Impact of Corporate Governance on Disclosure Transparency

in Bank Annual Reports in Bangladesh

AKM Waresul Karim

Saint Mary's College of California, USA

Monirul Alam Hossain

East West University, Bangladesh

Mohammad Nurunnabi

University of Edinburgh Business School, UK

and

Md. Mahabbat Hossain*

Bangladesh Institute of Bank Management, Bangladesh

(Karim, A.K.M.W, Hossain, M.A, Nurunnabi, M. and Hossain, M.M.

(2011), “Impact of Corporate Governance on the Extent of Disclosure by

Listed Commercial Banks in Bangladesh”, PROSHIKHYAN, a Journal of

Bangladesh Society for Training and Development, Vol. 19, No. 2) (July-

December)

*Corresponding Author: Faculty Member, Bangladesh Institute of Bank Management

(BIBM), Mirpur-2, Dhaka-1216, Phone: 01716373565, Email:

mahabbat_mba@yahoo.com, mahabbat@bibm.org.bd

1

Impact of Corporate Governance on Disclosure Transparency

in Bank Annual Reports in Bangladesh

AKM Waresul Karim

Associate Professor

Department of Accounting

Saint Mary's College of California

P.O. Box 4230

Moraga, CA 94575, United States

E-mail: Wares.Karim2@stmarys-ca.edu

Monirul Alam Hossain

Professor

Department of Business Administration

East West University

Mohakhali, Dhaka, Bangladesh

E-mail: monirulhossain@yahoo.com

Mohammad Nurunnabi

Research Student

University of Edinburgh Business School

University of Edinburgh

8 Buccleuch Place, Edinburgh

EH8 9LW, United Kingdom

Fax: + 44 (0) 131 668 3053

E-mail: M.Nurunnabi@sms.ed.ac.uk

and

Md. Mahabbat Hossain

Faculty Member

Bangladesh Institute of Bank Management (BIBM)

Mirpur-2, Dhaka-1216, Bangladesh

Phone: (Office) (02) 9003031-5 (Ext. 215)

(Cell) 01716 373565

E-mail: mahabbat_mba@yahoo.com or

2

Mahabbat@bibm.org.bd

Biographical notes:

AKM Waresul Karim is an Associate Professor of Accounting at Saint Mary's College

of California, USA. He received his PhD in Accounting from the University of Leeds,

UK. He has published extensively in academic and professional journals including the

International Journal of Accounting, Asia Pacific Journal of Accounting and Economics,

Research in Banking and Finance, Research in Accounting Regulation and Corporate

Governance: An International Review.

Monirul Alam Hossain is a Professor of Accounting at East West University,

Bangladesh. He received his PhD in Accounting from the Manchester Business School,

University of Manchester, UK. His current research focuses on Financial Reporting,

International Accounting Standards, Corporate Governance and Islamic Accounting &

Banking. He has published extensively in academic and professional journals and

conference proceedings.

Mohammad Nurunnabi is a research student at University of Edinburgh, UK. He has an

undergraduate degree in Accounting and Finance, an MSc degree in Accounting and

Finance and a Post Graduate Diploma in Social Science Research Methodology. He has

presented papers in British Accounting Association (BAA), Irish Accounting and Finance

Association (IAFA) and The Institute of Chartered Accountants of Scotland (ICAS).

Md. Mahabbat Hossain is a Faculty Member at Bangladesh Institute of Bank

Management (BIBM). He conducts training for the senior and mid level bankers in the

field of Accounting, Finance and Business Laws. He also conducts classes in the Masters

in Bank Management (MBA) program. He has to do research on the topic regarding

banking industry as a part of his job. He has published in academic and professional

journals. He is M. Phil. fellow in Accounting at Institute of Business Administration

(IBA), University of Rajshahi, Bangladesh.

3

Impact of Corporate Governance on Disclosure Transparency

in Bank Annual Reports in Bangladesh

Abstract

This paper reports the results of an empirical study of the role of selected corporate

governance variables on financial reporting transparency of listed banks in Bangladesh.

The three corporate governance variables examined were: the institution of an audit

committee; (ii) institutional shareholding; and (iii) auditor reputation. A comprehensive

disclosure index comprising 446 voluntary and mandatory items has been used to

measure the degree of financial reporting transparency in terms of disclosure

comprehensiveness. A multivariate analysis of annual reports of 27 banks (out of 29

listed at the time of analysis) shows that banks that have instituted audit committees by

the end of 2003 and employed Big 4 auditors produce significantly more transparent

financial reports than those who did not. The results also show that leverage is

negatively associated with disclosure transparency. Finally, institutional shareholding,

size, profitability, and complexity do not have significant impact on disclosure

transparency. Results of this study provide a greater understanding of the role of

corporate governance tools in enhancing financial reporting transparency in the

financial services sector in developing countries.

Key Words: Financial reporting transparency, corporate governance, audit

committees

4

Impact of Corporate Governance on Disclosure Transparency

in Bank Annual Reports in Bangladesh

1. Introduction

It is well known that the financial reporting practices of a country depend on several

factors, and the legal, economic, political, cultural and historical background of a country

forms the basis of the financial reporting environment. The extent of information

disclosure, its adequacy, relevance and reliability are important characteristics of

financial reporting practices prevalent in a country (Hossain, 1999). The financial

reporting practices have been changed during the last few decades. The researchers in

International accounting emphasize the importance of compliance with IASs/IFRSs as a

significant element in the quality of financial reporting practices. Abd-Elsalam and

Weetman (2003) opted that the growing acceptance of the International Accounting

Standards (IASs) by emerging capital markets has encouraged empirical investigation of

compliance with the requirements of and there is a number of studies in the area of

compliance of International Accounting Standards (IASs) to developing and/or emerging

economies (Nurunnabi, 2009; Ahmed, 2009; Hossain, 2008; Samaha and Stapleton,

2008; Dahawy and Conover, 2007; Abd-Elalam and Weetman, 2007; Hossain, Cooper,

and Islam, 2006, Islam 2006; Akhtaruddin, 2005; Ahmed, 2005a and 2005b; Hossain,

2003; Rahman and Jannah, 2003; Abd-Elalam and Weetman, 2003; Joshi and Ramadhan,

2002; Hossain and Imam, 2002; Hossain, 2001; Chamisa, 2000; Owusu-Ansah, 2000;

Susela, 1999; Rahman, 1999; Banerjee et al.; 1998; Larson and Kenny, 1998 and 1996;

Watty and Carlson, 1998; Hassan, 1998; Al-Rai and Dahmash, 1998; Mirghani, 1998;

Carlson, 1997; Marston and Robson, 1997; Islam, 1996; Ahmed and Nicholls (1995) or

Nicholls and Ahmed (1995), Wallace and Briston, 1993; Larson, 1993; Wallace, 1993;

Akter and Hoque, 1993; Hove, 1990, Shakoor, 1989; Perera, 1989 and Marston, 1986).

However, there is a shortage of existing literature which has investigated compliance

disclosure (mandatory or voluntary) in Corporate Annual Reports of Banking Sector in

the context of an emerging economy in general and in Bangladesh in particular.

5

Karim and Ahmed (2005) opted that the quality of financial reporting in developing

countries appears to be a major concern for the international financial community. In

addition, researchers like Levitt (1998) believe that the success of capital market is

directly dependent on the quality of accounting transparency and disclosure systems. Full

compliance of disclosure with proper and effective audit is very important to maintain

accountability and bring about transparency of firms, and as a result banking companies,

which collect people‟s money and make a profit by investing those funds, require more

stringent audit and disclosure practices than non-financial firms (Reaz and Arun, 2006).

Karim (1995), Hossain (1999), Akhtaruddin (2005), Hossain et al. (2006) found that the

disclosure levels of Bangladeshi listed companies are generally poor which ultimately

raises the question on accounting transparency in Bangladesh. Ahmed and Karim (2005)

also found that the disclosure in the in half-yearly financial statements or quarterly

financial statements of the companies in Bangladesh, is very weak in Bangladesh.

Sundarajan and Balino (1991) found that the undesirable banking practices such as poor

risk diversification, inadequate loan evaluation and fraudulent activities has mainly

created the reasons for banking crises in some emerging economies like Argentina,

Chile, Malaysia, Philippines, Spain, Thailand etc. Greuning and Bratanovic (2003) has

opted that the modern IT based banking system have been involved with high-risk

activities such as trading in financial markets and different off-balance sheet activities

more than ever before which in turn make it very important for the banking sector to

comply with the IAS 30 in the preparation and audit of the financial reports of these

companies. In Bangladesh, there are allegations of „window dressing‟ by the banks to

hide underlying problems, weaknesses and irregularities, and there are many examples of

banks revealing different figures under the same heading in different disclosures

(Reaz and Arun, 2006). Nurunnabi (2009) commented that corruption, bureaucratic

inefficiency, political interference in administration, nepotism, misuse of power and

resources, improper and non-observance of the rule of law, non-accountable and non-

transparent administration are the common features of Bangladesh. To ensure more

transparency in accounting system and disclosure of important accounting policies of

banks and financial institutions in Bangladesh, the Central Bank (Bangladesh Bank)

6

issued a circular (BRPD) Circular No. 3/2000 dated 18/04/2000) for mandatory adoption

of IAS-30. As a result, since 2000, all banks in Bangladesh are required to use the IAS-30

in the preparation of their corporate annual reports.

This paper focuses on the measurement and analysis of the extent of voluntary disclosure

in the company annual reports of the Banking companies in Bangladesh as an example of

an emerging economy. Including the introduction, the paper is organized in seven

sections: Section two discusses the regulatory framework of banking industry in

Bangladesh. Section three reviews related prior research, section four contains the

theories and hypotheses and research methodology of the study are in section five;

Section six presents the results of the study followed by conclusion and limitations of the

study in Section seven.

2. Banking Regulatory Framework in Bangladesh

The Bangladesh Bank Order, 1972, states that:

“Central bank in Bangladesh to regulate the issue of currency and the keeping of

reserves and manage the monetary and credit system in Bangladesh with a view to

stabilizing domestic monetary value; preserving the par value of the Bangladesh

Taka; promoting and maintaining a high level of production, employment and real

income in Bangladesh; and fostering growth and development of the country‟s

productive resources in the best national interest” (Government of Bangladesh

1972, President‟s Order No. 127, p.4).

The financial reporting practice of a country depends on legal, economic, political,

cultural reasons (Ahmed, 2006). The Bangladesh Bank Order, 1972 and the Bank

Companies Act, 1991 empower the Bangladesh Bank to regulate and supervise the

banking sector of the country (World Bank, 2003). The complex process of banking

regulation exists in Bangladesh (Sobhan and Werner, 2003) (See Appendix-1 and

Appendix- 2). The amendment of Banking Ordinance 1961 is replaced by the Banking

Companies Act, 1991. In addition, the Securities and Exchange Rule, 1987, Listing

7

requirements and adopted accounting standards are the main basis of the financial

reporting practices and disclosure made by the Banking companies in Bangladesh.

However, disclosure of information of the Banking Sector in Bangladesh has not been

increased over the last twelve years (World Bank, 2003; Ahmed, 2006). The laws of

Bangladesh (Companies Act 1994 and Securities and Exchange Rules 1987 for listed

companies) set minimum legal requirements as to the disclosure of accounting

information in corporate annual reports and is likely to be confined only to „minimum

disclosure‟ concepts. In such a situation, accounting standards, without having any legal

backing, are likely to have a very little influence on the financial reporting system in

Bangladesh. In Bangladesh, it could be seen that different companies are using different

accounting policies and procedures in the preparation and presentation of their financial

statements in their company/corporate annual reports (Asian Development Bank, 2007).

As a result of diversified use of accounting practices, a meaningful comparison of

financial position as well as performance among the companies became difficult on the

part of the users of accounting information for their decision-making purposes. Unless

the compliance is made at the national level, there is little scope of global harmonisation

of accounting standards

In Bangladesh, there are two accountancy bodies- the Institute of Chartered Accountants

of Bangladesh (ICAB) and the Institute of Cost and Management Accountants of

Bangladesh (ICMAB). The members of ICAB are entitled to attest to the validity of

accounts and to report to shareholders whether a company‟s financial statements comply

with statutory provisions (Nicholls and Ahmed, 1995). The Institute of Chartered

Accountants of Bangladesh (ICAB) is solely responsible for the accounting standards

adhered to in Bangladesh. In 1983, ICAB became the member of the International

Accounting Standard Committee (now IASB). Bangladeshi Accounting Standards

(BASs) include International Accounting Standards (IASs/IFRSs) adopted by the ICAB.

The Securities and Exchange Commission has by a notification dated 29th

December

1997 requires all listed companies to abide by Accounting Standards adopted by the

ICAB and hence, accounting standards are mandatory only for the companies listed in the

Dhaka Stock Exchange (DSE) and the Chittagong Stock Exchange (CSE) (Bangladesh

8

Bank, 2006). As a result, the companies in Bangladesh are expected to comply with the

prescribed accounting standards as prescribed by the SEC. The Securities and Exchange

Commission (SEC) is the authoritative body, who has made the listed companies to adopt

sixteen Bangladesh Accounting Standards (BASs) effective from February, 2000

(Deloitte and Touche Tohmatsu, 2007). To ensure more transparency in accounting

system and disclosure of important accounting policies of banks and financial institutions

in Bangladesh, the Central Bank (Bangladesh Bank) issued a circular (BRPD) Circular

No. 3/2000 dated 18/04/2000) for mandatory adoption of IAS-30 (Bangladesh Bank,

2003-2004). The mandatory disclosure provisions under Banking Companies Act, 1991

are shown in Appendix 1 and mandatory disclosure provisions under IAS 30 (BAS 30)

are in Appendix 2.

Bangladesh also has a liberal policy towards foreign direct investment (FDI). However,

when compared to those of the India, Sri Lanka, Pakistan, Thailand and Malaysia, CG in

practice and philosophy have up till now remained relatively under-developed in

Bangladesh (Nurunnabi, 2009). The Companies Act 1994 does not contain any provision

for mandatory observance of the adopted IFRSs and ISAs in practice (Nurunnabi, 2009).

In Bangladesh, the old Banking Ordinance was replaced by the Banking Companies Act

1991. As per the section 11 of the Securities and Exchange Ordinance 1969, all listed

companies should submit the annual reports to the Stock Exchange, to the security

holders and to the SEC. As we have already discussed that the Securities and Exchange

Commission (SEC) of Bangladesh through its "gazette notification" published in

December 1997 has amended the Securities and Exchange Rules 1987, whereby all listed

entities in Bangladesh are now required to comply with the requirements of all applicable

IAS, as adopted by ICAB, in the preparation and presentation of their Financial

Statements [Rule 12(2)] and all audit practices are required to ensure compliance with

relevant ISA, as adopted by the ICAB, in the conduct of and reporting on the audit of

financial information of listed entities [Rule 12(3)] (Nurunnabi, 2009). In addition, they

found no integrity between the professional bodies and the SEC, the corruption in

corporate culture, lack of auditors‟ professional ethics, lack of monitoring and

supervision and finally the political tension all the year basis.

9

3. Review of Prior Research

Nowadays, there are several researches have focused on the disclosure of information in

corporate annual reports of non-banking sector in the developed and developing

countries. However, a very few research can be found reflecting the disclosure of

information of the financial companies in Bangladesh. Hossain, Cooper, and Islam (2006)

argued that if the enterprises within IASB member countries do not comply with the

promulgated accounting or financial reporting standards, global harmonization will not

be achieved (Hossain, Cooper and Islam, 2006). More specifically, Islam (2006) in his

study found that the percentage of compliance rate for Bangladeshi sample companies

taking into consideration of 21 mandatory accounting Standards was only 71%. Other

empirical studies measuring the compliance of mandatory and voluntary disclosure like

Ahmed, 2009 (Bangladesh), Hossain, 2008 (India), Samaha and Stapleton, 2008 (Egypt),

Dahawy and Conover, 2007 (Egypt), Abd-Elalam and Weetman, 2007 (Egypt), Hossain,

Cooper, and Islam, 2006 (Bangladesh), Islam, 2006 (India, Pakistan, Bangladesh and Sri

Lanka), Akhtaruddin, 2005 (Bangladesh), Ahmed, 2005a (India), Ahmed, 2005b

(Bangladesh), Abd-Elalam and Weetman, 2003 (Egypt), Joshi and Ramadhan, 2002

(Bahrain), Hossain, 2001 (Bangladesh), Owusu-Ansah, 2000 (Zimbabwe), Hossain,

1999 (India, Pakistan and Bangladesh), Karim (1995), and Ahmed and Nicholls, 1994

(Bangladesh) found that the companies of a number of developing countries are not

following the mandatory accounting standards while preparing their financial reports or

statement. This section reviews research on the current situation of the financial reporting

system in Bangladesh in general and the disclosure of information (voluntary and

mandatory both) of the banking sector in the context of other countries in particular.

This part of the literature review will discuss the studies that focus the financial reporting

in Bangladesh in general. Ahmed (1982) while evaluating financial statements as a

communication device in Bangladesh found that the companies Act 1913 is inadequate to

ensure desired disclosure. Parry and Khan (1984) surveyed 74 companies including 13

banks (9 commercial banks and 4 other banks), and found that annual reports were

generally informative and complied with legal requirements, but no attempt was taken to

10

comply with IASs. Similar findings were found in another study undertaken by Parry

(1989). Toha (1986) has made an empirical study of the practical application of IASs in

Bangladesh, and found that the application of IASs in Bangladesh is very limited. Hye

(1987) examined the legal framework of the banking sector (public sector commercial

banks in Bangladesh), has noticed that there are deficiencies of disclosure annual reports

of the public sector commercial banks in Bangladesh.

Alam (1989) found serious drawbacks in the provisions of the Companies Act, 19131

relating to financial statements, and commented that the statutory requirements for the

disclosure of accounting information are inadequate in Bangladesh. Alam (1990)

surveyed annual reports of 62 companies in Bangladesh to evaluate their financial

reporting practices in Bangladesh which did not include any financial companies, and

found that about 10 percent of the companies in Bangladesh fulfilled the 1987

requirements of the Securities and Exchange Rules. Hye (1992) observed that in spite of

the recommendation of the ICAB, the picture depicted by published accounts is not

satisfactory at all.

Rahman and Jannah (2003) examined 46 sets of financial statements of major listed

companies, including 8 banks and 3 insurance companies. By using a checklist for

determining compliance included selected IAS requirements; their study revealed that it

is very common for the listed sample companies not to comply with the IAS

requirements. Nicholls and Ahmed (1995) assessed empirically assess the quality of

disclosure in nonfinancial companies in Bangladesh and their results reveals that the

quality of disclosure had improved significantly, particularly because of the enforcement

of the Securities and Exchange Rules and the adoption of at least six International

Accounting Standards by the Institute of Chartered Accountants of Bangladesh at that

time. They commented that one of the most important features of corporate financial

reporting was the lack of compliance with mandatory disclosure provisions. Rahman

(1999) in his study found that the compliance with voluntary disclosure requirements in

Bangladesh is much lower compared to the compliance with mandatory disclosure

requirements. It is found in his study that companies do not comply with the disclosure

11

requirements set by the regulatory bodies and Acts in Bangladesh. Using a sample of 20

Dhaka stock exchange-listed companies, with a list of 375 disclosure items they found

that the extent of mandatory and voluntary disclosure varies widely within this

environment. The findings of the study also indicate that the compliance with voluntary

disclosure requirements is much lower compared to the compliance with mandatory

disclosure requirements and that no company disclosed all mandatory information items

in its annual reports.

Hossain (1999) examined empirically the association between a number of corporate

attributes and levels of disclosure in corporate annual reports of listed non-financial

companies in three developing countries, India, Pakistan and Bangladesh. A disclosure

index (weighted and unweighted) comprising 94 items of information has been

developed, and applied to the corporate annual reports for a sample of 78 Bangladesh

companies, for the 1992-1993. It was found for the Bangladeshi companies that size

(total assets) and subsidiary of a multinational company were significantly associated

with the extent of disclosure. The study of Hossain (1999) showed mean disclosure level

of the sample companies as 29.33% in 1993. Akhtaruddin (2005) reports the results of the

extent of mandatory disclosure and the association between company-specific

characteristics and mandatory disclosure of 94 companies in Bangladesh. His results

showed that on average, the sample companies were disclosing 44% of the items of

information, which leads to the conclusion that prevailing regulations are ineffective

monitors of disclosure compliance by companies. Among the corporate attributes,

company age found not to be significant for mandatory disclosure while there is little

support for industry size as a predictor of mandatory disclosure except where size is

measured by sales. Further, profitability was also found to have no effect on disclosure.

Hossain, Cooper, and Islam (2006) in their study focuses on the extent of corporate

disclosure based on International Accounting Standards (IASs/IFRSs) adopted in an

emerging economy, Bangladesh. Using a disclosure index consisting of items of

information with a sample annual reports of 106 Bangladeshi manufacturing and trading

companies have been examined for the year ending 2001-2002. Their results showed that

12

the listed non-financial companies significantly followed the selected accounting

standards under review and did bring remarkable changes in the financial reporting

practices made by the listed companies in Bangladesh. Their study reports that the

average disclosure level is 69.05% with a minimum and maximum level of 35.85% and

94.34% respectively which is not very much encouraging. Further, the association

between the extent of disclosure and various corporate characteristics was examined

using multiple linear regression models revealed that net profit margin of Bangladeshi

companies and subsidiary of a multinational company was significantly associated with

the extent of disclosure as per sample accounting standards.

This part of the literature review will consider those empirical studies on the disclosure of

banking companies in the world with special emphasis to Bangladesh. Kahl and Belkaoui

(1981) pioneered the research on Bank Annual Report Disclosure Adequacy

Internationally. Their study investigates the overall extent of disclosure by banks located

in 18 countries. Using 1975 annual reports of the 70 banks were evaluated on the basis of

the response score assigned to 30 informational items in the disclosure index. Kahl and

Belkaoui (1981) found that the differences in disclosure adequacy exist internationally, at

least for the countries included in their sample, with considerable variability in extent,

and with US banks definitely the leaders. Further the evidence in their study supported

the positive correlation between asset size and extent of disclosure, although less strongly

than might have been expected.

Shakoor (1989) has focused on the financial reporting practices of the 6 nationalized

commercial by evaluating the performance of nationalized commercial banks in

Bangladesh during 1972 to 1984. Skakoor (1989) commented that financial reporting

system of banks needs to disclose more information to be disclosed and more methodical.

Hye (1989) in his another study opined that financial reporting is embodied in the legal

framework which out dated and suffers from serious limitations. Islam (1996) in a study

attempted to evaluate the practices relating to disclosure of accounting policies in the

financial statements of the banks working in Bangladesh on Islamic principles. He

commented that the banks should disclose confidently promulgation as to compliance

13

with the professional requirements that are followed. Islam (1997) evaluates in his study-

financial reporting in the commercial banks working in Bangladesh covering a period of

10 years based on published annual reports and relevant legal and professional reporting

requirements. The observations give testimony that annual reporting practices of the

selected banks mainly comply with the legal requirements. The existing forms including

contents of bank balance sheet and profit & loss account do not provide adequate data to

calculate important ratios and items of information evaluating the performance and risk,

solvency, liquidity and profitability of the banks. He added, as the banks are habituated to

comply with the legal requirements, the professional requirements would ultimately be

followed provided that the forms of balance-sheet and profit & loss account are re-

arranged or modified in the light of the professional requirements specially IAS-30.

Alam (1991) in his study found that the forms and contents of annual accounts prescribed

in the first schedule of the Bank Company Act. 1991 is out-dated and hence inadequate.

He identified some major inadequacies Akter and Hoque (1993) examined the disclosure

practices of the banking sector in Bangladesh. Based on their empirical evidence Akter

and Hoque (1993) commented that the disclosure and reporting in banking sector in

Bangladesh are not merely only inadequate but also biased and misleading. They

observed that in many cases financial statements of the sample banking companies are

“dressed up and cosmetised”, and legal framework is outdated. Chowdhury (1997)

describing the usefulness of adopting IAS 30 (Azizuddin, 2001), found that the practical

implementation of IAS 30 with disclosure of compliance have significant impact on the

banking sector over the years (Khan and Kumar, 2001). Azizuddin (2001) overviewed

that the adoption and implementation of IAS-30 which reflects greater accountability in

bank operations and greater transparency in the published financial information of

banking companies. Hossain (2004) has made an attempt to discuss shortcomings in the

published accounts and audit reports of some private commercial banks, and proposed

some recommendations for both ICAB, which regulates the independent auditors, and the

Bangladesh Bank, which regulates the clients of the auditors. In his study, the survey

findings are reported only as examples. In his study Hossain (2004) found that improving

the published financial information of banking companies‟ results in greater transparency

14

and accountability and leads to better performance of the whole financial sector. By

successfully implementing a significant part of IAS-30 in year 2000 and 2003,

Bangladesh Bank has proven that the financial sector is keen on improving its image. In

addition to new circulars a revised and updated Bank Companies Act, 2005 would be

another milestone for the Government in general and the Bangladesh Bank is particular.

Hossain (2001) empirically investigates the extent of disclosure of 25 banks in

Bangladesh and associations between company size, profitability, and audit firm with

disclosure level. A total of 61 items of information, both voluntary and mandatory, were

included in the disclosure index, and the approach to scoring items was dichotomous. The

results showed that size and profitability of the banks are statistically significant in

determining their disclosure levels. However, the audit firm variable was not significant

at conventional levels in the model. Chipalkatti (2002) examined the association between

the nature and quality of annual report disclosures made by 17 Indian banks and market

microstructure variables. He constructed a Bank Transparency Score (BTS) consisting of

90 items of information considering the recommendations of the Basel committee and

IAS 30. The study showed no significant association between the level of disclosure and

percentage of shares held by the government, and the percentage of shares held by

foreign shareholders respectively. The results also indicated that larger banks provide

more transparent disclosure and there was no significant difference in the disclosure

scores of banks across profitability levels, but banks with lower levels of leverage did

have significantly higher disclosure scores.

Baumann and Nier (2003) addressed the issues of developing a set of disclosure

requirements by Pillar 3 of Basel II that improved market participants‟ ability to assess a

bank‟s value using a unique dataset on almost 600 banks in 31 countries over the period

1993-2000. These are Australia, Australia, Argentina, Belgium, Brazil, Canada, Chile,

Finland, France, Germany, Hong Kong, Indonesia, Ireland, Israel, Italy, Japan, Korea,

Malaysia, the Netherlands, Norway, Poland, Portugal, Singapore, Spain, Sweden,

Switzerland, Taiwan, Thailand, Turkey, the UK and the US. The dataset contains detailed

information about the items disclosed by banks in their annual accounts. They

15

constructed a composite disclosure index that informs about disclosure at the bank level,

and they then analysed each of the 17 sub-indices of disclosure that make up the

composite index in order to investigate which, if any, items of the banks‟ balance sheet

disclosure are most beneficial from the point of view of the bank and most useful for

financial markets. Their findings generally confirm the hypotheses that disclosure

decreases stock volatility, increases market values, and increases the usefulness of

company accounts in predicting valuations.

Hossain (2008) investigate empirically the extent of both mandatory and voluntary

disclosure by listed banking companies in India.. A total of 184 items were selected of

which 101 and 81 were mandatory and voluntary respectively. The study revealed that in

disclosing mandatory items, the average score is 88, whilst the average score for

voluntary disclosure is 25. The findings of Hossain (2008) indicate that size, profitability,

board composition, and market discipline variables are significant, and other variables

such as age, complexity of business and asset-in-place are insignificant in explaining the

level of disclosure. Further, Indian banks are very compliant with the rules regarding

mandatory disclosure, and in contrast, they are far behind in disclosing voluntary items.

Hossain (2008) opined that his study can be a good example for other developing

countries, who are trying to have a high level of compliance in mandatory disclosure.

In recent study, Ahmed (2009) empirically examined the relationship between the

disclosure score and selected corporate attributes in a developing country like

Bangladesh. The determinants or corporate attributes he used are size of the bank {total

assets, gross revenue and number of branches}, profitability {EPS, ROA, ROI and net

profit margin (NPM)}, credit deposit ratio (CDR), Capital Adequacy Ratio (CAR), Debt

Equity Ratio (DER) and Shareholder‟s Risk ratio]. In order to identify the determinants

of disclosure, regression analysis, multiple linear regression techniques have been used.

Using 25% of the population (12 banks) observations over a period of 5 years (2002-

2006), the extent of disclosure has been measured using the unweighted disclosure index.

The results showed that disclosure levels are associated with some company

characteristics. Only two variables that were found to be significant in determining

16

disclosure levels are return on assets and capital adequacy ratio. Ahmed and Dey (2009)

empirically measured and analyzed the performance of disclosure items in a developing

country like Bangladesh. Using 25% of the population (12 banks) observations over a period

of 5 years (2002-2006), the performance of disclosure has been measured using the

unweighted disclosure index. The study shows the top and bottom ranked banks by the size

of the UDI. The results showed that Arab Bangladesh Bank (AB Bank) appeared to have the

highest levels of disclosure and Standard bank appeared to have the lowest levels of

disclosure.

To sum up, it is very clear from the discussion of prior research is that the financial

reporting practices in Bangladesh are very poor in general and in the banking sector in

particular. Most of the companies including banks making disclosure of financial facts

follow mainly the legal requirements in preparing their financial statements. But the

forms are prescribed by the relevant laws, and mandatory IAS 30 for the preparations of

financial statements to ensure the desired disclosure. Most of the existing studies

criticized the legal requirements, but also they failed to suggest specific change or

modifications to update the forms of preparing the financial statements of banks. Finally,

time is an important factor, which along with other factors can distinguish the findings

and evidence of the present researchers from the studies of other researchers.

4. Theories and Hypotheses Development

4.1. Theories

4.1.1. Agency Theory

This theory explains why managers disclose information for the shareholders (Firth,

1979; Wallace, 1988; Cooke, 1989, 1993; Hossain et al., 1994; and Aljifri, 2008).

Managers believe that the shareholders will get their control behavior through the agent-

owners contract and the disclosure will be a means of achieving the optimal contact. The

theory assumes that the agency cost will vary with corporate attributes (e.g. size,

leverage, listing status, corporate governance compliance). For instance, the agency

17

theory predicts that the highly leverage company would disclose more information to

satisfy the debenture holders. By doing this, the cost of capital would be reduced and the

investors‟ uncertainty would be lower. This argument would be the same for larger

company in terms of size, because if the larger company would use the higher debt

because of the tax advantage, then they will disclose more to satisfy the creditors. The

other corporate characteristics might be explained in the same argument. So, by

disclosing more, the mangers will reduce the agency cost to be trustworthy to the

shareholders, and then the agency theory would be justified in this regard.

4.1.2. Signaling Theory

Spence (1973) introduced signaling theory to explain the labor markets. This theory can

explain why some firms disclose more information than the others (Watts and

Zimmerman, 1986). The theory assumes that the disclosure of information is a reaction to

informational asymmetry in markets. Companies hold much more information than the

investors. Therefore, if the company discloses much more information would reduce the

information asymmetry (Akerlof, 1970). The managers of the company will distinguish

themselves from the others. The signal of the company would be credential in terms of

getting potential and prospective investors and creditors (Morris, 1987). For example, the

old company, the profitable company and the company using big audit firms would

disclose than the others (e.g. loss making companies, new companies etc). This argument

may be the same for internet reporting companies and interim reporting produced

companies.

In short, the accounting policy of a firm and its existence and form are determined by the

considerations of contracting efficiency (Ball, 1989, p. 3) states,). Therefore, firms with

serious agency problems will spend more resources on contracting and monitoring than

firms with lower agency costs (Maijoor, 1991, p. 127). The same logic may be applied to

signaling theory. With reference to the signaling argument, Watts and Zimmerman (1986,

p. 166) opined that the expenditure of resources on information improves the allocation

of capital, because more efficient firms receive more capital.

18

5. Research Methodology

5.1. Sample Selection

The sample covers all stock exchange listed banks operating in the country 2003. That

means our sample excludes all nationalized banks, development financial institutions

(DFIs) and foreign banks operating in Bangladesh. All available annual reports for the

year ending 31 December 2003 were collected. On 31 December 2003, there were 29

banks listed on Dhaka Stock Exchange. Annual reports for the relevant year (i.e., 2003)

were not available for 2 banks. Thus our sample resulted in 27 banks.

5.2. The Disclosure Index

5.2.1. Information Items Included in the Disclosure Index

Disclosure of information in corporate annual reports is an area of research in both

developed and developing countries. There is a large accounting literature relating to

studies which have used disclosure indexes to measure the extent of disclosure made by

the companies in corporate annual reports. Disclosure indexes are based upon extensive

lists of selected items of accounting information which may be disclosed in corporate

annual reports. Disclosure indexes seek to measure the extent of disclosure by using

numerical weights on items of accounting information. This study analyses corporate

financial disclosure of the banking companies in an emerging economy, Bangladesh.

The quality of financial reporting in a country depends on the legal requirements

governing disclosure together with professional recommendations which may have a

varying degree of effectiveness depending on the influence of the professional bodies

concerned (Marston, 1986). In addition, national and international accounting standards

and stock exchange requirements may have an impact on the disclosure of information in

corporate annual reports. Companies usually disclose information in a number of ways,

such as through annual report and accounts, interim and quarterly reports, prospectus,

employee reports and announcements to the stock exchange. It may be strongly argued

19

that the most important medium of external financial disclosure is the corporate annual

report. The selection of items included in the disclosure index is a major task in the

construction of any disclosure index (Marston and Shrieves, 1991). As a result, the major

task of the present researchers is to develop a suitable disclosure index comprising items

of all mandatory information that are expected to be disclosed in corporate annual report

of the banking sector in Bangladesh. The resulting disclosure index has been used for the

evaluation of disclosure of financial companies in the three developing countries being

studied.

Marston and Shrieves (1991) are of the opinion that the usefulness of the disclosure index

as a measure of disclosure is dependent on the selection of items to be included in the

index. There is no generally accepted theory to predict users‟ information needs and there

is an absence of an appropriate generally accepted model for the selection of the items of

information to be included in a disclosure index to judge the quality of information of a

corporate annual report. As one notable researcher observes „to the extent that research

foci amongst researchers, there is no theory on item selection‟ (Wallace, 1988; p. 354).

An item of information may be of great importance to a particular interested user group

while it may have little importance to other user groups. Most of the previous studies

have included items of information of interest to a particular group. In the present study,

items of information have been included keeping in mind their relevance to a broad range

of users. In most previous studies, the number of items selected was relatively small.

Special attention has been given to both mandatory items of information in the sample

countries. In this study the disclosure index has been developed by extensively following

IAS 30, Securities and Exchange rules 1987, Banking Companies Act 1991, listing

requirements of Dhaka Stock Exchange and Bangladesh bank BRPD Circular No. 3/2000

dated 18/04/2000. In addition, the disclosure requirements relating to mandatory

Bangladeshi Accounting Standards by the sample banking companies have been

considered and taken into account in selecting items of information where relevant, have

been included in the disclosure index. The disclosure index considered both quantitative

and qualitative items in the corporate annual reports of the sample companies. The

20

disclosure index constructed for this study included 446 items comprising both voluntary

and mandatory items.

5.2.2. Scoring of the Disclosure Index

There are various approaches available to develop a scoring scheme to determine the

disclosure level of corporate annual reports from the works of other researchers. In the

present study, the annual reports of the companies examined against both weighted and

unweighted indexes. In case of weighted disclosure index, weights are assigned to

individual items of information in order to discriminate between disclosures of more

important items. Some studies have used the mean scores received by each item of

information in the questionnaire as weights to individual items in the disclosure index.

For the weighted index to be used in this study the mean responses of users to individual

item in the user survey will be averaged and a mean importance score will be calculated

to provide weights to be used in the weighted disclosure index. The researchers have

decided to use the unweighted disclosure index as all mandatory disclosure of

information are equally important in the preparation of the financial statements of the

banking companies in Bangladesh. An unweighted index is the ratio of the value of the

number of items a company discloses divided by total value that it could disclose. Under

an unweighted disclosure index, all items of information in the index are considered

equally important to the average user. The unique advantage of using an unweighted

index is that it permits an analysis independent of the perception of a particular user

group (Chow and Wong-Boren, 1987; p.537). If various users of accounting information

are asked to weigh the importance of different items of information in the disclosure

index, they may attach different weights to the same items of information. Despite the

attractions of reflecting users‟ perceptions, the perceptions of different groups of users

vary due to subjective judgement and interests, subjective judgements may average each

other out (Cooke, 1992; p.233) or neutralise the relative importance of each disclosure

item to all members of a user group (Wallace, 1987; p.355). The choice of an unweighted

index over a weighted one does not produce substantially different results (e.g. Chow and

21

Wong-Boren, 1987; p.537) and there are researchers who favoured the use of unweighted

indexes (e.g. Spero, 1979; p.57 and Rubbins and Austin, 1986).

Under unweighted disclosure indexes (UDI), while measuring the level and extent of

disclosure, the disclosure will be considered as a dichotomous variable. Here, the only

consideration is that whether a company discloses an item of information in its corporate

annual report it will be awarded „1‟ and if not, it will be awarded „0‟. In the disclosure

model which will be used and followed in this study, the total disclosure score for a

banking company taken to be additive. The disclosure model for the unweighted

disclosure thus measures the total disclosure (TD) score for a company as follows:

TD=

dii

n

1

Where, d = 1 if the item di is disclosed

0 if the item di is not disclosed

n = number of items

Finally, the selected banking company attributes such as size (total assets), profitability

(return on equity, audit firm‟s international affiliations, institutional shareholding,

whether the bank has an audit committee have been extracted from corresponding annual

reports. A multivariate analysis was carried out to examine the association between the

extent of disclosure and 3 corporate governance variables and four control variables.

5.3 Hypothesis of the Study

The primary aim of the study, as mentioned earlier, is to examine the role of corporate

governance financial reporting transparency of banks in Bangladesh. The expected role

is examined by testing the following hypothesis:

H0: There is no significant association between a number of corporate governance

attributes (viz. audit committee, institutional ownership and Big 4 affiliation of audit

firms) and the extent of disclosure in published annual reports.

The multiple linear regression technique is used to test the hypothesis.

22

5.4 The Dependent and Explanatory Variables

5.4.1 Dependent Variable

Disclosure scores are calculated for each bank and used as the dependent variables in the

regression. The overall disclosure index (ODI) for each bank is obtained by using a

dichotomous procedure whereby the total score received by a bank is equal to the number

of items disclosed in its annual report divided by the total number of items in the

disclosure index. The normality of the distribution of the index scores was tested using

the normality plot and histogram and both were found to be normally distributed.

5.4.2 Explanatory Variables:

Three corporate governance variables are used as test variables. They are: (i) the

institution of an audit committee; (ii) institutional shareholding; and (iii) auditor

reputation. Besides, four control variables wee used. They are: (i) bank size measured

by natural log of tital assets; (ii) profitability measured by return on equity (ROE); (iii)

complexity measured by loans and advances as a proportion of total assets; and (iv)

leverage measured as debt to book value (market value for negative equity firms) of

equity. The procedure for operationalising the variables in the regression analysis and the

rationale for expecting them to explain cross-sectional disclosure variability are outlined

in the following paragraphs.

Audit Committee: Audit committees are increasingly being seen as one of the more

effective corporate governance levers used in both the Anglo-Saxon and Japan-German

models of corporate governance. Since Cadbury (1992) Committee recommendations, all

the so-called corporate governance best practice codes recommend institution of audit

committees in order to improve monitoring quality of both internal and external audits.

Recent corporate governance pronouncements emphasize not just having audit

committees but how independent the said committee is? That means in major

industrialized economies it is no longer sufficient to have an audit committee per se,

increased attention is being paid on the composition of audit committees. The question

23

being asked more frequently in recent times focuses on the proportion of audit committee

members are represented by independent directors. Institution of audit committees has

been made mandatory for banks in Bangladesh in 2003 via Bangladesh Bnak‟s circular

no. 12 and 16 issued on June 10, 2003 and July 24, 2003, respectively. As of 31

December 2003, 16 of the 27 banks in our sample have instituted audit committees. We

expect these 16 banks to demonstrate greater transparency in their financial reporting.

We expect so because either these are banks that are more eager to embrace corporate

governance best practice and hence are more likely to be more transparent or the audit

committee would act as a positive influence on their disclosure behavior. A dummy

variable, labelled AUDCOM, is used whereby a value of 1 is awarded to firms having

audit committees and zero otherwise.

Institutional Shareholding: Institutional shareholding is considered an important

corporate governance mechanism whereby institutional shareholders exert their influence

and expertise in providing leadership in the boardroom. They also act as a safety valve in

preventing management or other dominant shareholders to engage in value destructive

behavior. Institutional investors have incentives to care about the quality of financial

reporting including its comprehensiveness. The presence of one or more significant

institutional shareholder(s) is therefore expected to enhance the level of disclosure in firm

financial statements. We use the actual percentage of institutional shareholding to

capture this variable. The variable is labeled INSTTSHLD.

Auditor Reputation: The size of a firm‟s audit firm and/or its international link is

believed to influence both the quality and the quantity of information disclosed by the

firm. It is expected that in countries where the Big-Four audit firms operate, financial

statements certified by any Big-Four firm carry more credibility than those audited by

non-Big-Four firms. DeAngelo (1981) argued that larger audit firms invest more to

maintain the reputation of their audit quality. Haque (1984) suggested that in

Bangladesh, only large audit firms enjoy the privilege of choosing the clients and the

audit job. Many disclosure studies examined the potential association between the

auditor size and extent of disclosure. Among them Singhvi and Desai (1971) and Ahmed

24

and Nicholls (1994) found positive association between audit firm size and the extent of

disclosure.

In Bangladesh, none of the Big-Four audit firms have a named branch. However, some

of the larger Bangladeshi firms claim affiliations with the international Big-Four. These

few big firms are responsible for auditing most of the big companies in the private sector

and almost all the multinational companies operating in Bangladesh. In the present study,

the international link of audit firms were considered for use as explanatory variables.

Audit firms having an affiliation with an international Big-Four were distinguished from

those that do not. In order to see if the auditor's international link had any impact on

disclosure comprehensiveness, this was considered for being used as an explanatory

variable labelled AUDITOR. A dichotomous procedure was used to operationalise the

variable awarding one if the bank‟s audit firm was big and zero if it was not.

Size: The size of the firm has been a major variable in most studies examining disclosure

variability. With the exception of Spero (1979) and Stanga (1976), all the studies found

that corporate size significantly explains disclosure levels and variability.

The size of a firm can be measured in a number of different ways and there is no

overriding reason to prefer one to the other(s) (Cooke, 1991). Several measures of size

were available in this study including: total deposits, total loans and advances, total

assets, total capital, shareholders equity, and the market value of the bank. After a

primary examination based on the correlation between the dependent variable and the

available size variables, we decided to drop all but total assets as our size measure. The

chosen size variable was not normally distributed as expected. This problem was averted

by computing the natural log of the size variable which produced normality of the

distributions. The log of total assets (LOGASSETS) is used in the study as the size

variable.

Profitability: Bank profitability affects disclosure in many ways. Studies on the

understandability of financial statement messages found that narrative disclosures in

25

corporate annual reports are deliberately made complex to communicate bad news and

made more lucid and easily understandable to communicate good news (Adelberg, 1979).

Banks are likely to feel more comfortable when disclosing favourable rather than

unfavourable information, because one of the objectives of information disclosure is to

increase share prices.

Profitability was used as an explanatory variable by Cerf (1961), Singhvi (1967), Singhvi

and Desai (1971), Belkaoui and Kahl (1978), Spero (1979) and Wallace (1987). Cerf

(1961), Singhvi (1967), Singhvi and Desai (1971) found positive association between

profitability and disclosure while Belkaoui and Kahl (1978) found a negative association

between them. A number of profitability measures were used by previous researchers.

They include net profit to sales, earnings growth, dividend growth and dividend stability

(Cerf, 1961), rate of return and earnings margin (Singhvi, 1967 and Singhvi and Desai,

1971), and return on assets (Belkaoui and Kahl, 1978). In this study, a number of

profitability measures were computed from the annual report data, but the return on

equity was selected for the analysis. The variable was labeled ROE.

Complexity: Complexity is likely to have a bearing on disclosure comprehensiveness.

As operations become more and more complex, it usually warrants more disclosure.

Several measures of complexity has been used in the literature. They include diversity of

product and customers, number of branches, number of subsidiaries or associates, number

of overseas subsidiaries, number of industries in which the client operates, the absolute

amount of inventory and receivables, and the proportion of assets in inventory and

receivables. We use the proportion of loans and advances to total assets as our measure

of complexity. The use of a relative measure of audit complexity meant that the size

effect was not affected by the inclusion of the variable. The variable was labelled

COMPLEX.

Leverage: The degree to which a firm's financial structure is geared has been used in a

few disclosure studies to examine if there exists any association between gearing ratio

and disclosure levels. Chow and Wong-Boren (1987) and Ahmed and Nicholls (1994)

26

found no significant association between leverage ratio and the extent of voluntary

disclosure in Mexico and Bangladesh respectively while Belkaoui and Kahl (1978)

observed a significant negative relationship between the two variables. On the other

hand, Robbins and Austin (1986) found a significant positive association between debt

and municipal disclosure. The debt-equity ratio is used in the present study as the

measure of leverage. For banks with negative equity, their book value of equity was

replaced by market value of equity before applying the leverage formula. The variable is

labelled LEVERAGE.

6. Test of Hypothesis

The descriptive statistics for the explanatory and dependent variables are presented in

Table 2. The descriptive statistics shows that the mean disclosure level of the sample

banks is 39.01 percent, which is equivalent to 174 items (out of 446 items examined).

The minimum number of items disclosed by a sample bank was 110 items while the

maximum number of items disclosed was 232. Fifty-nine percent, (i.e., 16 out of 27) of

the banks in our sample had an audit committee while 44 percent (i.e., 12) had a Big 4

auditor. Of the 16 banks that had audit committees, 7 had Big 4 auditors. Average

institutional shareholding was 13.31 percent with a minimum of zero and a maximum of

70 percent. Average total assets of the sample banks was Tk21,896 million (US$377

million) with a minimum and maximum of Tk301 million and Tk81,705 million

respectively. Average ROE was 14.43 percent while average complexity measure was

59.47 percent. Average leverage was 2.748 with a minimum of 0.40 and a maximum of

8.56.

A correlation matrix of all the above explanatory variables along with the dependent

variables was constructed which is shown in Table 3.

27

6.1 The multivariate model

The model developed in this paper is as follows:

ODI = + Auditcomm + Insttholding + Big4 + Complex +

Leverage+ ROE + Assets + ε

The above model, developed in this paper is based on 27 banks. A summary of the

regression output is provided in Table 4. The results show that audit committee, auditor

reputation, and leverage have significant bearing on the extent of disclosure made by

banks in Bangladesh. Banks that have constituted audit committees by 2003 disclose

significantly more items of information than those that have not. A comparison of the

average number of items disclosed by the two categories of banks shows that banks with

audit committees disclose 188.37 items on average while those without audit committees

disclose only 153.09 items on average. A non-parametric t-test also shows the above

difference to be statistically significant (t value of 3.541). The results also show that

banks who have employed Big 4 affiliated audit firms disclose significantly more

information than those who do not. This finding is particularly important given the fact

that only 12 of our sample banks have a Big 4 affiliated auditor of which only 7 have

audit committees. Therefore, the influence of a Big 4 affiliated auditor does not

necessarily overlap with that of an audit committee. The average number of items

disclosed by Big 4 affiliated banks in our sample is 181.17 while the average for non-Big

4 affiliated banks is only 168.27. The third variable that emerged significant in

explaining cross-sectional variations in disclosure levels is leverage. As expected,

leverage has an inverse relationship with disclosure levels. It shows that banks that have

higher levels of borrowing from other financial institutions and the central bank are more

conservative in disclosing information.

Our results also show that institutional shareholding, complexity, profitability, and size

do not have significant influence on disclosure levels. Although insignificant, each of

these variables have expected positive signs of their beta co-efficients. The results may

28

be driven by the highly regulated nature of the banking industry, relative uniformity in

disclosure and the relatively large size of each of these banks that make them

economically visible. As a result, their relative size, profitability, leverage, and

complexity do not appear to make significant differences in their disclosure levels.

Results reported in Table 4 provide evidence of the important role corporate governance

in general and audit committees and Big 4 affiliated auditors are playing in enhancing

financial reporting transparency in the banking sector in Bangladesh.

7. Conclusion and Limitations

This paper reports the results of a multiple linear regression analysis of the role of 3

corporate governance variables – audit committee, auditor reputation, and institutional

ownership – on the extent of disclosure in bank annual reports. The extent of disclosure

was measured using a comprehensive disclosure index comprising 446 items including

both mandatory and voluntary items.

The results show that disclosure levels are associated with two corporate governance

attributes – whether the bank has instituted an audit committee and the reputation of its

audit firm. Disclosure levels are also associated with the level of financial leverage

employed by the bank. The results also show that institutional ownership does not have a

significant influence on financial reporting transparency of banks. However, it has a

positive, albeit insignificant, influence. It is interesting to see that size, profitability and

complexity do not have significant influence on bank disclosure either. Again, each of

these variables has the expected positive sign.

Findings of this study have important policy implications. First, audit committee

constitution was not mandatory until 2003. By the end of the year only 16 banks have

constituted audit committees. Our finding of a positive association between audit

committees and disclosure levels is encouraging if audit committees are pushing for

greater transparency. It could also be interpreted as banks that are more transparent are

29

swift in constituting audit committees. The significance of the Big 4 variable is

significant in the backdrop of a lack of Big 4 dominance in the country‟s banking sector.

The share of the Big 4 affiliated firms in the banking sector is only 44 percent! By

international standards, this is extremely low given the size of banks as economic

institutions compared with average firms in other industries. The evidence of a positive

role played by Big 4 auditors can be expected to be helpful in enhancing disclosure

comprehensiveness in the banking sector in Bangladesh.

The study has several limitations: First, although it covered all but 2 banks operating in

Bangladesh in 2003, the size of the sample remains small – only 27. This poses a threat

to the validity of our findings as a bigger sample size is warranted for running multiple

linear regressions. Second, the index used to capture disclosure levels included both

voluntary and mandatory items. Our Overall Disclosure Index (ODI) measure does not

distinguish between the two. It is therefore possible to have a trade-off between the two

groups of items – voluntary and mandatory – making it difficult to interpret disclosure

levels with greater mandatory compliance or voluntary disclosure or both. Finally, the

dichotomous scoring procedure employed in the study, while consistent with the tradition

of most disclosure studies, has some fundamental flaws such as its failure to distinguish

quality of disclosure from its quantity and its inability to reward or penalize firms for the

depth or breadth of such disclosure.

Notes:

1 In Bangladesh, the Companies Act 1913 that was enacted by the British

legislators in the sub-continent has been repealed by the enactment of the

Companies Act 1994.

30

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35

Table 1: Descriptive Statistics of the Dependent and Explanatory Variables

Variable

N Minimum Maximum Mean

Standard

Deviation

Overall disclosure index 27 .25 .52 .3901 .07059

Audit committee 27 0 1 .59 .501

institutions' share 27 0 70 13.31 15.781

Big four and other firms 27 0 1 .44 .506

Natural log of total assets 27 2.48 4.91 4.1060 .56837

Return on equity 27 -30.39 31.03 14.4285 11.76349

Audit complexity 27 .20 .86 .5947 .14874

Leverage 27 0.40 8.56 2.748 2.0116

Table 2: Independent Variables, Proxy and Expected Sign

Independent Variable Proxy Expected

Sign

Test Variables:

AUDCOM Corporate Governance Link

If the companies have Audit

committee =1 otherwise 0

+

INSTTSHLD Institutional shareholding Percentage of shares held by

institutional investors

+

BIG4 Auditor Reputation Whether the company is audited

by a Big 4 affiliated audit firm

+

Control variables:

LNASSETS Size

Natural log of total assets +

ROE Profitability Return on Equity =

Net Profit/Total Shareholders‟

Equity

+

COMPLEX Audit complexity Proportion of loans and advances

to total assets

+

LVG Leverage Debt-to-equity ratio -

36

Table 3: Correlation Matrix

Overall disclosure

index

Overall

disclosure

index

Audit

committee

institutions'

share

Big four

and other

firms

Natural log

of total

assets

Return on

equity

Audit

complexity

Audit committee .561**

institutions' share .006 -.232

Big four and other

firms

.207 -.017 -.004

Natural log of total

assets

.376 .412* -.220 .009

Return on equity .170 .161 .154 .224 -.266

Audit complexity .485* .476

* -.242 -.128 .627

** -.069

Leverage -.215 -.028 .215 .343 -.263 .505** -.354

Table 4: Summary of the regression output for the whole sample

ODI = + Auditcomm + Insttholding + Big4 + Complex +

Leverage+ ROE + Assets + ε

Dependent Variable Coefficients t-statistic Sig.

(Constant) .226 2.406 .026

Audit committee .063 2.412 .026

institutions' share .001 1.386 .182

Big four and other firms .045 1.958 .065

Natural log of total assets .008 .315 .756

Return on equity .001 1.106 .282

Audit complexity .097 .927 .365

Leverage -.009 -1.921 .070

F Statistic 3.492

Model Significance 0.014

Adjusted R2 0.402

N 27

37

Appendix-1: Relevant Regulation for Banking Industry in Bangladesh

Bangladesh Bank Order No. 127, 1972

Bangladesh Bank (Amendment) Act, 2003

Banking Companies Act No. 14, 1991

Bank Company (Amendment) Act No. 13, 1993

Banking Companies (Amendment) Act No. 25, 1995

Banking Companies (Amendment) Act, 2003

Companies Act No. 18, 1994

Money Laundering Prevention Act No. 7, 2002

Bangladesh Bank Framework for Internal Control Systems in Banking

Organizations

Bangladesh Bank Guidelines for Merger/Amalgamation of

Banks/Financial Institutions

Bangladesh Bank Prudential Regulations for Banks, 2007

Bangladesh Bank Guidance Notes on Prevention of Money Laundering

Bank Regulation and Policy Division Circular No. 5, 2006

Bank Regulation and Policy Division Circular No. 14, 2007

Appendix-2: Relevant Institutions for issuing regulation and monitoring Banking

Industry in Bangladesh

Bangladesh Bank (BB): Issuing regulation and monitoring the banks

Institute of Chartered Accountants of Bangladesh (ICAB): Assist on

Issuing regulation

Ministry of Finance (MOF): Issuing regulation through Bangladesh Bank

(BB)

Ministry of Law, Justice and Parliamentary Affairs (MOLJPA): Issuing

regulation

Securities and Exchange Commission of Bangladesh (SEC): Issuing

regulation and monitoring the banks

Dhaka Stock Exchange (DSE) and Chittagong Stock Exchange (CSE):

Monitoring the banks

38

Annexure-1: Mandatory Disclosure Provisions under Banking Companies Act, 1991

Section of

Banking

Companies

Act, 1991

Disclosure Provisions

Section 2 The provisions bearing of this Act shall be in addition to and not, save

as hereinafter express by provided, in derogation of, the Companies Act,

1994 and any other laws for the time being in force. In addition, as the

banking companies are registered with the registered joint stock

companies, the banking companies should comply with the provisions of

the Companies Act 1994 if otherwise expressed in the Banking

Companies Act, 1991

Section 24

Every bank shall make a reserve fund and if the amount in that fund

together with amount in the share premium account is below the amount

than it‟s paid up capital. Bank will transfer to the reserve fund not less

than 20 on profit before tax and it should be disclosed in the profit and

loss account made under section 38 of this Act.

Section 25 Every bank shall maintain a cash reserve fund not less than 5% with

Bangladesh Bank or its agent bank and that should disclosed in the

financial statements.

Section 33 The detailed disclosure provisions with regard to the liquid assets of the

banking companies in Bangladesh.

Section 36 Every Bank company shall submit reports to the Bangladesh Bank on

the 31st day of December and 30

th day of June of each year showing its

assets and liabilities in the prescribed form and manner.

Section 37 For the purpose of benefit of public, Bangladesh Bank may publish in

consolidated form or otherwise any information contained by it under

this Act relating to overdue loans and advances of more than thirty days.

Section 38 The Accounts and Balance Sheet: should prepared as per BRPD circular

3/2000 and also the provision of the Companies Act, 1994 (Schedule XI

of this Act). As per section 39, financial statement should be audited by

a person who is qualified according to the Bangladesh Chartered Order,

1973.

Section 39

(3)

An auditor is required to state whether or not adequate provisions have

been made, financial reports has been made in accordance with the

standard issued by the Bangladesh Bank.

Section 40

The accounts and balance sheet shall be submitted to Bangladesh Bank

within the three months of the close of the period to which they relate.

Section 41

The bank is required, if it is a private company, to submit the accounts

and balance sheet to registrar.

Section 42

Every banking company incorporated outside Bangladesh shall not later

than the 1st Monday in February of the year when it runs the business,

39

display a copy of the last balance sheet and profit and loss account made

under section 38 in a conspicuous place in its principal office and every

branch office in Bangladesh until submitted by a copy of the subsequent

balance sheet and accounts are displayed in the same way.

Annexure 2: Mandatory Disclosure Provisions under IAS 30 (BAS 30)

Para Mandatory Disclosure Provisions

Para 8 Like other business entity, banks may use different methods for

recognition and measurement of items in their financials. So, for better

understanding of the users of financial statements, banks should disclose

the accounting policies that are followed for preparing financial

statements. Banks should disclose the following; Policy regarding the

recognition of the principal types of income; policy regarding the valuation

of investment and dealing securities; the distinction between those

transactions and other events that result in the recognition of assets and

liabilities on the balance sheet and those transactions and other events that

only give rise to contingencies and commitments; the basis for the

determination of losses on loans and advances and for writing off

uncollectible loans and advances; the basis for the determination of

charges for general banking risks and the accounting treatment of such

charges.

Para 9 In the income statement, income and expenses should be presented as

grouped by nature and principal types of income and expenses should be

disclosed separately.

Para 10 It has provided some prescribed items of income statement that includes

interest and similar income; Interest expense and similar charges; Dividend

income; Fee and commission income; Fee and commission expense; Gain

less loss arising from dealing securities; Gain less loss arising from

investment securities; Gain less arising from dealing in foreign currencies;

Other operating income; Losses on loans and advances; and Other

operating expenses.

Para 11 The principal types of income, interest, fees for services, commission and

dealing results should be separately disclosed.

Para 12 The principal types of expense, interest, commissions, losses on loans and

advances, charges relating to the reduction in the carrying amount of

investments and general administrative expenses should be disclosed

separately.

Para 13 Income and expense items should not be offset except for those relating to

hedges and to assets and liabilities which have been offset in accordance

with paragraph 23.

Para 15 The gain and losses arising from each of the following are normally

reported on a net basis: Disposal and changes in the carrying amount of

dealing securities; Disposal of investment securities and Dealing in foreign

40

currencies.

Para 16 It prescribes that interest income and interest expense should be disclosed

separately.

Para 17 Governments‟ assistance to bank by making deposits and other credit

facilities should be disclosed.

Para 18 It favored that assets and liabilities should be grouped as their nature and

presented as their liquidity. Regarding the classification and disclosure of

Balance sheet items.

Para 19 The following items should be disclosed in the balance sheet of a bank:

Cash and balance with the central bank; Treasury bills and other bills

eligible for rediscounting with the central bank; Government and other

securities held for dealing purposes; Placements with, and loans and

advances to, other banks; Other money market placements; Loans and

advances to customers; Investment securities; Deposits from other banks;

Other money market deposits; Amounts owed to other depositors;

Certificates of deposits; Promissory notes and other liabilities evidenced

by paper; and Other borrowed funds.

Para 20 It is no longer required to group the assets and liabilities as currents and

non-currents.

Para 21 The balance with the central bank, placement with other banks and other

money market placements should be shown separately. Bank also should

separately present deposits from other banks, other money market deposits

and other deposits.

Para 23 The bank should not offset any asset or liability with other liability or asset

unless a legal right of set-off exists and the offsetting represents the

expectation as to the realization or settlement of the asset or liability.

Para 24 The bank should disclose the fair values of each class of its financial assets

and liabilities regarding the presentation the classification of financial

assets.

Para 25 The classification should be made under the following heads: Loans and

receivables originated by the enterprise; held to maturity investments; held

for trading; and available-for-sale.

Para 26,

27, 28 &

29

The bank should disclose the contingent liabilities and commitments

because these are significant in amount and risk and may be revocable or

irrevocable.

Para 30,

31 & 32 The maturity grouping of assets and liabilities should be disclosed by the

bank.

Para 34 In the maturity grouping, maturity period of assets and liabilities should be

same.

Para 35 The maturity could be expressed in terms of the remaining period to the

repayment date; the original period to the repayment date; or the remaining

period to the next date at which interest rates may be changed.

Para 36 The bank should disclose an analysis expressed in terms of contractual

41

maturities. In case if there is no contractual maturity date.

Para 37 The bank should assume the expected date on which the assets will be

realized.

Para 39 The management may provide, in its commentary on the financial

statements, information about the effective periods and about the way in

manages and controls the risks and exposures associated with different

maturity and interest rate profiles.

Para 40 The bank should disclose any significant concentrations of its assets,

liabilities and off balance sheet items. Such disclosures should be made in

terms of: Geographical areas; Customer or industry group or other

concentration of risk. In addition, a bank should also disclose the amount

of significant net foreign currency exposures.

Para 43 The bank should disclose about the provision for losses on loans and

advances.

Para 44 Any amount set aside in respect of losses on loans and advances in

addition to those losses that have been specifically identified or potential

losses which experience indicates are present in the portfolio of loans and

advances should be accounted for as appropriation of such retained

earnings.

Para 47 The movements in the provision, including the amounts previously written

off that have been recovered during the period, are shown separately.

Para 50 Any amount set aside for banking risks should be separately disclosed as

appropriation of retained earnings.

Para 53 A bank should disclose the aggregate amount of secured liabilities and the

nature and carrying amount of the assets pledged as security.

Para 56 The disclosure of related party transactions.

Para 57 The accounting polices regarding uncollectible loans and advances.

Para 59 Any amount set aside in respect of general banking risk should be

separately disclosed as appropriation of retained earnings.

Para 60 Secured liabilities and assets pledged as security.