need exists for this research. As mentioned in
Chapter 3, a recent study by Al-Shammari et al. (2008) finds significant variations in
the extent of IFRS compliance among companies in Gulf Cooperation Council
(GCC) countries. Therefore, the Kuwaiti stock market provides an ideal setting for
investigating this issue further and exploring the relationship between the level of
compliance and the value relevance of accounting information.
Chapter 4 developed this study’s theoretical framework. It argued that the quality of
accounting information is a function of both the quality of accounting standards and
the enforcement of those standards. Consequently, the value relevance of accounting
information was expected to be influenced by the quality of the accounting standards
used and the level of compliance with those standards. Several external and internal
governance factors do influence levels of IFRS compliance. However, external audit
quality was expected to be a key factor influencing the enforcement of accounting
standards and thus the compliance level.
Chapter 4 developed 13 research hypotheses to address the study’s objectives and
research questions. Seven of the hypotheses addressed the influence of firm-specific
attributes on the level of compliance with IFRS disclosures, while four focused on
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the value relevance of accounting earnings and book value to KSE investors during
the 1995–2006 period. The two remaining hypotheses addressed the association
between IFRS compliance and the value relevance of accounting earnings and book
value to KSE participants.
Regarding IFRS compliance, this study hypothesised that compliance levels increase
with firm age (H1), leverage (H3), firm size (H4), profitability (H5) and the number
of Big-4 auditing firms that audit a firm's financial statements (H6). The study
predicted that compliance levels decrease when a firm has a higher liquidity ratio
(H2). In addition, the level of IFRS compliance was expected to vary by industry
category (H7). Regarding the value relevance of accounting information, the study
hypothesised that book value (H8) and earnings (H9) were value relevant to KSE
participants. In addition, it predicted that the value relevance of KSE-listed firms’
book values (H10) and earnings (H11) increased during the 1995–2006 period.
Finally, the study hypothesised that the higher the level of IFRS compliance, the
greater the value relevance of book value (H12) and earnings (H13).
Chapter 5 outlined the research design used to investigate the extent of IFRS
compliance and the value relevance of accounting information. The investigation of
value relevance covered the period from 1995 to 2006. However, due to limited data
availability, the investigation of IFRS compliance was limited to only 2006. Because
all KSE-listed firms must comply with IFRS requirements and a relatively small
number of firms are listed in the KSE, this study’s sample included all the
companies listed in the KSE in 2006.
Out of the 39 IAS/IFRS at issue by the end of 2006, only 27 standards were
considered relevant and applicable to this investigation of the extent of KSE-listed
firms’ compliance. A total of 419 mandatory disclosure requirements were obtained
from the 27 applicable IFRS.
Using the 27 IAS/IFRS, the extent of IFRS compliance among KSE-listed firms was
measured using a self-constructed, item-based compliance index (CINDEX).
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Consistent with the approaches used in previous studies, several procedures were
used to minimise and overcome the potential bias and uncertainty in coding the
index. The level of compliance (CINDEX) was used as the dependent variable to
investigate the relationship between the level of compliance with IFRS mandatory
disclosures and firms’ attributes to explain why companies vary in compliance
levels. The company attributes likely to be associated with differences in compliance
(age, liquidity, leverage, size, profitability, auditing quality and industry category)
were used as independent variables. Multiple regression analysis was used to
investigate the relationship between the dependent and independent variables.
To assess the value relevance of the information contained in financial statements,
two types of valuation models were used to examine accounting value relevance to
investors: price model and returns model. The price model followed that of Ohlson
(1995), and examined the association between stock price and earnings and book
value. The returns model followed that of Easton and Harris (1991), and reviewed
the association between stock returns and the levels and changes of accounting
earnings.
To explore whether the extent of IFRS compliance is associated with the value
relevance of accounting information, the standardised compliance score obtained
from the self-constructed index was used as an additional explanatory variable
(CINDEX) in the price and returns models. Since the investigation of compliance
with IFRS mandatory disclosure was limited to 2006, the examination of the
association between IFRS compliance level and firm value to market participants
was also restricted to 2006.
8.1.1 Results of Compliance with IFRS-Required Disclosures
This study’s first research question aimed to determine the extent to which KSE-
listed companies comply with IFRS. To explore this further, the second question
sought to determine which factors caused variations in KSE-company compliance
levels. The study developed seven hypotheses to examine the influence of firm-
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specific attributes on the level of compliance with IFRS disclosures (H1–H7).
Chapter 6 then reported the results of investigating these hypotheses.
The results showed that the mean (median) level of compliance with IFRS
mandatory disclosures for all 163 KSE-listed firms in 2006 was 72.6% (74%), with
a range of 49–92%. Although most KSE-listed firms complied with most IFRS
mandatory disclosures, no firm complied fully in the 2006 fiscal year financial
statements. This finding raises concerns about the effectiveness of the regulatory
body in monitoring firm compliance with IFRS mandatory disclosures. It also raises
concerns about the role and quality of external auditing in promoting compliance
with required laws and regulations, particularly as that none of the 163 KSE-listed
firms in 2006 received a qualified audit opinion on non-compliance with IFRS
required disclosures.34
Remarkable variations occurred in the extent of firms’ compliance with mandatory
disclosure. The results showed that 10% of KSE-listed firms achieved an IFRS
compliance score between 49% and 59%. Additionally, 27% of firms achieved
scores between 60% and 69% while 38% of firms achieved scores between 70% and
79%. Only 25% achieved scores above 79%. This notable variation in the
compliance levels of KSE firms encourages an examination of the corporate
characteristics behind this variation.
Compliance variation occurred not only across firms but also across standards. The
results showed a significant variation in compliance levels among the 27 IFRS/IAS
examined. The mean compliance ranged from 49% for the IAS 17 (Lease) to 91%
for IAS 27 (Consolidated and Separate Financial Statements). Only seven standards
exhibited high levels of compliance (above 80%); however, these standards
generally had simple compliance requirements. Thirteen standards attained an
average level of compliance (higher than 60% but lower than 81%). Firm-specific
characteristics seemed to be major determinants of compliance for these standards.
Seven other standards exhibited low levels of compliance (equal or below 60%),
34In 2006, all 163 KSE-listed firms received an unqualified audit opinion.
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which could be explained by factors such as proprietary costs, difficulty in
adherence, the sensitive nature of the disclosure requirements and lack of experience
in implementing the standard.
The results of this investigation into IFRS compliance for KSE-listed firms in 2006
suggested that the compliance level among KSE-listed firms was lower than those in
other developed and developing countries. In addition, the level of compliance with
mandatory IFRS disclosure among KSE-listed firms was also lower than compliance
with voluntary disclosures by firms in other developed and developing countries.
The second research question attempted to clarify which factors were associated
with variations in the compliance levels of KSE-listed firms. Company attributes
were expected to be important factors influencing compliance levels. To investigate
the relationship between compliance levels and firm attributes in explaining why
companies vary in compliance, the study used the level of compliance (CINDEX),
obtained from the self-constructed compliance checklist, as the dependent variable.
Company attributes such as age, liquidity, leverage, size, profitability, auditing
quality and industry category were used as independent variables.
Results indicated a significant, positive association between IFRS compliance levels
and several company attributes, i.e. firm age, leverage, size and profitability.
Consequently, the findings suggest that older, highly leveraged, larger and profitable
KSE-listed firms are associated with high levels of compliance with IFRS-required
disclosures. Importantly the results reveal significant variations in compliance across
the three possible auditor combinations. Firms audited by two Big-4 audit firms
achieved the highest level of compliance, followed by firms audited by one Big-4
and one non-Big-4 firm, and finally firms audited by two non-Big-4 audit firms.
These findings showed the importance of high-quality and rigorous external audits
in promoting compliance with IFRS requirements. The findings also showed
significant differences in the IFRS compliance levels across the KSE’s five industry
categories.
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Several robustness tests were conducted to ensure that the regression results were
not sensitive to alternative measures of dependent and independent variables. For the
dependent variable, the first test involved transforming the dependent variable
(CINDEX) and the second involved collapsing the CINDEX scores into sub-groups.
For the independent variables, robustness tests were conducted on alternative
measures for the independent variables. All the robustness tests confirmed the
results obtained in the primary model.
8.1.2 Results of Value Relevance of Accounting Information
The third and fourth research questions addressed the value relevance of IFRS-based
financial statements in Kuwait over time. Four hypotheses were developed to
address the value relevance of accounting earnings and book value to KSE investors
over the 1995–2006 period (H8–H11). Chapter 7 reported the results derived for
these hypotheses.
Two types of valuation models were used to examine accounting information value
relevance to investors: the price model and the returns model. Control variables were
incorporated into the price and returns models to capture the influence of
profitability, industry category and firm size on the value relevance of accounting
earnings and book value.
Price Model Findings
The results of the pooled cross-sectional, time-series regression showed that
earnings and book value were, jointly and individually, positively and significantly
related to stock price. The findings indicated that earnings and book value jointly
explained about 57% of the variations in KSE-listed firms’ stock prices during the
1995–2006 period.
Results obtained from the year-by-year price model regressions supported the
conclusion based on the result obtained in the pooled cross-sectional, time-series
regression. The adjusted R² of the yearly cross-sectional regressions of price on
earnings and book value ranged from 54% in 2005 to 83% in 1995, with a mean
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(median) of 65% (63%). These results suggested that investors in KSE-listed firms
consistently perceived earnings and book value to be value relevant in every year
and in all years combined. However, close examination of the year-by-year
regressions over time showed a clear deterioration in the adjusted R²s over the study
period. In 1995, earnings and book value jointly explained 83% of variations in
stock prices compared with 59% in 2006.
The value relevance of KSE-listed firms’ earnings and book value were found to be
generally consistent with those of developed markets, and greater than in some
emerging markets. However, when compared to a previous Kuwait-related value
relevance study (Elshamy and Kayed, 2005),35 the value relevance of earnings and
book value reported in this study was lower. Consequently, the value relevance of
earnings and book value were examined to determine whether any significant
change in value relevance occurred over the 1995–2006 period.
This study assessed changes in the value relevance of earnings and book value by
incorporating a year dummy variable and regressing R²s on a time trend. Taken
together, these approaches revealed a significant decline in the value relevance of
earnings and book value over the 1995–2006 period. The results show that there are
noticeable differences in the composition of industry categories across the study
period. Hence the change in the number of firms across industry categories could be
one explanation for the decline in the value relevance of earnings and book value.
Another factor could have been the increased attention that the Kuwaiti financial
market received from press and financial advisories after the restriction on foreign
investors was lifted in 2001, which, as discussed, can significantly affect the
information environment of business firms, and increase the amount of publicly
available information about such firms (Bushee et al., 2007). Consequently, the
number of useful non-financial statement sources for KSE investors has increased in
recent years. Therefore, the decline in the value relevance of earnings and book
35 Using the price model, the study examines the value relevance of earnings and book value based on a sample of 31–75 KSE firms per year over the 1992–2001 period.
198
value could be due to an increase in available information from non-financial
statement sources, potentially making accounting information less timely and
relevant than in the early years of the study period.
Consistent with the value relevance literature, profitability, industry category and
firm size were identified as potential factors influencing the value relevance of
earnings and book value. For profitable firms, the results showed that earnings were
a more important determinant of equity valuation than book value. For loss firms,
the findings revealed book value to be more relevant for equity valuation than
earnings. The results showed significant variations in value relevance across
industry categories due to differences in underlying real economic activities.
Additionally, the results showed book value to be more important than earnings in
valuing smaller rather than larger firms.
Returns Model Findings
The results of the pooled cross-sectional time-series regression showed that earnings
level and earnings changes, both jointly and individually, were positively and
significantly related to stock returns. These results indicated that earnings level and
earnings changes jointly explained about 27% of the variation in annual returns
during the 1995–2006 period. Significant year-by-year results supported the
conclusion based on the pooled data. The adjusted R² of the yearly cross-sectional
regressions of stock returns on earnings level and changes ranged from 12% in 2001
to 52% in 1999, with a mean (median) of 30% (26%).
These results suggested that earnings level and earnings changes explained a
significant portion of stock returns variations in every year and for all years of the
study period combined. However, similar to the price model findings, a comparison
of year-by-year regressions across time revealed a noticeable decline in the adjusted
R²s across the study period. Earnings level and changes explained 40% of annual
returns variations in 1995 but only 23% in 2006.
199
The value relevance of earnings level and earnings changes of KSE listed firms were
found to be higher, in terms of adjusted R² and earnings coefficients, than the
findings observed in some developed and emerging countries. The greater
association between annual stock returns and earnings level and change could be
attributed to the nature of the KSE. Similar to other emerging markets, the KSE has
a large proportion of unsophisticated, naïve investors. Literature on financial
markets has documented that the likelihood of unsophisticated investors functionally
fixating on earnings information is greater than for sophisticated investors (Hand,
1990). Thus, the high association between stock returns and earnings could be
partially due to the influence of naïve KSE investors. Consequently, the value
relevance of earnings is greater in the KSE than other well-developed markets. In
addition, it could be argued that earnings are more value relevant to KSE investors
because of the lack of alternative sources of information in Kuwait about prospects.
Similar to the price model, the change in value relevance was investigated for the
1995–2006 period. The assessment revealed a decline in the value relevance of
earnings level and earnings changes jointly, and a decline in the value relevance of
earnings level individually, during the study period. In contrast, the results showed
that the value relevance of earnings changes individually increased over time.
Investigating the change further revealed that that the decline in the value relevance
of earnings level and earnings changes jointly, and earnings level individually, was
not significant, while the increase in the value relevance of earnings changes
individually was significant.
In investigating the influence of profitability, industry category and firm size on the
value relevance of earnings, the results showed that only profitability (positive
versus negative earnings firms) influenced the value relevance of earnings over the
study period. Industry category and firm size did not significantly influence the
value relevance of earnings level and earnings changes. The insignificant results
could have been due to an omitted variable, such as the omission of book value in
the returns model.
200
8.1.3 Results of Value Relevance and Level of IFRS Compliance
The fifth question in this study explored whether a positive association existed
between the level of IFRS compliance and the value relevance of accounting
information to KSE market participants. The noticeable variation observed in IFRS
compliance among KSE-listed firms provided an ideal environment in which to
investigate the association between financial disclosure compliance levels and the
value relevance of these financial statements to KSE market participants.
Two hypotheses were developed to address the association between IFRS
compliance and the value relevance of accounting earnings and book value to
investors (H12 and H13). Chapter 7 reported the results of evaluating these
hypotheses.
Based on the potential improvement in value relevance associated with adopting
high-quality accounting standards and the potential for non-compliance to
undermine the effectiveness of IFRS standards in producing high-quality accounting
information, this study predicted that the greater the level of IFRS compliance, the
greater the value relevance of earnings and book value to investors.
The findings from the price model indicated that the coefficient estimate of the IFRS
compliance level was positive and significant. This suggested that greater IFRS
compliance in financial reports was significantly associated with firm value. The
results from the returns model also showed that the coefficient estimates of the IFRS
compliance level were positive and significant. This supported the price model
results. Taken together, the results revealed that KSE market participants
significantly valued greater IFRS compliance in the process of firm valuation during
the study period. Table 8.1 summarises this study’s research questions and their
corresponding hypotheses, as well as the test results for those hypotheses.
201
Table 8.1 : Research Questions and Corresponding Hypotheses, and Hypotheses Test Results
Research Question Hypotheses Results 1-To what extent do KSE-listed companies comply with IFRS disclosure requirements? 2- What factors explain the differences in KSE-listed company compliance levels, and how important is the auditor-quality factor?
H1: The level of compliance with IFRS requirements is positively associated with a firm's age. Supported
H2: The level of compliance with IFRS requirements is negatively associated with a firm's liquidity ratio. Not
Supported
H3: The level of compliance with IFRS requirements is positively associated with a firm's leverage. Supported
H4: The level of compliance with IFRS requirements is positively associated with a firm's size. Supported
H5: The level of compliance with IFRS requirements is positively associated with a firm's profitability. Supported
H6: The level of compliance with IFRS requirements is positively associated with the number of Big-4 auditing firms that audit a firm's financial statements.
Supported
H7: The level of compliance with IFRS requirements varies according to a firm's industry type. Supported
3- Was accounting information—earnings and book value—value relevant to KSE participants during the 1995–2006 period?
H8: Book values of KSE-listed firms were value relevant to KSE participants during the 1995–2006 period. Supported
H9: Earnings of KSE-listed firms were value relevant to KSE participants during the 1995–2006 period. Supported
4- Did the value relevance of accounting information—earnings and book value— change during the 1995–2006 period?
H10: The value relevance of the book values of KSE-listed firms increased during the 1995–2006 period. Not
Supported
H11: The value relevance of the earnings of KSE-listed firms increased during the 1995–2006 period. Not
Supported
5- To what extent do compliance levels affect the value relevance of accounting information?
H12: The higher the level of compliance with IFRS requirements, the greater the value relevance of book values. Supported
H13: The higher the level of compliance with IFRS requirements, the greater the value relevance of earnings. Supported
202
8.2 Major Contributions and Implications
The findings presented in this study provide a number of significant contributions to
and implications for an understanding of the value relevance of accounting
information, IFRS compliance levels among KSE-listed companies and the factors
that influence compliance levels.
First, the study assessed the level of IFRS compliance among KSE-listed companies
and the factors that influence compliance in light of the currently enforced securities
law and enforcement environment. Users of KSE-listed firms’ financial statements
might reasonably expect greater compliance with IFRS mandatory disclosures from
older, larger, highly leveraged and profitable KSE-listed firms, as well as firms with
a greater number of Big-4 audit firms on their auditing team.
Second, as Kuwait’s enforcement body applies the same rules to all KSE-listed
companies, no variation would be expected regarding the effect of regulatory
monitoring on the enforcement of accounting standards. Consequently, this study
did not empirically test the effectiveness of the enforcement body in ensuring IFRS
compliance. However, the study’s finding that no firm complied fully with all IFRS
mandatory disclosures during the study period, and the noticeable variations in the
compliance levels across listed firms, does raise concerns about the effectiveness of
the Kuwaiti enforcement body that oversees compliance with IFRS required
disclosures.
These results suggest that the enforcement body’s current enforcement mechanisms
may need to be strengthened. Investors and others have strongly criticised Kuwait’s
Commercial Company Law for being weak and outdated (Borsuly, 2007). By
assessing the level of IFRS compliance based on the securities law currently
enforced, this study provides empirical evidence to support the implementation of
adequate mechanisms to ensure compliance with accounting standards, either in the
current law or proposed laws.
203
Third, this study raises concerns about the quality of auditing. The study found that
although none of the 163 KSE-listed firms fully complied with all IFRS mandates
disclosures during the study period, the external auditors for all the firms attested to
full IFRS compliance. This observation confirms the arguments of the International
Accounting Standards Board (IASB) and the President of the International
Federation of Accountants (IFAC), which criticise external auditors for asserting
that financial statements fully comply with prescribed IAS/IFRS requirements when,
in fact, accounting policies and notes indicate otherwise (Cairns, 1997).
As KSE-listed companies must be audited by two different, external auditing firms,
this study’s finding have a direct implication for the effectiveness of this
requirement in promoting compliance with laws and regulations. Given empirical
evidence of widespread non-compliance with mandatory IFRS requirements, the
results of this study should raise questions about the quality and reliability of
requiring two external auditors, and the associated cost–benefit of this requirement
for KSE-listed firms.
Fourth, previous studies theorise a positive association between the quality of
accounting information and the existence and enforcement of effective laws that
ensure compliance with those standards (Kothari, 2000; Barth et al., 2005).
However, no known research examines this association empirically. This thesis
provides the first known empirical evidence of an association between IFRS
compliance level and the value relevance of financial statements to market
participants.
The results of the price and returns models found a significant association between
firm value and IFRS compliance level. These results offer empirical evidence to
support a theoretical expectation of an association between IFRS compliance level
and the value relevance of accounting information to market participants. These
findings have important policy implications for KSE administrators. The evidence
that moving toward stricter IFRS compliance is likely to improve the value
relevance of financial statement information to KSE participants clearly highlights
204
the effectiveness of greater compliance, and the associated benefits for market
participants of higher quality and more value relevant financial statement
information.
Fifth, the examination of the value relevance of accounting earnings and book value
showed that market participants relied heavily on this information to make
investment decisions over the 1995–2006 period. It is particularly interesting that the
value relevance of accounting earnings is higher than the value relevance of earnings
observed in some developed and emerging markets. This finding could imply that
KSE investors rely on earnings information more than investors in other markets.
One reason that accounting information has greater value relevance for the KSE than
for other markets could be the fairly limited sources of credible and useful
competing information available to market participants. This potentially makes
accounting information more important and powerful for participants in making
investment decisions. An important implication of this finding is that the KSE needs
to develop its information environment further to become more efficient in offering
a free exchange of information about companies listed on its exchange.
8.3 Limitations and Areas for Future Research
As with any research, certain limitations should be considered when interpreting the
results. This study has five potential limitations, which are outlined below.
First, although this thesis attempted to cover all KSE-listed companies, the
conclusions drawn are subject to an unavoidably small sample size as the KSE is a
relatively small market. In addition, due to data availability, the study period was
limited to 12 years in investigating the value relevance of accounting information,
and one year in assessing the level of IFRS compliance and it is influence on firm
valuation.
205
Second, the study concentrated mainly on the value relevance of accounting
information to, and the extent of IFRS compliance by, KSE-listed companies.
Consequently, it does not cover other types of unlisted business enterprises.
Third, the subjectivity inherent in scoring disclosure compliance was a concern in
this and previous disclosure studies. However, consistent with previous, well-known
disclosure studies, several approaches were undertaken to minimise and overcome
this potential bias and uncertainty in determining firm compliance scores. These
included carefully reviewing the complete annual reports before scoring the
checklist, and employing a priori assumption approach.
Fourth, due to Kuwait’s unique economic, legal, accounting and cultural
environment, generalising the findings of this study to other stock markets should be
done carefully. As well as institutional factor differences, the KSE may exhibit
unique characteristics in terms of its number of listed companies, size, maturity or
market capitalisation. All these factors may limit the study’s application to other
markets.
Fifth, the explanatory variables used in the study were expected to explain variations
in the value relevance of accounting information and IFRS compliance levels by
KSE-listed firms. However, the possibility always exists that the study may have
omitted other factors that would assist in explaining this variation, such as corporate
governance quality. Although regression analysis provides insight into the nature
and magnitude of accounting information’s effect on firm value, or the impact of
company characteristics on IFRS compliance levels, its limitation is its failure to
prove causality. Thus, significant associations between IFRS compliance levels and
company characteristics do not prove that the nature of company characteristics
necessarily cause variations in a firm’s compliance level.
This study’s findings and limitations offer several possible areas for further research.
For example, future research could focus on overcoming some of this study’s
limitations. For example, the study’s scope is limited to KSE-listed firms. Therefore,
206
it would be interesting to investigate the level of IFRS compliance for Kuwaiti firms
not listed on the KSE. In addition, it would be interesting to compare the value
relevance of KSE-listed firms with the value relevance of firms listed on other GCC
exchanges, since these have similar institutional and legal settings.
Due to data limitations, the results of IFRS compliance, and the association between
compliance level and the value relevance of accounting information, are based on
data from a one-year period. Future research could investigate the change in
compliance level and the associated value relevance over time.
Further, the study’s finding of non-compliance raises a serious concern about the
quality of external auditing, as auditors asserted that financial statements fully
complied with IAS/IFRS when, in fact, the study shows otherwise. In 2006, none of
the 163 KSE-listed firms received a qualified audit opinion. One area for future
research would be investigating the factors that influence the quality of external
auditing in Kuwait. In addition, investigating why external auditors are willing to
attest to accounts that do not fully comply with IFRS requirements.
Despite these limitations, this study makes significant contributions to existing
knowledge in the area of the value relevance of accounting information by linking it
to the literature on compliance with International Financial Reporting Standards.
207
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APPENDIXES
Appendix A: IAS/IFRS and Effective Dates
Table A1: Current Status and Effective Dates of IAS/IFRS
Standard Title Effective Date IFRS 1 First-time Adoption of International Financial Reporting Standards 1 Jan 2004 IFRS 2 Share-Based Payment 1 Jan 2005 IFRS 3 Business Combinations 31 March 2004 IFRS 4 Insurance Contracts 1 Jan 2005IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations 1 Jan 2005 IFRS 6 Exploration for and Evaluation of Mineral Resources 1 Jan 2006 IFRS 7 Financial Instruments: Disclosures 1 Jan 2007 IFRS 8 Operating Segments 1 Jan 2009 IAS 1 Presentation of Financial Statements 1 Jan 2005 IAS 2 Inventories 1 Jan 2005 IAS 7 Cash-Flow Statements 1 Jan 1994 IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors 1 Jan 2005 IAS 10 Events after the Balance-Sheet Date 1 Jan 2005 IAS 11 Construction Contracts 1 Jan 1995 IAS 12 Income Taxes 1 Jan 1998IAS 14 Segment Reporting 1 July 1998 IAS 16 Property, Plant, and Equipment 1 Jan 2005 IAS 17 Leases 1 Jan 2005 IAS 18 Revenue 1 Jan 1995 IAS 19 Employee Benefits 1 Jan 1999
IAS 20 Accounting for Government Grants and Disclosure of Government Assistance
1 Jan 1984
IAS 21 Effects of Changes in Foreign Exchange Rates 1 Jan 2005 IAS 23 Borrowing Costs 1 Jan 1995 IAS 24 Related Party Disclosures 1 Jan 2005 IAS 26 Accounting and Reporting by Retirement Benefit Plans 1 Jan 1988IAS 27 Consolidated and Separate Financial Statements 1 Jan 2005 IAS 28 Investments in Associates 1 Jan 2005 IAS 29 Financial Reporting in Hyperinflationary Economies 1 Jan 1990
IAS 30 Disclosures in the Financial Statements of Banks and Similar Financial Institutions
1 Jan 1991
IAS 31 Interests in Joint Ventures 1 Jan 2005 IAS 32 Financial Instruments: Disclosure and Presentation 1 Jan 2005 IAS 33 Earnings Per Share 1 Jan 2005 IAS 34 Interim Financial Reporting 1 Jan 1999 IAS 36 Impairment of Assets 31 March 2004 IAS 37 Provisions, Contingent Liabilities, and Contingent Assets 1 July 1999 IAS 38 Intangible Assets 31 March 2004 IAS 39 Financial Instruments: Recognition and Measurement 1 Jan 2005 IAS 40 Investment Property 1 Jan 2005 IAS 41 Agriculture 1 Jan 2003
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Appendix B: IAS/IFRS Included and Excluded from Compliance Checklist
Table B1: IAS/IFRS Included and Excluded from Compliance Checklist
Panel A: IAS/IFRS Included in this Study
Standard Title IFRS 2 Share-Based Payment IFRS 3 Business Combinations IFRS 4 Insurance Contracts IFRS 5 Non-Current Assets Held for Sale and Discontinued Operations IAS 1 Presentation of Financial Statements IAS 2 Inventories IAS 7 Cash-Flow Statements IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors IAS 10 Events after the Balance Sheet Date IAS 11 Construction Contracts IAS 14 Segment Reporting IAS 16 Property, Plant, and Equipment IAS 17 Leases IAS 18 Revenue IAS 21 Effects of Changes in Foreign Exchange RatesIAS 23 Borrowing Costs IAS 24 Related Party Disclosures IAS 27 Consolidated and Separate Financial Statements IAS 28 Investments in Associates IAS 30 Disclosures in the Financial Statements of Banks and Similar Financial Institutions IAS 31 Interests in Joint Ventures IAS 32 Financial Instruments: Disclosure and Presentation IAS 33 Earnings Per Share IAS 36 Impairment of Assets IAS 37 Provisions, Contingent Liabilities and Contingent Assets IAS 38 Intangible Assets IAS 40 Investment Property
Panel B: Excluded IFRS and Reasons for Exclusion from Compliance Checklist
Standard Title Justification for Exclusion
IFRS 1 First-Time Adoption of IFRS KSE-listed firms are not first-time IFRS adopters.
IFRS 7 Financial Instruments: Disclosures Effective beginning January 2007 IFRS 8 Operating Segments Effective beginning January 2009 IFRS 6 Exploration for and Evaluation of Mineral No firm engaged in the exploration
IAS 12 Income Taxes KSE-listed firms are not subject to income tax.
IAS 19 Employee Benefits KSE firms are obligated to adhere to local law
IAS 20 Accounting for Government Grants Not relevant to KSE-listed companies
IAS 26 Accounting and Reporting by Retirement Benefit Plans
KSE firms are obligated to adhere to local law
IAS 29 Financial Reporting in Hyperinflationary Economies
Not applicable to the Kuwaiti economy
IAS 34 Interim Financial Reporting Irrelevant to the focus of study
IAS 39 Financial Instruments: Recognition and Measurement
Does not include any presentation or disclosure requirements.
IAS 41 Agriculture Not applicable to KSE firms activities in 2006.
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Appendix C: IASs/IFRSs Compliance Checklist36 Name of Company: Industry Category: Total Compliance Score:
IFRS standard/ Source of Info.
Item No.
Disclosure Requirements Score*
IAS 1 Presentation of Financial Statements
Para. 8(a) 1 Financial statements should include a balance sheet Para. 8(b) 2 Financial statements should include an income statement
Para. 8(c) 3 Financial statements should include a statement of change in equity, showing either all changes in equity or changes in equity other than those arising from transactions with equity holders acting in their capacity as equity holders
Para. 8(d) 4 Financial statements should include a cash flow statement Para. 8(e) 5 Financial statements should include notes, comprising a summary of significant accounting policies and other explanatory notes
Para. 13&15 6 Financial statements should include additional disclosures when compliance with the specific requirements in IFRSs is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the enterprise’s financial position and financial performance
Para. 14 7 An enterprise whose financial statements comply with IFRS should include an explicit and unreserved statement of compliance with IFRS in the notes. Financial Statements should not be described as complying with IFRS unless they comply with all the requirements of IFRSs
Para. 17&18 If the enterprise management concludes that compliance with a requirement in an IFRS would be so misleading that it would conflict with the objective of financial statements set out in the Framework and decide to depart from the requirement, enterprise’s financial statements should include the following disclosures:
Para. 18(a) 8 Disclose that management has concluded that the financial statements present fairly the enterprise’s financial position, financial performance and cash flows
36 The official IASB volume for 2006 (IASB, 2006) was used to obtain details about each IAS/IFRS requirement.
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Para. 18(b) 9 Disclose that it has complied with applicable IFRSs, except that it has departed from a particular requirement to achieve a fair presentation
Para. 18(c) 10 Disclose the title of the IFRS, nature of the departure, reason for the departure, and the treatment adopted
Para. 18(d) 11 For each period presented, disclose the financial impact of the departure on each item in the financial statements that would have been reported in complying with the requirement
Para.19 12 When the enterprise departed from a requirement of IFRS in a prior period, and that departure affects the amount recognized in the financial statements for the current period, the enterprise’s financial statements should include disclosures about the title of the IFRS, nature of the departure, reason for the departure, and the treatment adopted
Para.29 13 Each material class of similar items should be presented separately in the enterprise’s financial statements Para.36 14 Comparative information should be disclosed in respect of the previous period for all amounts reported in the financial statements
Para.36 15 Comparative information should be included in narrative and descriptive information when it is relevant to an understanding of the current year’s financial statements
Para.38 16 When the presentation or classification of items in the financial statements has been amended, comparative amounts should be reclassified, unless it is impracticable to do so. When comparative amounts have been reclassified, the enterprise should disclose the nature, the amount and the reason for the reclassification.
Para.44 17 Financial statements should be identified clearly and distinguished from other information in the same published document Para. 46 (a) 18 Financial statements should display prominently the name of the enterprise Para. 46 (b) 19 Financial statements should disclose whether the financial statements cover the individual enterprise or a group of enterprises Para. 46 (c) 20 Financial statements should disclose the balance sheet date or the period covered by the financial statements Para. 46 (d) 21 Financial statements should disclose the reporting currency
Para. 46 (d) 22 Financial statements should disclose the level of rounding used in presenting amounts in the financial statements (e.g. thousands or millions of units of the reporting currency)
Para. 51 23 Financial statements should present current and non-current assets, and current and non-current liabilities, as separate classifications on the face of the balance sheet except when a presentation based on liquidity provides information that is reliable and is more relevant. When a presentation is based on liquidity, assets and liabilities should be presented broadly in order of liquidity
Para.76 (a (i) 24 For each class of share capital, an enterprise should disclose the number of shares authorized, either on the face of the balance sheet or in the notes to the financial statements
Para.76 (a (ii) 25 For each class of share capital, an enterprise should disclose the number of shares issued and fully paid, and issued but not fully paid, either on the face of the balance sheet or in the notes to the financial statements
Para.76 (a (iii) 26 For each class of share capital, an enterprise should disclose the par value per share, or that the shares have no par value, either on the face of the balance sheet or in the notes to the financial statements
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Para.76 (a (iv) 27 For each class of share capital, an enterprise should disclose a reconciliation of the number of shares outstanding at the beginning and at the end of the period, either on the face of the balance sheet or in the notes to the financial statements
Para.76 (a (v) 28 For each class of share capital, an enterprise should disclose the rights, preferences and restrictions attaching to that class, including restrictions on the distribution of dividends and the repayment of capital, either on the face of the balance sheet or in the notes to the financial statements
Para.76 (a (vi) 29 For each class of share capital, an enterprise should disclose shares in the enterprise held by the enterprise itself or by subsidiaries or associates, either on the face of the balance sheet or in the notes to the financial statements of the enterprise
Para.76 (a (vii) 30 For each class of share capital, an enterprise should disclose shares reserved for issue under options and contracts for the sale of shares, including the terms and amounts, either on the face of the balance sheet or in the notes to the financial statements
Para.76 (b) 31 An enterprise should disclose a description of the nature and purpose of each reserve within equity, either on the face of the balance sheet or in the notes to the financial statements
Para.85 33 An enterprise should not present any items of income and expense as extraordinary items, either on the face of the income statement or in the notes to the financial statements
Para.88 34 An enterprise should disclose, either on the face of the income statements or in the notes to the income statement, an analysis of expenses using a classification based on either the nature of the expenses or their function within the enterprise
Para. 93 35 An enterprise classifying expenses by function should disclose additional information on the nature of expenses, including depreciation and amortisation expense and employee benefit expense
Para.95 36 An enterprise should disclose, either on the face of the income statement or the statement of changes in equity, or in the notes, the amount of dividends recognised as distributions to equity holders during the period, and the related amount per share
Para.104 37 Each item on the face of the balance sheet, income statement, statement of changes in equity and cash flow statement should be cross-referenced to any related information in the notes
Para.108 38 The significant accounting policies section of the notes to the financial statements should describe the measurement basis used in preparing the financial statements
Para.125 (a) 39 An enterprise should disclose the amount of dividends proposed or declared before the financial statements were authorized for issue but not recognized as a distribution to equity holders during the period, and the related amount per share
Para.125 (a) 40 An enterprise should disclose the amount of any cumulative preference dividends not recognised Para.126(a) 41 Financial statements should include the domicile of the enterprise Para.126(a) 42 Financial statements should include the legal form of the enterprise Para.126(a) 43 Financial statements should include the enterprise’s country of incorporation Para.126(a) 44 Financial statements should include the address of the enterprise’s registered office Para.126(b) 45 Financial statements should include a description of the nature of the enterprise’s operations and its principal activities
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Para.126(b) 46 Financial statements should include the name of the parent enterprise and the ultimate parent of the group Total Score for Compliance with IAS 1 Requirements
IFRS standard / Source of Info.
Item No.
Disclosure Requirements Score*
IAS 2 Inventories
Para. 36(a) 1 Financial statements should include the accounting policies adopted in measuring inventories, including the cost formula used
Para. 36(b) 2 Financial statements should include the total carrying amount of inventories and the carrying amount in classification appropriate to the enterprise
Para. 36(c) 3 Financial statements should include the carrying amount of inventories carried at fair value less costs to sell Para. 36(d) 4 Financial statements should include the amount of inventories recognized as an expense during the period Para. 36(e) 5 Financial statements should include the amount of any write-down of inventories recognised as an expense in the period
Para. 36(f) 6 Financial statements should include the amount of any reversal of any write-down that is recognised as a reduction in the amount of inventories recognised as expense in the period
Para. 36(g) 7 Financial statements should include the circumstances or events that led to the reversal of a write-down of inventories Para. 36(g) 8 Financial statements should include the carrying amount of inventories pledged as security for liabilities Total Score for Compliance with IAS 2 Requirements
IFRS standard / Source of Info.
Item No.
Disclosure Requirements Score*
IAS 7 Cash Flow Statements
Para. 10 1 Enterprise’s cash flow statement should report cash flows during the period classified by operating, investing and financing
Para. 18 (a) & (b)
2
An enterprise should report cash flows from operating activities using either the direct method, whereby major classes of gross cash receipts and gross cash payments are disclosed; or the indirect method, whereby profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals of past or future operating cash receipts or payments, and items of income or expense associated with investing or financing cash flows
226
Para. 21 3 An enterprise should report separately major classes of gross cash receipts and gross cash payments arising from investing and financing activities
Para. 28 4 An enterprise should report the effect of exchange rate changes on cash and cash equivalents held or due in a foreign currency in the cash flow statement in order to reconcile cash and cash equivalents at the beginning and the end of the period
Para. 31 5 An enterprise should disclose separately cash flows arising from interest received (inflows) Para. 31 6 An enterprise should disclose separately cash flows arising from interest paid (outflows) Para. 31 7 An enterprise should disclose separately cash flows arising from dividends received (inflows) Para. 31 8 An enterprise should disclose separately cash flows arising from dividends paid (outflows)
Para.43 9 An enterprise should exclude from the cash flow statement investing and financing transactions that do not require the use of cash or cash equivalents
Para.43 10 Investing and financing transactions that do not require the use of cash or cash equivalents should be disclosed elsewhere in the financial statements in away that provides all the relevant information about these investing and financing activities
Para.45 11 An enterprise should disclose the components of cash and cash equivalents
Para.45 12 An enterprise should present a reconciliation of the amounts for cash and cash equivalents in its cash flow statement with the equivalent reported in the balance sheet
Para.46 13 An enterprise should disclose the policy that it adopts in determining the composition of cash and cash equivalents
Para.48 14 An enterprise should disclose the amount of significant cash and cash equivalent balance held by the entity that are not available for use by the group
Total Score for Compliance with IAS 7 Requirements
IFRS standard / Source of Info.
Item No.
Disclosure Requirements Score*
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
Para. 28 When initial application of an IFRS has an effect on the current period or any prior or future period, enterprise financial statements should include the following disclosures:
Para. 28 (a) 1 Disclose the title of the IFRS Para. 28 (b) 2 Disclose that the change in accounting policy has been made in accordance with its transitional provisions Para. 28 (c) 3 Disclose the nature of the change in accounting policy
227
Para. 28 (d) 4 Disclose a description of the transitional provisions Para. 28 (e) 5 Disclose the transitional provisions that might have an effect on future periods
Para. 28 (f) 6 Disclose the amount of the adjustment for each financial statement line item affected and for basic and diluted earnings per share. These disclosures should be presented for the current period and each prior period presented
Para. 28 (g) 7 Disclose the amount of the adjustment relating to periods before those presented
Para. 28 (h) 8 If retrospective application is impracticable for a particular period, or for period before those presented, the enterprise should disclose the circumstances that led to the existence of that condition and a description of how and from when the change in accounting policy has been applied
Para.30 (a) 9 When an enterprise has not applied a new IFRS that has been issued but is not yet effective, the entity should disclose that fact
Para.30 (b) 10 When an enterprise has not applied a new IFRS that has been issued but is not yet effective, the entity should present a reasonably estimable information relevant to assessing the possible impact that application of the new IFRS will have on the enterprise’s financial statements in the period of initial application
Para. 39 11 An enterprise should disclose the nature and amount of a change in an accounting estimate that has an effect in the current period or which is expected to have an effect in future periods
Para. 40 12 If the amount of the effect in future periods is not disclosed because estimating it is impracticable, the enterprise should disclose that fact
Para. 49 In correcting prior period errors, the enterprise should disclose the following: Para. 49 (a) 13 Disclose the nature of the prior period error
Para. 49 (b) 14 For each prior period presented, disclose the amount of the correction for each financial statement line item affected and for basic and diluted earnings per share
Para. 49 (c) 15 Disclose the amount of the correction at the beginning of the earliest prior period presented
Para. 49 (d) 16 If retrospective restatement is impracticable for a particular period, the enterprise should disclose the circumstances that led to the existence of that condition and a description of how and from when the error has been corrected
Total Score for Compliance with IAS 8 Requirements
IFRS standard / Source of Info.
Item No.
Disclosure Requirements Score*
IAS 10 Events after the Balance Sheet Date
Para.13 1 If dividends are declared after the balance sheet date but before the financial statements are authorized for issue, the enterprise should
228
disclose such dividends in the notes to the financial statements Para.17 2 An enterprise should disclose the date when the financial statements were authorized for issue Para.17 3 An enterprise should disclose the body who gave the authorization of issuing the financial statements Para.17 4 An enterprise should disclose if the shareholders or others have the power to amend the financial statements after issuance Para.21 (a) 5 An enterprise should disclose the nature of event when non-adjusting event occur after the balance sheet data
Para.21 (b) 6 An enterprise should disclose an estimate of its financial effect, or a statement that such an estimate cannot be made when non-adjusting event occur after the balance sheet data
Total Score for Compliance with IAS 10 Requirements
IFRS standard / Source of Info.
Item No.
Disclosure Requirements Score*
IAS 11 Construction Contracts
Para. 39(a) 1 An enterprise should disclose the amount of construction contract revenue recognized as revenue in the period Para. 39(b) 2 An enterprise should disclose the methods used to determine the construction contract revenue recognized in the period Para. 39(c) 3 An enterprise should disclose the methods used to determine the stage of completion of construction contracts in progress Para. 40 An enterprise should disclose each of the following for construction contract in progress at the balance sheet date: Para. 40 (a) 4 Disclose the aggregate amount of costs incurred and recognised profits (less recognized losses) to date Para. 40 (b) 5 Disclose the amount of advance received Para. 40 (c) 6 Disclose the amount of retentions Para. 42 (a) 7 An enterprise should disclose the gross amount due from customers for contract work as an asset Para. 42 (b) 8 An enterprise should disclose the gross amount due to customers for contract work as a liability Total Score for Compliance with IAS 11 Requirements
IFRS standard / Source of Info.
Item No.
Disclosure Requirements Score*
IAS 14 Segment Reporting
229
Para. 51 1 For each reportable segment, an enterprise should disclose the segment revenue from sales to external customers Para. 51 2 For each reportable segment, an enterprise should disclose the segment revenue from transactions with other segments
Para. 52 3 For each reportable segment, an enterprise should disclose segment result from continuing operations separately from segment result from discontinued operations
Para. 55 4 An enterprise should disclose the total carrying amount of segment assets for each reportable segment Para. 56 5 An enterprise should disclose segment liabilities for each reportable segment
Para. 57 6 An enterprise should disclose the total cost incurred during the period to acquire segment assets that are expected to be used during more than one period (property, plant, equipment, and intangible assets) for each reportable segment
Para. 58 7 An enterprise should disclose the total amount of expense included in segment result for depreciation and amortisation of segment assets for the period for each reportable segment
Para. 61 8 For each reportable segment, an enterprise should disclose the total amount of significant non-cash expenses (other than depreciation and amortisation) that were included in segment expense
Para. 67 9 An enterprise should present a reconciliation between segment revenue and the enterprise’s revenue from external customers
Para. 67 10 An enterprise should present a reconciliation between segment result from continuing operations and a comparable measure of the enterprise’s operating profit or loss from continuing operations
Para. 67 11 An enterprise should present a reconciliation between segment result from discontinued operations and the enterprise’s profit or loss from discontinued operations
Para. 67 12 An enterprise should present a reconciliation between segment assets and the enterprise’s assets Para. 67 13 An enterprise should present a reconciliation between segment liabilities and the enterprise’s liabilities
Para. 69 If the enterprise’s primary format for reporting segment information is business segments, the following information should be disclosed:
Para. 69 (a) 14 Disclose segment revenue from external customers, by geographical area, based on geographical location of its customers, for each geographical segment whose revenue from sales to external customers is 10 per cent or more of total enterprise revenue from sales to all external customers
Para. 69 (b) 15 Disclose the total carrying amount of segment assets, by geographical location of assets, for each geographical segment whose segment assets are 10 per cent or more of the total assets of all geographical segments
Para. 69 (c) 16 Disclose the total cost incurred during the period to acquire segment assets that are expected to be used during more than one period (property, plant, equipment, and intangible assets), by geographical location of assets, for each geographical segment whose segment assets are 10 per cent or more of the total assets of all geographical segments
Para. 70 If the enterprise’s primary format of reporting segment information is geographical segments, the enterprise should disclose the following segment information for each business segment whose revenue from sales to external customers is 10 per cent or more of
230
total entity revenue from sales to all external customers whose segment assets are 10 per cent or more of the total assets of all business segments:
Para. 70 (a) 17 Disclose segment revenue from external customers Para. 70 (b) 18 Disclose the total carrying amount of segment assets
Para. 70 (c) 19 Disclose the total cost incurred during the period to acquire segment assets that are expected to be used during more than one period (e.g. property, plant, equipment, and intangible assets)
Para. 75 20 An enterprise should disclose the basis of pricing inter-segment transfers Para. 75 21 An enterprise should disclose any changes in the basis of pricing inter-segment transfers
Para. 76 22 An enterprise should disclose changes in accounting policies adopted for segment reporting that have a material effect on segment information
Para. 76 23 An enterprise should disclose a description of the nature of the change in accounting policies Para. 76 24 An enterprise should disclose the reasons for the change in accounting policies
Para. 76 25 An enterprise should disclose the fact that comparative information has been restated to account for the change in accounting policies or that it is impracticable to do so
Para. 81 26 An enterprise should disclose the types of products and service included in each reported business segment Para. 81 27 An enterprise should disclose the composition of each reported geographical segment Total Score for Compliance with IAS 14 Requirements
IFRS standard / Source of Info.
Item No.
Disclosure Requirements Score*
IAS 16 Property, Plant and Equipment
Para. 73 (a) 1 For each class of property, plant and equipment, enterprise’s financial statements should disclose the measurement bases used for determining the gross carrying amount
Para. 73 (b) 2 For each class of property, plant and equipment, enterprise’s financial statements should disclose the depreciation methods used
Para. 73 (c) 3 For each class of property, plant and equipment, enterprise’s financial statements should disclose the useful lives or the depreciation rates used
Para. 73 (d) 4 For each class of property, plant and equipment, enterprise’s financial statements should disclose the gross carrying amount and the accumulated depreciation ( aggregated with accumulated impairment losses) at the beginning and end of the period
231
Para. 73 (e) 5
For each class of property, plant and equipment, enterprise’s financial statements should disclose a reconciliation of the carrying amount at the beginning and end of the period showing any additions; disposals; acquisitions through business combinations; increases or decreases during the period resulting from revaluations and from impairment losses recognised or reversed directly in equity; impairment losses recognised in profit or loss; impairment losses reversed in profit or loss; depreciation, the net exchange differences arising on the translation of financial statements of a foreign entity; and other changes
Para. 74 (a) 6 An enterprise should disclose the existence and amounts of restrictions on title, and property, plant and equipment pledged as security for liabilities
Para. 74 (b) 7 An enterprise should disclose the amount of expenditures recognised in the carrying amount of an item of property, plant and equipment in the course of its construction
Para. 74 (c) 8 An enterprise should disclose the amount of contractual commitments for the acquisition of property, plant and equipment
Para. 76 9 An enterprise should disclose the nature and effect of any change in accounting estimate relating to property, plant and equipment that has an effect in the current period or is expected to have an effect in subsequent periods
Para. 77(a) 10 For property, plant and equipment stated at revalued amounts, an enterprise should disclose the effective date of the revaluation
Para. 77(b) 11 For property, plant and equipment stated at revalued amounts, an enterprise should disclose wether an independent value was involved
Para. 77(c) 12 For property, plant and equipment stated at revalued amounts, an enterprise should disclose the methods and significant assumptions applied in estimating the items’ fair value
Para. 77(d) 13 For property, plant and equipment stated at revalued amounts, an enterprise should disclose the extent to which the items’ fair values were determined directly by reference to observable prices in an active market or recent market transactions on arm’s length terms or were estimated using other valuation techniques
Para. 77(e) 14 For each revalued class of property, plant and equipment, an enterprise should disclose the carrying amount that would have been recognised had the assets been carried under the cost model
Para. 77(f) 15 For property, plant and equipment stated at revalued amounts, an enterprise should disclose the revaluation surplus, indicating the change for the period and any restrictions on the distributions of the balance to shareholders
Total Score for Compliance with IAS 16 Requirements
IFRS standard / Source of Info.
Item No.
Disclosure Requirements Score*
IAS 17 Leases
Para. 31 (a) 1 For finance leases in which the enterprise is the lessee, the enterprise should disclose the net carrying amount at the balance sheet date
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for each class of asset
Para. 31 (b) 2 For finance leases in which the enterprise is the lessee, the enterprise should disclose a reconciliation between the total of future minimum lease payments at the balance sheet date, and their present value
Para. 31 (b) 3 For finance leases in which the enterprise is the lessee, the enterprise should disclose the total of future minimum lease payments at the balance sheet data, and their present value, for not later than one year period, later than one year and not later than five years period, and later than five years period
Para. 31 (c) 4 For finance leases in which the enterprise is the lessee, the enterprise should disclose contingent rents recognised as an expense for the period
Para. 31 (d) 5 For finance leases in which the enterprise is the lessee, the enterprise should disclose the total of future minimum sublease payments expected to be received under non-cancellable sublease at the balance sheet date
Para. 31 (e) 6
For finance leases in which the enterprise is the lessee, the enterprise should disclose a general description of the lessee’s significant leasing arrangements including the basis on which contingent rent payable is determined, the existence and terms of renewal or purchase options and escalation clauses, and restrictions imposed by lease arrangements such as those concerning dividends, additional debt, and further leasing
Para. 35 (a) 7 For operating leases in which the enterprise is the lessee, the enterprise should disclose the total of future minimum lease payments under non-cancellable operating leases for not later than one year period, later than one year and not later than five years period, and later than five years period
Para. 35 (b) 8 For operating leases in which the enterprise is the lessee, the enterprise should disclose the total of future minimum sublease payments expected to be received under non-cancellable subleases at the balance sheet data
Para. 35 (c) 9 For operating leases in which the enterprise is the lessee, the enterprise should disclose the lease and sublease payments recognised as an expense for the period, with separate amounts for minimum lease payments, contingent rents, and sublease payments
Para. 35 (d) 10
For operating leases in which the enterprise is the lessee, the enterprise should disclose a general description of the lessee’s significant leasing arrangements including the basis on which contingent rent payable is determined, the existence and terms of renewal or purchase options and escalation clauses, and restrictions imposed by lease arrangements such as those concerning dividends, additional debt, and further leasing
Para. 47(a) 11 For finance leases in which the enterprise is the lessor, the enterprise should disclose a reconciliation between the gross investment in the lease at the balance sheet data, and the present value of minimum lease payments receivable at the balance sheet data
Para. 47(a) 12 For finance leases in which the enterprise is the lessor, the enterprise should disclose the gross investment in the lease and the present value of minimum lease payments receivable at the balance sheet date, for not later than one year period, later than one year and not later than five years period, and later than five years period
Para. 47(b) 13 For finance leases in which the enterprise is the lessor, the enterprise should disclose unearned finance income
Para. 47(c) 14 For finance leases in which the enterprise is the lessor, the enterprise should disclose the unguaranteed residual values accruing to the benefit of the lessor
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Para. 47(d) 15 For finance leases in which the enterprise is the lessor, the enterprise should disclose the accumulated allowance for uncollectible minimum lease payments receivable
Para. 47(e) 16 For finance leases in which the enterprise is the lessor, the enterprise should disclose contingent rents recognised as income in the period
Para. 47(f) 17 For finance leases in which the enterprise is the lessor, the enterprise should disclose a general description of the lessor’s material leasing arrangements
Para. 56(a) 18 For operating leases in which the enterprise is the lessor, the enterprise should disclose the future minimum lease payments under non-cancellable operating leases in aggregate
Para. 56(a) 19 For operating leases in which the enterprise is the lessor, the enterprise should disclose the future minimum lease payments under non-cancellable operating leases for not later than one year period, later than one year and not later than five years period, and later than five years period
Para. 56(b) 20 For operating leases in which the enterprise is the lessor, the enterprise should disclose the total contingent rents recognised as income in the period
Para. 56(c) 21 For operating leases in which the enterprise is the lessor, the enterprise should disclose a general description of the lessor’s leasing arrangements
Total Score for Compliance with IAS 17 Requirements
IFRS standard / Source of Info.
Item No.
Disclosure Requirements Score*
IAS 18 Revenue
Para. 35(a) 1 An enterprise should disclose the accounting policies adopted for the recognition of revenue Para. 35 (b) (i) 2 An enterprise should disclose the amount of significant revenue recognised during the period arising from the sale of goods Para. 35 (b) (ii) 3 An enterprise should disclose the amount of significant revenue recognised during the period arising from the rendering of service Para. 35 (b) (iii) 4 An enterprise should disclose the amount of significant revenue recognised during the period arising from interest Para. 35 (b) (iv) 5 An enterprise should disclose the amount of significant revenue recognised during the period arising from royalties Para. 35 (b) (v) 6 An enterprise should disclose the amount of significant revenue recognised during the period arising from dividends
Para. 35 (c) 7 An enterprise should disclose the amount of revenue arising from exchange of goods or service included in each significant category of revenue
Total Score for Compliance with IAS 18 Requirements
234
IFRS standard / Source of Info.
Item No.
Disclosure Requirements Score*
IAS 20 Accounting for Government Grants and Disclosure of Government Assistance
Para.21 1
Where a government grant has been awarded for the purpose of giving immediate financial support to the enterprise, rather than as an incentive to undertake specific expenditures, such that the grant has been recognised as income in the period in which the enterprise qualifies to receive it, the enterprise is required to provide sufficient disclosures to ensure that the effect of the grant is clearly understood
Para. 22 2 Where a government grant has been awarded as compensation for expenses or losses already incurred, rather than as an incentive to undertake specific expenditures, such that the grant has been recognised as income in the period in which the enterprise qualifies to receive it, the enterprise is required to provide sufficient disclosure to ensure that the effect of the grant is clearly understood
Para. 39 (a) 3 An enterprise should disclose the accounting policy adopted for government grants, including the methods of presentation adopted in the financial statements
Para. 39 (b) 4 An enterprise should disclose the nature and extent of government grants recognised in the financial statements and an indication of other forms of government assistance from which the enterprise has directly benefited
Para. 39 (c) 5 An enterprise should disclose unfulfilled conditions and other contingencies attaching to government assistance that has been recognised
Total Score for Compliance with IAS 20 Requirements
IFRS standard / Source of Info.
Item No.
Disclosure Requirements Score*
IAS 21 The effects of Changes in Foreign Exchange Rates
Para.52 (a) 1 An enterprise should disclose the amount of exchange differences recognised in profit or loss
Para.52 (b) 2 An enterprise should disclose net exchange differences classified in a separate component of equity, and a reconciliation of the amount of such exchange differences at the beginning and end of the period
Para. 53 3 When the presentation currency is different from the functional currency of the enterprise, the enterprise should disclose that fact, the
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functional currency, and the reason for using a different presentation currency
Para. 54 4 When there is a change in the functional currency of either the reporting enterprise or a significant foreign operation, that fact and the reason for the change in functional currency should be disclosed
Para. 55 5 When an enterprise present its financial statements in a currency that is different from its functional currency, it should describe the financial statements as complying with IFRSs only if they comply with all requirements of each applicable IFRS
Para. 57 6
When an enterprise present its financial statements or other financial information in a currency that is different from either its functional currency or its presentation currency, and the requirement of Para.55 are not met, the enterprise should clearly identify the information as supplementary information to distinguish it from the information that complies with IFRSs, disclose the currency in which supplementary information is displayed, and disclose the entity’s functional currency and the method of translation used to determine the supplementary information
Total Score for Compliance with IAS 21 Requirements
IFRS standard / Source of Info.
Item No.
Disclosure Requirements Score*
IAS 23 Borrowing Costs
Para. 9 & 29(a) 1 Enterprise’s financial statements should disclose the accounting policy adopted for borrowing costs
Para. 29(b) 2 If the enterprise has applied the allowed alternative treatment under which borrowing costs are capitalized, the amount of borrowing costs capitalised during the period should be disclosed
Para. 29(c) 3 If the enterprise has applied the allowed alternative treatment under which borrowing costs are capitalized, capitalisation rate used to determine the amount of borrowing costs eligible for capitalisation should be disclosed
Total Score for Compliance with IAS 23 Requirements
IFRS standard / Source of Info.
Item No.
Disclosure Requirements Score*
IAS 24 Related Party Disclosures
Para. 12 1 An enterprise should disclose the name of its parent and, if different, its ultimate controlling party
Para. 13 2 An enterprise should disclose the related party relationship when control exist, irrespective of whether there have been transaction between the related parties
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Para.17 3 Where there have been transactions between related parties, the enterprise should disclose the nature of the related party relationship
Para.17 4 Where there have been transactions between related parties, the enterprise should disclose the types of transactions (for example, good or service sold/purchased, management service, directors’ remuneration and emoluments, loans and guarantees)
Para.17 5 Where there have been transactions between related parties, the enterprise should disclose the amount of transactions
Para.17 6 Where there have been transactions between related parties, the enterprise should disclose the amount of outstanding balances (including terms and conditions, secured or not, the nature of the consideration to be provided in settlement and any guarantees given or received)
Para.17 7 Where there have been transactions between related parties, the enterprise should disclose provisions for doubtful debts related to the amount of outstanding balances
Para.17 8 Where there have been transactions between related parties, the enterprise should disclose the expense recognised during the period in respect of bad or doubtful debts due from related parties
Para.21 9 Disclosures that related party transactions were made on terms equivalent to those that prevail in arm’s length transactions are made only if such terms can be substantiated
Total Score for Compliance with IAS 24 Requirements
IFRS standard / Source of Information
Item No.
Disclosure Requirements Score*
IAS 27 Consolidated and Separate Financial Statements
Para. 40 (c) 1 An enterprise should disclose the nature of the relationship between the parent and a subsidiary when the parent does not own, directly or indirectly through subsidiaries, more than half of the voting power
Para. 40 (d) 2 For an investee of which more than half of the voting or potential voting power is owned, directly or indirectly through subsidiaries, but which, because of the absence of control, is not a subsidiary, an enterprise should disclose the reasons why the ownership does not constitute control
Para. 40 (e) 3 An enterprise should disclose the reporting date of the financial statements of a subsidiary when such financial statements are used to prepare consolidated financial statements and are as of a reporting date or for a period that is different from that of the parent, and the reason for using a different reporting date or period
Para. 40 (f) 4 An enterprise should disclose the nature and extent of any significant restrictions (e.g. resulting from borrowing arrangements or regulatory requirements) on the ability of subsidiaries to transfer funds to the parent in the form of cash dividends or to repay loans or advances
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Para. 41 (a) 5 When separate financial statements are prepared for a parent that elect not to prepare consolidated financial statements, the enterprise should disclose the fact that the financial statements are separate financial statements
Para. 41 (a) 6 When separate financial statements are prepared for a parent that elect not to prepare consolidated financial statements, the enterprise should disclose the fact that the exemption from consolidation has been used
Para. 41 (a) 7 When separate financial statements are prepared for a parent that elect not to prepare consolidated financial statements, the enterprise should disclose the name and country of incorporation or residence of the entity whose consolidated financial statements that comply with IFRSs have been produced for public and the address where these are obtainable
Para. 41 (b) 8 When separate financial statements are prepared for a parent that elect not to prepare consolidated financial statements, the enterprise should disclose a listing of names of significant investments in subsidiaries
Para. 41 (b) 9 When separate financial statements are prepared for a parent that elect not to prepare consolidated financial statements, the enterprise should disclose a listing of the country of incorporation or residence of significant investments in subsidiaries
Para. 41 (b) 10 When separate financial statements are prepared for a parent that elect not to prepare consolidated financial statements, the enterprise should disclose proportion of ownership interest and if different, proportion of voting power held
Para. 41 (c) 11 When separate financial statements are prepared for a parent that elect not to prepare consolidated financial statements, the enterprise should disclose a description of the methods used to account for significant investments in subsidiaries
Total Score for Compliance with IAS 27 Requirements
IFRS standard / Source of Information
Item No.
Disclosure Requirements Score*
IAS 28 Investment in Associates
Para. 37(a) 1 An enterprise should disclose the fair value of investments in associates for which there are published price quotations
Para. 37(b) 2 An enterprise should disclose summarised financial information of associates, including the aggregated amounts of assets, liabilities, revenues and profit or loss
Para. 37(c) 3 An enterprise should disclose the reasons why the presumption that an investor (the enterprise) does not have significant influence is overcome if the investor holds, directly or indirectly through subsidiaries, less than 20 per cent of the voting or potential voting power of the investee but concludes that it has significant influence
Para. 37(d) 4 An enterprise should disclose the reasons why the presumption that an investor (the enterprise) has significant influence is overcome if the investor holds, directly or indirectly through subsidiaries, 20 per cent or more of the voting or potential voting power of the investee but concludes that it does not have significant influence
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Para. 37(e) 5 An enterprise should disclose the reporting date of the financial statements of an associate, when such financial statements are used in applying the equity method and are as of a reporting date or for a period that is different from that of the investor (the enterprise) , and the reason for using a different reporting date or different period
Para. 37(f) 6 An enterprise should disclose the nature and extent of any significant restrictions (e.g. resulting from borrowing arrangements or regulatory requirements) on the ability of associates to transfer funds to the investor (the enterprise) in the form of cash dividends, or repayment of loans or advances
Para. 37(g) 7 An enterprise should disclose the unrecognised share of losses of an associate, both for the period and cumulatively, if an investor (the enterprise) has discontinued recognition of its share of losses of an associate
Para. 37(h) 8 If the investment is classified as held for sale, an enterprise should disclose the fact that an associate is not accounted for using the equity method in accordance with IFRS 5
Para. 37(i) 9 An enterprise should disclose summarised financial information of associates, either individually or in groups, that are not accounted for using the equity method, including the amounts of total assets, total liabilities, revenues and profit or loss
Para. 38(a) 10 The enterprise’s share of the profit or loss of associates accounted for using the equity method should be separately disclosed Para. 38(b) 11 The carrying amount of investments in associate accounted for using the equity method should be separately disclosed
Para. 38(c) 12 The enterprise’s share of the of any discontinued operation of such associate accounted for using the equity methods should be separately disclosed
Para. 39 13 The enterprise’s share of changes recognised directly in the associate’s equity should be disclosed in the statement of changes in equity
Para. 40 (a) 14 The enterprise’s share of the contingent liabilities of an associate incurred jointly with other investors
Para. 40 (b) 15 The enterprise (as investor) should disclose those contingent liabilities that arise because the investor is severally liable for all or part of the liabilities of the associate
Total Score for Compliance with IAS 28 Requirements
IFRS standard / Source of Information
Item No.
Disclosure Requirements Score*
IAS 30 Disclosure in the Financial Statements of Banks and Similar Financial Institutions
Para. 9 1 A bank should present an income statement which groups income and expenses by nature and discloses the amount of the principal types of income and expenses
Para. 10 (a) 2 The disclosures in the income statements or the notes to the financial statements of a bank should include interest and similar income
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Para. 10 (b) 3 The disclosures in the income statements or the notes to the financial statements of a bank should include interest expense and similar charges
Para. 10 (c) 4 The disclosures in the income statements or the notes to the financial statements of a bank should include dividend income Para. 10 (d) 5 The disclosures in the income statements or the notes to the financial statements of a bank should include fee and commission income
Para. 10 (e) 6 The disclosures in the income statements or the notes to the financial statements of a bank should include fee and commission expense
Para. 10 (f) 7 The disclosures in the income statements or the notes to the financial statements of a bank should include gains less losses arising from dealing securities
Para. 10 (g) 8 The disclosures in the income statements or the notes to the financial statements of a bank should include gain less losses arising from investment securities
Para. 10 (h) 9 The disclosures in the income statements or the notes to the financial statements of a bank should include gains less losses arising from dealing in foreign currencies
Para. 10 (i) 10 The disclosures in the income statements or the notes to the financial statements of a bank should include other operating income
Para. 10 (j) 11 The disclosures in the income statements or the notes to the financial statements of a bank should include impairment losses on loans and advances
Para. 10 (k) 12 The disclosures in the income statements or the notes to the financial statements of a bank should include general administrative expenses
Para. 10 (l) 13 The disclosures in the income statements or the notes to the financial statements of a bank should include other operating expenses Para. 18 14 A bank should present a balance sheet that groups assets and liabilities by nature Para. 18 15 A bank should list assets and liabilities in order that reflect their relative liquidity
Para. 19(a) 16 The disclosures in the balance sheet or the notes to the financial statements of a bank should include in the assets: cash and balances with the central bank
Para. 19(b) 17 The disclosures in the balance sheet or the notes to the financial statements of a bank should include in the assets: treasury bills and other bills eligible for rediscounting with the central bank
Para. 19(c) 18 The disclosures in the balance sheet or the notes to the financial statements of a bank should include in the assets: government and other securities held for dealing purposes
Para. 19(d) 19 The disclosures in the balance sheet or the notes to the financial statements of a bank should include in the assets: placements with, and loans and advances to, other banks
Para. 19(e) 20 The disclosures in the balance sheet or the notes to the financial statements of a bank should include in the assets: other money market placements
Para. 19(f) 21 The disclosures in the balance sheet or the notes to the financial statements of a bank should include in the assets: loans and advances
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to customers
Para. 19(g) 22 The disclosures in the balance sheet or the notes to the financial statements of a bank should include in the assets: investment securities
Para. 19(h) 23 The disclosures in the balance sheet or the notes to the financial statements of a bank should include in the liabilities: deposits from other banks
Para. 19(i) 24 The disclosures in the balance sheet or the notes to the financial statements of a bank should include in the liabilities: other money market deposits
Para. 19(j) 25 The disclosures in the balance sheet or the notes to the financial statements of a bank should include in the liabilities: amounts owed to other depositors
Para. 19(k) 26 The disclosures in the balance sheet or the notes to the financial statements of a bank should include in the liabilities: certificates of deposits
Para. 19(l) 27 The disclosures in the balance sheet or the notes to the financial statements of a bank should include in the liabilities: promissory notes and other liabilities evidenced by paper
Para. 19(m) 28 The disclosures in the balance sheet or the notes to the financial statements of a bank should include in the liabilities: other borrowed funds
Para. 25 29 A bank should disclose the fair value of its loans and receivables Para. 25 30 A bank should disclose the fair value of its held-to-maturity investments Para. 25 31 A bank should disclose the fair value of its financial assets at fair value through profit or loss Para. 25 32 A bank should disclose the fair value of its available-for-sale financial assets
Para. 26 (a) 33 A bank should disclose the nature and amount of commitments to extend credit that are irrevocable because they cannot be withdrawn at the discretion of the bank without the risk of incurring significant penalty or expense
Para. 26 (b) 34 A bank should disclose the nature and amount of a contingent liabilities and commitments arising from off-balance sheet items (e.g. direct credit substitutes including general guarantees of indebtedness, bank acceptance guarantees and standby letters of credit)
Para. 30 35 A bank should disclose an analysis of assets and liabilities into relevant maturity groupings based on the remaining period from the balance sheet date to the contractual maturity date
Para. 40 36 A bank should disclose any significant concentration of its assets, liabilities and off-balance sheet items in terms of geographical areas, customer or industry groups or other concentrations of risk
Para. 40 37 A bank should disclose the amount of significant net foreign currency exposures
Para. 43 (a) 38 A bank should disclose the accounting policy which describes the basis on which uncollectible loans and advances are recognised as an expense and written off
Para. 43 (b) 39 A bank should disclose the movements in any allowance for impairment losses on loans and advances during the period
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Para. 43 (b) 40 A bank should disclose the amount recognised as an expense in the period for impairment losses on uncollectible loans and advances Para. 43 (b) 41 A bank should disclose the amount charged in the period for loans and advances written off Para. 43 (b) 42 A bank should disclose the amount credited in the period for loans and advances previously written off that have been recovered
Para. 43 (c) 43 A bank should disclose the aggregate amount of any allowance account for impairment losses on loans and advances at the balance sheet date
Para. 50 44 A bank should disclose any amounts set aside for general banking risk, including future losses and other unforeseeable risks or contingencies, as appropriations of retained earnings
Para. 53 45 A bank should disclose the aggregate amount of secured liabilities Para. 53 46 A bank should disclose the nature of the assets pledged as security Para. 53 47 A bank should disclose the carrying amount of the assets pledged as security
Para. 55 48 If the bank is engaged in significant trust activities, disclosure of that fact and an indication of the extent of those activities is made in its financial statements
Total Score for Compliance with IAS 30 Requirements
IFRS standard / Source of Information
Item No.
Disclosure Requirements Score*
IAS 31 Interest in Joint Ventures
Para. 54(a) 1 The enterprise (as a venturer) should disclose separately the aggregate amount of any contingent liabilities that the enterprise has incurred in relation to its interest in joint ventures and its share in each of the contingent liabilities that have been incurred jointly with other venturers
Para. 54(b) 2 The enterprise (as a venturer) should disclose separately the aggregate amount of its share of the contingent liabilities of the joint ventures themselves for which it is contingently liable
Para. 54(c) 3 The enterprise (as a venturer) should disclose separately those contingent liabilities that arise because the venture is contingently liable for the liabilities of the other venturers of a joint venture
Para. 55(a) 4 The enterprise (as a venturer) should disclose separately the aggregate amount of any capital commitments of the venturer in relation to its interests in joint ventures and its share in the capital commitments that have been incurred jointly with other venturers
Para. 55(b) 5 The enterprise (as a venturer) should disclose separately the aggregate amount of its share of the capital commitments of the joint ventures themselves
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Para. 56 6 The enterprise (as a venturer) should disclose a listing and description of interests in significant joint ventures Para. 56 7 The enterprise (as a venturer) should disclose the proportion of ownership interest held in each of its jointly controlled entities
Para. 56 8 The enterprise (as a venturer) that recognises its interest in jointly controlled entities using the line-by-line reporting format for proportionate consolidation or the equity method, should disclose the aggregate amounts of each of current assets, long-terms assets, current liabilities, long-term liabilities, income and expenses related to its interests in joint ventures
Para. 56 9 The enterprise (as a venturer) should disclose the method it uses to recognise its interest in jointly controlled entities Total Score for Compliance with IAS 31 Requirements
IFRS standard / Source of Information
Item No.
Disclosure Requirements Score*
IAS 32 Financial Instruments: Disclosure and Presentation
Para. 56 1 The enterprise should describe its financial risk management objective and policies including its policy for hedging each main type of forecast transaction for which hedge accounting is used
Para. 58(a) 2 The enterprise should disclose a separate description of the hedge for designated fair value hedges, cash flow hedges and hedges of a net investment in a foreign operation
Para. 58(b) 3 The enterprise should disclose a separate description of the financial instruments designated as hedging instruments and their fair values at the balance sheet date for designated fair value hedges, cash flow hedges and hedges of a net investment in a foreign operation
Para. 58(c) 4 The enterprise should disclose separately the nature of the risks being hedged for designated fair value hedges, cash flow hedges and hedges of a net investment in a foreign operation
Para. 58(d) 5 For cash flow hedges, the enterprise should disclose the periods in which the cash flows are expected to occur, when they are expected to enter into the determination of profit or loss and a description of any forecast transaction for which hedge accounting has previously been used but which is no longer expected to occur
Para. 59(a) 6 When a gain or loss on a hedging instrument in a cash flow hedge has been recognised directly in equity, through the statement of changes in equity, the enterprise should disclose the amount that was so recognised in equity during the period
Para. 59(b) 7 When a gain or loss on a hedging instrument in a cash flow hedge has been recognised directly in equity, through the statement of changes in equity, the enterprise should disclose the amount that was removed from equity and included in profit or loss for the period
Para. 59(c) 8 When a gain or loss on a hedging instrument in a cash flow hedge has been recognised directly in equity, through the statement of changes in equity, the enterprise should disclose the amount that was removed from equity during the period and included in the
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initial measurement of the acquisition cost or other carrying amount of a non-financial asset or non-financial liability in a hedged highly probable forecast transaction
Para. 60(a) 9 For each class of financial asset, financial liabilities and equity instrument, both recognised and unrecognised, the enterprise should disclose information about the extent and nature of the financial instruments, including significant terms and conditions that may affect the amount, timing and certainty of future cash flows
Para. 60(b) 10 For each class of financial asset, financial liabilities and equity instrument, both recognised and unrecognised, the enterprise should disclose all significant accounting policies and methods adopted, including the criteria for recognition and the basis of measurement applied
Para. 67 11 For each class of financial asset, financial liabilities, the enterprise should disclose information about its exposure to interest rate risk including contractual repricing or maturity dates and effective interest rates
Para. 76 12 For each class of financial asset and other credit exposures, including those not recognised on the balance sheet (such as certain financial guarantees), the enterprise should disclose information about its exposure to credit risk, including the amount that best represent its maximum credit risk at the balance sheet date and significant concentrations of credit risk
Para. 86 13
For each class of financial assets and financial liabilities, the enterprise should disclose the fair value of that class of assets and liabilities in a way that permits it to be compared with the corresponding carrying amount in the balance sheet. When it is not practicable within constraints of timeliness or cost to determine the fair value of a financial assets or financial liability with significant reliability, that fact should be disclosed together with a description of the financial instruments, their carrying amount, an explanation of why fair value cannot be measured reliably
Para. 92(a) 14 The enterprise should disclose the methods and significant assumptions applied in determining fair values of financial assets and financial liabilities separately for significant classes of financial assets and financial liabilities
Para. 92(b) 15 The enterprise should disclose whether fair values of financial assets and financial liabilities are determined directly in full or in part, by reference to published price quotations in an active market or are estimated using a valuation technique
Para. 92(c) 16 The enterprise should disclose whether the financial statements include financial instruments measured at fair values that are determined in full or in part using a valuation technique based on assumptions that are not supported by observable market prices or rates
Para. 92(c) 17 If a fair value estimated using a valuation technique is sensitive to valuation assumptions that are not supported by observable market prices, the enterprise should disclose this fact and present the effect on the fair value of using a range of reasonably possible alternative assumptions
Para. 92(d) 18 The enterprise should disclose the total amount of the change in fair value estimated using a valuation technique that was recognised in profit or loss during the period
Para. 94(b) 19 The enterprise should disclose the carrying amount of financial assets pledged by it as collateral for liabilities Para. 94(b) 20 The enterprise should disclose the carrying amount of financial assets pledged by it as collateral for contingent liabilities
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Para. 94(b) 21 The enterprise should disclose any material terms and conditions relating to assets pledged as collateral
Para. 94(c) 22 When an enterprise has accepted collateral that it is permitted to sell or repledge in the absence of default by the owner of the collateral, the enterprise should disclose the fair value of the collateral accepted, the fair value of any such collateral sold or repledged and whether the entity has an obligation to return it, and any material terms and conditions associated with its use of this collateral
Para. 94(e) 23 The enterprise should disclose financial assets that are classified as held for trading Para. 94(e) 24 The enterprise should disclose financial liabilities that are classified as held for trading
Para. 94(e) 25 The enterprise should disclose financial assets that, upon initial recognition, were designated by the enterprise as financial assets at fair value through profit or loss (i.e. those that are not financial assets classified as held for trading).
Para. 94(e) 26 The enterprise should disclose financial liabilities that, upon initial recognition, were designated by the enterprise as financial liabilities at fair value through profit or loss (i.e. those that are not financial liabilities classified as held for trading).
Para. 94(f) 27 The enterprise should disclose separately net gains or net losses on financial assets or financial liabilities designated by the enterprise as at fair value through profit or loss
Para. 94(g) 28
If the enterprise has designated a loan or receivable as at fair value through profit or loss, the enterprise should disclose the maximum exposure to credit risk at the reporting date of the loan or receivable, the amount by which any related credit derivative or similar instrument mitigates that maximum exposure to credit risk, and the amount of the change during the period and cumulatively in the fair value of the loan or receivable that is attributable to change in credit risk
Para. 94(g) 29
If the enterprise has designated a financial liability as at fair value through profit or loss, the enterprise should disclose the amount of change during the period and cumulatively in the fair value of the financial liability that is attributable to change in credit risk and difference between the carrying amount of the financial liability and the amount the entity would be contractually required to pay at maturity to the holder of the obligation
Para. 94(j) 30 If the enterprise has reclassified a financial asset as one measured at cost or amortised cost rather than at fair value, it should disclose the reason for that reclassification
Para. 94(k) 31 The enterprise should disclose the total interest income and total interest expenses (calculated using the effective interest method) for financial assets and financial liabilities that are not at fair value through profit or loss
Para. 94(k) 32 For available-for-sale financial assets, the enterprise should disclose the amount of any gain or loss recognised directly in equity during the period and the amount that was removed from equity and recognised in profit or loss for the period
Para. 94(k) 33 The enterprise should disclose the amount of interest income accrued on impaired financial assets
Para. 94(i) 34 The enterprise should disclose the nature and amount of any impairment loss recognised in profit or loss for a financial asset, separately for each significant class of financial asset
Para. 94(m) 35 With respect to any defaults of principal, interest, sinking fund or redemption provisions during the period on loans payable recognised as at the balance sheet date, and any other breaches during the period of loan agreements when those breaches can permit the lender to demand repayment, the enterprise should disclose details of those breaches and the amount recognised as at the balance
245
sheet date in respect of the loans payable on which the breaches occurred Total Score for Compliance with IAS 32 Requirements
IFRS standard / Source of Information
Item No.
Disclosure Requirements Score*
IAS 33 Earning per Share
Para. 66 1 The enterprise should present on the face of the income statement basic and diluted earnings per share for profit or loss from continuing operations attributable to the ordinary equity holders of the parent entity
Para. 66 2 The enterprise should present on the face of the income statement basic and diluted earnings per share for profit or loss for the period attributable to the ordinary equity holders of the parent entity
Para. 66 3 The enterprise should present basic and diluted earnings per share with equal prominence for all periods presented
Para. 68 4 The enterprise that report a discontinued operation should disclose the basic and diluted amounts per share for the discontinued operation either on the face of the income statement or in the notes to the financial statements
Para. 69 5 The enterprise should present the basic and diluted earnings per share, even if the amounts disclosed are negative (i.e. a loss per share)
Para. 70(a) 6 The enterprise should disclose the amounts used as the numerators in calculating basic and diluted earnings per share, and a reconciliation of those amount to profit or loss attributable to the parent entity for the period
Para. 70(b) 7 The enterprise should disclose the weighted average number of ordinary shares used as the denominator in calculating basic and diluted earnings per share, and a reconciliation of these denominators to each other
Para. 70(c) 8 The enterprise should disclose instruments (including contingently issuable shares) that could potentially dilute basic earnings per share in the future, but were not included in the calculation of diluted earnings per share because they are anti-dilutive for the period(s) presented
Para. 70(d) 9
The enterprise should disclose a description of ordinary share transactions or potential ordinary share transactions, other than as a result of capitalisation, bonus issues or share splits or decrease as a result of a reverse share splits, that occur after the balance sheet date but before the financial statements are authorized for issue that would have changed significantly the number of ordinary shares or potential ordinary shares outstanding at the end of the period if those transactions had occurred before the end of the reporting period
Total Score for Compliance with IAS 33 Requirements
246
IFRS standard / Source of Information
Item No.
Disclosure Requirements Score*
IAS 36 Impairment of Assets
Para. 126(a) 1 For each class of assets, the enterprise should disclose the amount of impairment losses recognised in profit or loss during the period and the line item(s) of the income statement in which those impairment losses are included
Para. 126(b) 2 For each class of assets, the enterprise should disclose the amount of reversals of impairment losses recognised in profit or loss during the period and the line item(s) of the income statement in which those impairment losses are reversed
Para. 126(c) 3 For each class of assets, the enterprise should disclose the amount of impairment losses on revalued assets recognised directly in equity during the period
Para. 126(d) 4 For each class of assets, the enterprise should disclose the amount of reversals of impairment losses on revalued assets recognised directly in equity during the period
Para. 129(a) 5 An enterprise that reports segment information should disclose for each reportable segment based on an enterprise’s primary reporting format the amount of impairment losses recognised in profit or loss and directly in equity during the period
Para. 129(b) 6 An enterprise that reports segment information should disclose for each reportable segment based on an enterprise’s primary reporting format the amount of reversals of impairment losses recognised in profit or loss and directly in equity during the period
Para. 130(a) 7 For each material impairment loss recognised or reversed during the period for an individual asset, including goodwill, or cash-generating unit, the enterprise should disclose the events and circumstances that led to the recognition or reversal of the impairment loss
Para. 130(b) 8 For each material impairment loss recognised or reversed during the period for an individual asset, including goodwill, or cash-generating unit, the enterprise should disclose the amount of the impairment loss recognised or reversed
Para. 131(a) 9 For impairment losses or reversals that are not individually material, the enterprise should disclose the main classes of assets affected by impairment losses and the main classes of assets affected by reversals of impairment losses
Para. 131(b) 10 For impairment losses or reversals that are not individually material, the enterprise should disclose the main event and circumstances that led to the recognition of these impairment losses and reversals of impairment losses
Para. 133 11 If any portion of the goodwill acquired in a business combination during the period has not been allocated to cash-generating unit (group of units) at the reporting date, the enterprise should disclose the amount of unallocated goodwill together with the reasons why that amount remains unallocated
Para. 134(a) 12
For each cash-generating unit (group of units) for which the carrying amount of goodwill or intangible assets with indefinite useful lives allocated to that unit (group of units) is significant in comparison with the enterprise’s total carrying amount of goodwill or intangible assets with indefinite useful lives, the enterprise should disclose the carrying amount of goodwill allocated to the unit (group of units)
247
Para. 134(b) 13
For each cash-generating unit (group of units) for which the carrying amount of goodwill or intangible assets with indefinite useful lives allocated to that unit (group of units) is significant in comparison with the enterprise’s total carrying amount of goodwill or intangible assets with indefinite useful lives, the enterprise should disclose the carrying amount of intangible assets with indefinite useful lives allocated to the unit (group of units)
Para. 134(c) 14
For each cash-generating unit (group of units) for which the carrying amount of goodwill or intangible assets with indefinite useful lives allocated to that unit (group of units) is significant in comparison with the enterprise’s total carrying amount of goodwill or intangible assets with indefinite useful lives, the enterprise should disclose the basis on which the unit’s (group of units’) recoverable amount has been determined ( i.e. value in use or fair value less cost to sell)
Total Score for Compliance with IAS 36 Requirements
IFRS standard / Source of Information
Item No.
Disclosure Requirements Score*
IAS 37 Provisions, Contingent Liabilities and Contingent Assets
Para. 84 (a) 1 For each class of provision, an enterprise should disclose the carrying amount at the beginning and end of the period
Para. 84 (b) 2 For each class of provision, an enterprise should disclose additional provisions made in the period, including increases to existing provisions
Para. 84 (c) 3 For each class of provision, an enterprise should disclose the amount used (i.e. incurred and charged against the provision) during the period
Para. 84 (d) 4 For each class of provision, an enterprise should disclose unused amounts reversed during the period
Para. 84 (e) 5 For each class of provision, an enterprise should disclose the increase during the period in the discounted amount arising from the passage of time and the effect of any change in the discount rate
Para. 85 (a) 6 For each class of provision, an enterprise should disclose a brief description of the nature of the obligation and the expected timing of any resulting outflows of economic benefits
Para. 85 (b) 7 For each class of provision, an enterprise should disclose an indication of the uncertainties about the amount or timing of those outflows
Para. 85 (c) 8 For each class of provision, an enterprise should disclose the amount of any expected reimbursement, stating the amount of any asset that has been recognised for that expected reimbursement
Para. 86 9 Unless the possibility of any outflow in settlement is remote, an enterprise should disclose for each class of contingent liability at the balance sheet date a brief description of the nature of the contingent liability
248
Para. 86 (a) and Para. 91 10
Unless the possibility of any outflow in settlement is remote, an enterprise should disclose for each class of contingent liability at the balance sheet date an estimate of its financial effect. If it is not practicable to do so, that fact should be disclosed
Para. 86 (b) and Para. 91 11
Unless the possibility of any outflow in settlement is remote, an enterprise should disclose for each class of contingent liability at the balance sheet date an indication of the uncertainties relating to the amount or timing of any outflow. If it is not practicable to do so, that fact should be disclosed
Para. 86 (c) and Para. 91 12
Unless the possibility of any outflow in settlement is remote, an enterprise should disclose for each class of contingent liability at the balance sheet date the possibility of reimbursement. If it is not practicable to do so, that fact should be disclosed
Para. 89 (a) & (b) and Para. 91 13
When an inflow of economic benefits is probable, an enterprise should disclose a brief description of the nature of the contingent assets at the balance sheet date and an estimate of their financial effect at the balance sheet date. If it is not practicable to do so, that fact should be disclosed
Total Score for Compliance with IAS 37 Requirements
IFRS standard / Source of Information
Item No.
Disclosure Requirements Score*
IAS 38 Intangible Assets
Para. 118(a) 1 For each class of intangible assets, the enterprise should disclose whether the useful lives are indefinite or finite
Para. 118(a) 2 For each class of intangible assets, the enterprise should disclose the useful lives or the amortisation rates used for intangible assets with finite useful lives
Para. 118(b) 3 For each class of intangible assets, the enterprise should disclose the amortisation methods used for intangible assets with finite useful lives
Para. 118(c) 4 For each class of intangible assets, the enterprise should disclose the gross carrying amount and accumulated amortisation (aggregated with accumulated impairment losses) at the beginning and end of the period
Para. 118(d) 5 For each class of intangible assets, the enterprise should disclose the line item(s) of the income statement in which any amortisation of intangible assets is included
Para. 118(e) 6 For each class of intangible assets, the enterprise should disclose a reconciliation of the carrying amount at the beginning and end of the period
Para. 121 7 The enterprise should disclose the nature and amount of any change in accounting estimate relating to intangible assets that has a material effect in the current period or that is expected to have a material effect in subsequent periods
Para. 122(a) 8 For an intangible asset assessed as having an indefinite useful life, the enterprise should disclose the carrying amount of that asset
249
Para. 122(a) 9 For an intangible asset assessed as having an indefinite useful life, the enterprise should disclose the reasons supporting the assessment of an indefinite useful life and a description of the factor(s) that played a significant role in determining that the asset has an indefinite useful life
Para. 122(b) 10 For an intangible asset assessed as having an indefinite useful life, the enterprise should disclose a description, the carrying amount and remaining amortisation period of any individual intangible asset that is material to the financial statements of the enterprise
Para. 124(a) 11 If the intangible assets are accounted for at revalued amounts, the enterprise should disclose, by class of intangible assets, the effective date of the revaluation, the carrying amount of revalued intangible assets, and the carrying amount that would have been recognised had the revalued class of intangible assets been measured after recognition using the cost model
Para. 124(b) 12 If the intangible assets are accounted for at revalued amounts, the enterprise should disclose, in respect of the revaluation surplus relating to intangible assets, the amount of the surplus at the beginning and end of the period, the changes during the period, and any restrictions on the distribution of the balance to shareholders
Para. 124(c) 13 If the intangible assets are accounted for at revalued amounts, the enterprise should disclose the methods and significant assumptions applied in estimating the assets’ fair values
Para. 126 14 The enterprise should disclose the aggregate amount of research and development expenditure recognised as an expense during the period
Total Score for Compliance with IAS 38 Requirements
IFRS standard / Source of Information
Item No.
Disclosure Requirements Score*
IAS 40 Investment Property
Para. 75(a) 1 For investment property, the enterprise should disclose whether it applies the fair value model or the cost model
Para. 75(b) 2 If the enterprise applies the fair value model, it should disclose whether, and in what circumstances, property interest held under operating leases are classified and accounted for as investment property
Para. 75(c) 3 The enterprise should disclose the criteria it uses to distinguish investment property from owner-occupied property and from property held for sale in the ordinary course of business
Para. 75(d) 4 The enterprise should disclose the methods and significant assumptions applied in determining the fair value of investment property, including a statement whether the determination of the fair value was supported by market evidence or was more heavily based on other factors (which the enterprise should disclose) because of the nature of the property and lack of comparable market data
Para. 75(d) &(e) 5 The enterprise should disclose the extent to which the fair value of investment property (as measured or disclosed in the financial
250
statements) is based on a valuation by an independent valuer who holds a recognised and relevant professional qualification and has recent experience in the location and category of the investment property being valued. If there has been no valuation by an appropriate qualified independent values, this fact should be disclosed
Para. 75(f) 6
The enterprise should disclose the amount recognised in profit or loss for rental income form investment property, direct operating expenses (including repairs and maintenance) arising from investment property that generated rental income during the period, and direct operating expenses (including repairs and maintenance) arising from investment property that did not generate rental income during the period
Para. 75(g) 7 The enterprise should disclose the existence and amounts of restrictions on the relisability of investment property or the remittance of income and proceeds of disposal
Para. 75(h) 8 The enterprise should disclose contractual obligations to purchase, construct or develop investment property or for repairs, maintenance or enhancements
Para. 76 9 An enterprise that applies the fair value model should disclose a reconciliation between the carrying amounts of investment property at the beginning and end of the period
Para. 79(a) 10 An enterprise that applies the cost model should disclose the depreciation method used for investment property Para. 79(b) 11 An enterprise that applies the cost model should disclose the useful lives or the depreciation rates for investment property
Para. 79(c) 12 An enterprise that applies the cost model should disclose the gross carrying amount of investment property and the accumulated depreciation (aggregated with accumulated impairment losses) at the beginning and end of the period
Para. 79(d) 13 An enterprise that applies the cost model should disclose a reconciliation of the carrying amount of investment property at the beginning and end of the period
Para. 79(e) 14 An enterprise that applies the cost model should disclose the fair value of investment property. If the enterprise cannot determine the vair value of the investment property reliably, it should disclose a description of the investment property, an explanation of why fair value cannot be determined reliably, and if possible, the range of estimates within which fair value is highly likely to lie
Total Score for Compliance with IAS 40 Requirements
IFRS standard / Source of Information
Item No.
Disclosure Requirements Score*
IFRS 2 Share-based Payment
Para. 45(a) 1 The enterprise should disclose a description of each type of share-based payment arrangement that existed at any time during the period, including the general terms and conditions of each arrangement
251
Para. 45(b) 2 The enterprise should disclose the number and weighted average exercise price of share options for each of the following groups options: outstanding at the beginning of the period, granted during the period, forfeited during the period, exercised during the period, expired during the period, outstanding at the end of the period, and exercisable at the end of the period
Para. 45(c) 3 For share options exercised during the period, the enterprise should disclose the weighted average share price at the date of exercise
Para. 45(d) 4 For share options outstanding at the end of the period, the enterprise should disclose the range of exercise prices and weighted average remaining contractual life
Para. 46 5 The enterprise should disclose information that enables users of the financial statements to understand how the fair value of the goods or service received, or the fair value of the equity instruments granted, during the period was determined
Para. 47 If the enterprise has measured the fair value of goods or service received as consideration for equity instruments of the enterprise indirectly, by reference to the fair value of the equity instruments granted, the enterprise should disclose the following:
Para. 47(a) 6 For share options granted during the period, the enterprise should disclose the weighted average fair value of those share options at the measurement date and information on how the fair value of the share options was measured
Para. 47(b) 7 For equity instrument other than share options granted during the period, the enterprise should disclose the number and weighted average fair value of those equity instruments determined at the measurement date and information on how the fair value of the equity instruments was measured
Para.48 8 If share-based payment transactions were measured directly, using the fair value of goods or service received during the period, the enterprise should disclose how the fair value of the goods or services received was determined (e.g. whether fair value was measured at a market price for those goods and services)
Para.51 (a) 9 The enterprise should disclose the total expense recognised for the period arising from share-based payment transactions in which the goods or services received did not qualify for recognition as assets
Para.51 (a) 10 The enterprise should disclose the portion of the total expense recognised for the period that arises from transactions accounted for as equity-settled share-based payment transactions
Para.51 (b) 11 The enterprise should disclose the total carrying amount at the end of the period for liabilities arising from share-based payment transactions
Para.51 (b) 12 The enterprise should disclose the total intrinsic value at the end of the period of liabilities arising from share-based payment transactions for which the counterparty’s right to cash or other assets had vested by the end of the period (e.g. vested share appreciation rights).
Total Score for Compliance with IFRS 2 Requirements
252
IFRS standard / Source of Information
Item No.
Disclosure Requirements Score*
IFRS 3 Business Combination
Para. 67(a) 1 For each material business combination that was effected during the period, the enterprise (as the acquirer) should disclose the names and descriptions of the combining entities or business
Para. 67(b) 2 For each material business combination that was effected during the period, the enterprise (as the acquirer) should disclose the acquisition date
Para. 67(c) 3 For each material business combination that was effected during the period, the enterprise (as the acquirer) should disclose the percentage of voting equity instruments acquired
Para. 67(d) 4 For each material business combination that was effected during the period, the enterprise (as the acquirer) should disclose details of the cost of the combination, and a description of the components of that cost, including any costs directly attributable to the combination
Para. 67(d) 5 When equity instruments have been issued or become issuable as part of the cost of business combination that was effected during the period, the enterprise (as the acquirer) should disclose the number of equity instruments issued or issuable, the fair value of the equity instruments issued or issuable, and the basis for determining that fair value
Para. 67(e) 6 For each material business combination that was effected during the period, the enterprise (as the acquirer) should disclose details of any operation the enterprise has decided to dispose of as a result of the business combination
Para. 67(f) 7
For each material business combination that was effected during the period, the enterprise (as the acquirer) should disclose the amount recognised at the acquisition date for each class of the acquiree’s assets, liabilities and contingent liabilities, and, unless disclosure would be impracticable, the carrying amounts of each of those classes, determined in accordance with IFRSs, immediately before the combination(if such disclosure would be impracticable that fact should be disclosed together with an explanation of the case)
Para. 67(g) 8
For each material business combination that was effected during the period, the enterprise (as the acquirer) should disclose the amount of any excess recognised in the profit or loss associated with an excess in the acquirer’s interest in the net fair value of the acquiree’s identifiable assets, liabilities and contingent liabilities, over cost, and the line item in the income statement in which the excess is recognised
Para. 67(h) 9
For each material business combination that was effected during the period, the enterprise (as the acquirer) should disclose a description of the factors that contributed to a cost that results in the recognition of goodwill, including a description of each intangible asset that was not recognised separately from goodwill and an explanation of why the intangible asset’s fair value could not be measured reliably
Para. 67(i) 10 For each material business combination that was effected during the period, the enterprise (as the acquirer) should disclose the acquiree’s profit or loss since the acquisition date included in the acquirer’s profit or loss for the period, unless disclosures would be
253
impracticable (if such disclosure would be impracticable that fact should be disclosed together with an explanation of the case)
Para. 69 11 If the initial accounting for business combination that was effected during the period has been determined only provisionally, the enterprise should disclose that fact and an explanation of why this is the case
Para. 70(a) 12 The enterprise should disclose the revenue of the combined enterprise for the period as though the acquisition date for all business combinations effected during the period had been the beginning of the period. If it is not practicable to do so, that fact should be disclosed together with an explanation of why this is the case
Para. 70(b) 13 The enterprise should disclose the profit or loss of the combined enterprise for the period as though the acquisition date for all business combinations effected during the period had been the beginning of the period. If it is not practicable to do so, that fact should be disclosed together with an explanation of why this is the case
Para. 73(a) 14
The enterprise should disclose the amount, and an explanation, of any gain or loss recognised in the current reporting period that is of such a size, nature or incidence that disclosure is relevant to an understanding of the combined enterprise’s financial performance, and that relates to the identifiable assets acquired or liabilities or contingent liabilities assumed in business combination that was effected in either the current or a previous period
Para. 73(b) 15 If the initial accounting for a business combination that was effected in the immediately preceding period was determined only provisionally at the end of that period, the enterprise should disclose the amounts, and explanations, of adjustments to the provisional values recognised during the current period
Para. 73(c) 16 The enterprise should disclose information about error corrections for any of the acquiree’s identifiable assets, liabilities or contingent liabilities, or changes in values assigned to those items, that the acquirer recognises during the current period
Total Score for Compliance with IFRS 3 Requirements
IFRS standard / Source of Information
Item No.
Disclosure Requirements Score*
IFRS 4 Insurance Contracts
Para. 37(a) 1 The enterprise (as the insurer) should disclose its accounting policies for insurance contracts and related assets, liabilities, income and expense
Para. 37(b) 2 The enterprise (as the insurer) should disclose the recognised assets, liabilities, income and expense (and, if it presents its cash flow statements using the direct method, cash flows) arising from insurance contracts
Para. 37(b) 3 If the enterprise (as the insurer) is a cedant (i.e. the policy holder under a reinsurance contract), the enterprise should disclose gains and losses recognised in profit or loss on buying reinsurance, and if the cedant defers and amortises gains and losses arising on buying reinsurance, the amortisation for the period and the amounts remaining unamortised at the beginning and end of the period
254
Para. 37(c) 4 The enterprise (as the insurer) should disclose the process used to determine the assumptions that have the greatest effect on the measurement of recognised assets, liabilities, and income and expense amounts. If it is not practicable to do so, that fact should be disclosed
Para. 37(d) 5 The enterprise (as the insurer) should disclose the effect of changes in assumptions used to measure insurance assets and insurance liabilities, showing separately the effect of each change that has a material effect on the financial statements
Para. 37(e) 6 The enterprise (as the insurer) should disclose reconciliations of changes in insurance liabilities, reinsurance assets and, if any, related deferred acquisition costs
Para. 39(a) 7 The enterprise (as the insurer) should disclose its objective in managing risks arising from insurance contracts and its policies for mitigating those risks
Para. 39(b) 8 The enterprise (as the insurer) should disclose those terms and conditions of insurance contracts that have a material effect on the amount, timing and uncertainty of the insurer’s future cash flows
Para. 39(c) 9 The enterprise (as the insurer) should disclose information about risk (both before and after risk mitigation by reinsurance), including information about the sensitivity of profit or loss and equity to changes in variables that have a material effect on them, concentration of insurance risk, and actual claims compared with previous estimates
Para. 39(d) 10 The enterprise (as the insurer) should disclose information about interest rate risk and credit risk
Para. 39(e) 11 The enterprise (as the insurer) should disclose information about exposures to interest rate risk or market risk under embedded derivatives contained in a host insurance contract if the insurer is not required to, and does not, measure the embedded derivatives at fair value
Total Score for Compliance with IFRS 4 Requirements
IFRS standard / Source of Information
Item No.
Disclosure Requirements Score*
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations
Para. 33(a) 1 The enterprise should disclose a single amount on the face of the income statement comprising the total of (i) the post-tax profit or loss of discontinued operations, and (ii) the post-tax gain or loss recognised on the measurement to fair value less costs to sell or on the disposal of the assets or disposal group(s) constituting the discontinued operation
Para. 33(b) 2 The enterprise should disclose an analysis of the single amount disclosed in accordance with Para. 33(a), by identifying the revenue, expenses and pre-tax profit or loss of discontinued operations; the related income tax expense; and the gain or loss recognised on the
255
measurement to fair value less costs to sell or on the disposal of the assets or disposal group(s) constituting the discontinued operation
Para. 33(c) 3 The enterprise should disclose the net cash flows attributable to the operating, investing and financing activities of discontinued operations
Para. 34 4 The enterprise should re-present the disclosures required in Para. 33(a), (b) and (c) for prior periods presented in the financial statements so that the disclosure relate to all operations that have been discontinued by the balance sheet date for the latest period presented
Para. 36(a) 5 If an enterprise ceases to classify a component of any enterprise as held for sale, the results of operations of the component previously presented in discontinued operations should be reclassified and included in income from continuing operations for all periods presented
Para. 36(b) 6 If an enterprise ceases to classify a component of any enterprise as held for sale, the amounts for prior periods should be described as having been re-presented
Para. 38 7 The enterprise should present a non-current asset classified as held for sale and the assets of a disposal group classified as held for sale separately from other assets in the balance sheet
Para. 38 8 The liabilities of a disposal group classified as held for sale should be presented separately from other liabilities in the balance sheet Para. 38 9 Assets and liabilities classified as held for sale should not be offset and presented as a single amount
Para. 38 10 The major classes of assets and liabilities classified as held for sale should be separately disclosed either on the face of the balance sheet or in the notes to the financial statements
Para. 38 11 Any cumulative income or expense recognised directly in equity relating to a non-current asset(or disposal group) classified as held for sale should be presented separately
Para. 38 12 An enterprise should not reclassify or re-present amounts presented for non-current assets or for the assets and liabilities of disposal groups classified as held for sale in the balance sheets for prior periods to reflect the classification in the balance sheet for the latest period presented
Para. 41(a) 13 An enterprise should disclose, in the notes in the period in which a non-current asset (or disposal group) has been either classified as held for sale or sold, a description of the non-current asset (or disposal group)
Para. 41(b) 14 An enterprise should disclose, in the notes in the period in which a non-current asset (or disposal group) has been either classified as held for sale or sold, a description of the facts and circumstances of the sale, or leading to the expected disposal, and the expected manner and timing of that disposal
Total Score for Compliance with IFRS 5 Requirements * Scoring Procedure: 1 = Requirement is complied with 0 = Requirement is not complied with N/A = Requirement is not applicable
256
Appendix D: Detailed Sensitivity Analysis Results
Table D1: Multivariate Regression Results after Transforming the Dependent Variable (CINDEX) to its Logarithm
Dependent Variable: Log-CINDEX ( transformed)
Variable Predicted
Sign Coefficient
Intercept 1.023***
AGE + 0.001++
LIQUIDITY – –0.001
LEVERAGE + 0.009++
LSIZE + 0.048+++
PROFIT + 0.170+++
AUDIT + 0.035+++
IND_FT ? 0.160***
IND_INVST ? 0.145***
IND_INDUS ? 0.065
IND_SERV ? 0.129**
N R² Adj.R² F-statistic p-value (F-statistics)
163 0.594 0.567 22.196 0.000
++, +++ significant at the 0.05, and 0.01 levels respectively (one-tailed) **, *** significant at the 0.05, and 0.01 levels respectively (two-tailed) Log-CINDEX is the natural logarithm of the ratio of a firm's actual disclosure score to the maximum score that the firm is expected to achieve if the company fully complies with the mandatory disclosure requirements of the IFRS. AGE is the number of years passed since foundation to the end of 2006; LIQUIDITY is the ratio of the current assets to the current liabilities at the end of 2006; LEVERAGE is the ratio of total debt to total shareholders’ equity at the end of 2006; LSIZE is the natural logarithm of total assets at the end of 2006; and PROFIT is the Return on Equity (ROE) at the end of 2006, which is the ratio of net income to average common shareholders’ equity; AUDIT is a variable with value of 2 if two Big-4 audit firms audit the company’s financial statements, 1 if one Big-4 audit firm audits the company’s financial statement, and 0 if otherwise; IND_FT is a dummy variable that equals 1 for firms in the Financial Institutions category, and 0 otherwise; IND_INVST is a dummy variable that equals 1 for firms in the Investment category, and 0 otherwise; IND_INDUS is a dummy variable that equals 1 for firms in the Industrial category, and 0 otherwise; IND_SERV is a dummy variable that equals 1 for firms in the Service category, and 0 otherwise (the omitted industry category when all categories are zero is the Real Estate category).
257
Table D2: Multivariate Regression Results after Categorizing CINDEX into High/Medium/ Low Categories
Dependent Variable: CINDEX
Variable Predict Sign
High Group Coefficient
Medium Group Coefficient
Low Group Coefficient
Intercept 0.539*** 0.291*** 0.393***
AGE + 0.002 0.001++ 3.430
LIQUIDITY – –0.001 –0.001 7.300
LEVERAGE + 0.007+++ 0.007+ 0.012+
LSIZE + 0.023+++ 0.030+++ 0.021+++
PROFIT + 0.046 0.109+++ 0.073+++
AUDIT + 0.009+ 0.020++ 0.008
IND_FT ? –0.014 0.099*** 0.122***
IND_INVST ? 0.015 0.092*** 0.073***
IND_INDUS ? 0.026 0.032* 0.029*
IND_SERV ? 0.009 0.075*** 0.066***
N
36 104 23
Adj.R² 0.522 0.508 0.267
F-statistic 6.022 16.252 4.535
p-value (F-statistics)
0.000 0.000 0.000
+, ++, +++ significant at the 0.10, 0.05, and 0.01 levels respectively (one-tailed) *, **, *** significant at the 0.10, 0.05, and 0.01 levels respectively (two-tailed) CINDEX is the ratio of a firm's actual disclosure score to the maximum score that the firm is expected to achieve if the company fully complies with the mandatory disclosure requirements of the IFRS. AGE is the number of years passed since foundation to the end of 2006; LIQUIDITY is the ratio of the current assets to the current liabilities at the end of 2006; LEVERAGE is the ratio of total debt to total shareholders’ equity at the end of 2006; LSIZE is the natural logarithm of total assets at the end of 2006; and PROFIT is the Return on Equity (ROE) at the end of 2006, which is the ratio of net income to average common shareholders’ equity; AUDIT coded 2 if two Big-4 audit firms audit the company’s financial statements, 1 if one Big-4 audit firm audits the company’s financial statement, and 0 if otherwise; IND_FT is a dummy variable that equals 1 for firms in the Financial Institutions category, and 0 otherwise; IND_INVST is a dummy variable that equals 1 for firms in the Investment category, and 0 otherwise; IND_INDUS is a dummy variable that equals 1 for firms in the Industrial category, and 0 otherwise; IND_SERV is a dummy variable that equals 1 for firms in the Service category, and 0 otherwise (the omitted industry category when all categories are zero is the Real Estate category).
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Table D3: Multivariate Regression Results based on Alternative Measure for independent variables
+, ++, +++ significant at the 0.10, 0.05, and 0.01 levels respectively (one-tailed) *, **, *** significant at the 0.10, 0.05, and 0.01 levels respectively (two-tailed) CINDEX is the ratio of a firm's actual disclosure score to the maximum score that the firm is expected to achieve if the company fully complies with the mandatory disclosure requirements of the IFRS. AGE is the number of years passed since foundation to the end of 2006 (For robustness, the natural log of age is used an alternative measure); LIQUIDITY is the ratio of the current assets to the current liabilities at the end of 2006;LEVERAGE is the ratio of total debt to total shareholders’ equity at the end of 2006 (For robustness, the ratio of book value of total debt to market value of equity plus book value of total debt is used an alternative measure); LSIZE is the natural logarithm of total assets at the end of 2006 (For robustness tests, market capitalization is used as an alternative measure); and PROFIT is the Return on Equity (ROE) at the end of 2006, which is the ratio of net income to average common shareholders’ equity (For robustness tests, Return on Assets (ROA), which is the ratio of net income to average total assets is used as an alternative measure); AUDIT coded 2 if two Big-4 audit firms audit the company’s financial statements, 1 if one Big-4 audit firm audits the company’s financial statement, and 0 if otherwise (For robustness tests, the auditor quality variable was coded as one (1) if the firm was audited by Big-4 audit firms and zero (0) otherwise); IND_FT is a dummy variable that equals 1 for firms in the Financial Institutions category, and 0 otherwise; IND_INVST is a dummy variable that equals 1 for firms in the Investment category, and 0 otherwise; IND_INDUS is a dummy variable that equals 1 for firms in the Industrial category, and 0 otherwise; IND_SERV is a dummy variable that equals 1 for firms in the Service category, and 0 otherwise (the omitted industry category when all categories are zero is the Real Estate category).
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Appendix E: Detailed Descriptive Statistics for Variables Used in the Valuation Models
Table E1, Panel A: Year-by-Year Breakdown of Descriptive Statistics Based on Price Model Variables
