The Institute of Chartered Accountants of Sri Lanka (CA Sri Lanka) presents findings from the tax research paper titled “The Impact of Corporate Governance Characteristics of the Forward-Looking Disclosures in Integrated Reports of Bank, Finance, and Insurance Sector Companies in Sri Lanka” which was published in the latest research journal of CA Sri Lanka.

The impact of corporate governance characteristics of the forward-looking disclosures in integrated reports of bank, finance and insurance sector companies in Sri Lanka

Asra Mahir¹, Roshan Herath¹, Samanthi Senaratne¹

Department of Accounting, University of Sri Jayewardenepura¹

Public listed companies are required to publish Annual Reports consisting of financial statements, that reveal the financial situation of an organization, and corporate governance reports that reveal the level of corporate governance practices (Garcia-Sanchez et al., 2013). However, companies voluntarily publish corporate sustainability, social and environmental reports as a form of non-financial information disclosure to improve the transparency and accountability of disclosures (Oliveira et al. 2010). Though many disclosures are provided, the absence of a single report leads to information confusion and diffusion for stakeholders (Ioana & Adriana 2014). Hence, the provision of a single report combining both financial and non-financial information has been identified as a solution to this issue (Cheng et al. 2014). This led to the introduction of integrated reports by the International Integrated Reporting Council (IIRC) as distinct reports, which combine both financial and non-financial information focusing on the value creation of a business (IIRC 2013).

In this context, this paper examines the nature and extent of forward-looking disclosures (FLD) in IR and the impact of corporate governance characteristics on the provision of such information. Hence, the research questions addressed in the study are two-fold: (a) what is the nature and extent of FLD in integrated reports published by companies and (b) do the corporate governance characteristics of companies impact the level of FLD provided in integrated reports? This study was carried out in the companies listed in the Bank, Finance and Insurance (BFI) Sector of the Colombo Stock Exchange (CSE) during the three years from 2015 to 2017.

The quantitative approach has been followed since this study investigates the relationship between the selected corporate governance characteristics and the level of FLD. Furthermore, most prior research studies (Al-Najjar & Abed 2014, Uyar & Kilic2012, Aljifri & Hussainey 2007) have adopted a similar quantitative approach to investigate the relationship between the corporate governance characteristics and the level of FLD. The population and sample of the study are the same as all 22 companies of the BFI Sector that prepare integrated reports for three consecutive years from 2015 to 2017.

The FLD index covers six content elements of IIRF – Organizational Overview and External Environment (ORG), Governance (GOV), Business Model (BUS), Risks and Opportunities (RISK), Strategy and Resource Allocation (STR), and Performance (PERF), ignoring two content elements because the ‘Outlook’ element by its nature reflects future information and the ‘Basis of Preparation’ always represents historical data. Under these six areas, 27 information categories were identified. The integrated reports of sample companies were evaluated under each category by counting the related sentences on FLD. Thereafter, an FLD score for each content element of the index was calculated for sample companies for the three consecutive years based on the natural logarithm of the sentence count.

This study examined the nature and extent of FLD in integrated reports of BFI Sector companies and the effect of corporate governance characteristics on the level of FLD reported by these companies during the period 2015 to 2017. The study also examined the extent of FLDs in integrated reports using a disclosure index developed based on prior literature on the subject. Thereafter, the relationship between the corporate governance characteristics and the level of FLD in integrated reports was examined using correlation and regression (both OLS and panel) analyses. In these analyses, the corporate governance characteristics considered were board size, board independence, board gender diversity, board expertise, board meetings, size of audit committee, audit committee independence, expertise in audit committee, and audit committee meetings. The study considered firm size, ROA, and leverage as the control variables.

The study found that most FLDs are limited and qualitative in nature and most disclosures relate to the ‘Risks and Opportunities’ of these companies. On the other hand, the least amount of FLD is witnessed  with regard to the business model. Further, the FLD relating to ‘Organization Overview and External Environment and Governance’ is also limited. The study also finds that the degree of FLD fluctuates significantly among the companies that produce integrated reports in this sector.

It was found in the study that board size, board expertise, independence of the audit committee, audit committee meetings, and size of the firm have a positive and significant effect on the degree of FLD. On the other hand, board independence has a significant but negative impact on the degree of FLD. This indicates that some corporate governance characteristics play a significant role in the provision of FLD in integrated reports.

The findings of the study have several important implications. Theoretically, the study extends the discussion as to the nature and extent of FLD in integrated reports and shows how corporate governance variables impact FLD in a developing country context –Sri Lanka. Practically, this study shows policymakers and practitioners the types and degrees of FLD provided in integrated reports. As there are no specific guidelines as to the disclosure of FLD in IR, policymakers can draw insights to develop a framework or guidance to facilitate the companies in this respect.  In the absence of any established guidelines or rules related to the provision of FLD, the disclosures relating to forward-looking statements, profit targets, and risk exposure are solely determined by the management of an organization as for their preferences. (O’Sullivan et al. 2008). Further, due to the flexibility, type, and the nature of the forward-looking information published in the annual reports, it is difficult to provide any assurance as to these disclosures, which in turn leads investors and financial analysts to rely on unregulated and unaudited [foretasted?] information in their decision-making process. (Schleicher &Walker, 2010). In this context, practitioners can identify how the companies have responded to the need to provide FLD in integrated reports and the improvements required in this respect.

This study has several limitations. Firstly, it selected a few but prominent corporate governance characteristics to assess the impact of corporate governance on the level of FLD. However, these characteristics can be extended further in future studies in assessing the relationship between corporate governance and the level of FLD. Secondly, the study focused only on one sector of CSE. This study can be extended to cover a larger sample of companies in future studies.