Transparency & Disclosure Scores and their Determinants
in the Istanbul Stock Exchange
Mine Aksu
and
Arman Kosedag
Graduate School of Management, Sabanci University
September, 2005
Preliminary draft. Please do not quote. Comments welcome
1
Transparency & Disclosure Scores and their Determinants
in the Istanbul Stock Exchange
Mine Aksu
and
Arman Kosedag
Abstract
Recent financial reporting and auditing scandals on both sides of the Atlantic have led to a
global realization of the importance of sound corporate governance (CG) practices in alleviating the
agency problems in the corporate form of business and for efficient allocation of capital in
international markets. Transparency and disclosure (T&D) practices followed by firms are a vital
component and a leading indicator of CG quality. Transparent and full-disclosure of information is
especially vital for Turkey where the biggest agency problem centers on asymmetric information
and expropriation by majority shareholders.
We collaborate with S&P and base our survey on their scoring methodology, a customized
version of the 98 desirable T&D attributes they have used to evaluate the T&D practices in several
other countries, and their classification of the attributes into three categories: ownership structure
and investor relations, financial transparency and information disclosure, and board/management
structure and process. We next evaluate the T&D practices of the 52 largest and most liquid firms in
the Istanbul Stock Exchange (ISE), based on their English and local language annual reports and
websites. Our rankings provide a first time, objective assessment of the corporate disclosure
practices of ISE firms.
We also consider a simple model that sequentially links agency costs to CG/T&D
mechanisms in place and to firm-level and economy-wide financial performance. Concentrating on
the causal side of the model – the determinants of TDS--, we provide out-of-sample evidence that
among the commonly used proxies for agency conflicts, firm size, financial performance, growth
opportunities, and leverage best explain the variation in the T&D scores in the ISE. While our
results provide considerable support for prior findings in developed markets, they also shed light on
how specific agency problems faced by ISE firms impact their TD scores.
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I. Introduction
The recent corporate governance and financial reporting scandals on both sides of the
Atlantic have led to a global realization that sound corporate governance (CG) practices including
transparency and full disclosure (T&D) are important for long-term viability of companies and for
efficient allocation of capital in the international financial markets. Starting with the SarbanesOxley Act in the US, there has been an unprecedented amount of governmental and institutional
intervention and many countries are now in the process of restructuring their current laws,
regulations and enforcement capabilities within the framework of best corporate governance
practices.1 Furthermore, academicians, investment and data-base companies are constructing and
evaluating ethical, socially responsible, and strong CG indices2, and companies themselves are
paying hefty sums of money to have their CG practices rated by rating agencies such as Standard
and Poor’s (S&P) and Institutional Shareholder Services (ISS) to signal their quality in their quest
for external capital. Parallel to these developments, there has been a proliferation of country-level
(La Porta et al., 1996, 1997; Schleifer and Wolfenzon; 2002; Gugler et al. 2004) and firm level (see
for ex., Ashbaugh et al., 2004; Brown and Caylor, 2004) evidence that countries and firms with
better CG practices have lower cost of capital, higher firm values and thus easier access to foreign
capital.
Full disclosure and transparency (T&D) of financial information are vital components of the
CG framework (OECD, 1999) and are regarded as important indicators of CG quality.3
Beeks and Brown (2005) find that firms with higher CG quality make more informative
disclosures. Sadka (2004) provides theoretical and empirical evidence that the public sharing of
financial and analyst reports has enhanced factor productivity and economic growth in 30 countries.
1
A local example is the recent resolve to rewrite the Turkish Commercial Code that has been in effect since 1957 and
the new CG Principles of the Turkish Capital Markets Board, which will be effective in 2005. Another recent example
is the recent Reporting Standard (RS) 1 ‘The Operating and Financial Review’ in the UK. Announcing its publication,
Ian Mackintosh, the Chairman of the ASB, said: “This reporting standard represents an important step forward in
encouraging greater transparency and more open communication between companies and their shareholders.... This
should be of great benefit to many parties." (May 13, 2005, AIA newsletter).
2
See for ex., the G-Index of Gompers et al. (2003) and Gov-7 of Brown and Caylor (2005)
In their official report titled “Corporate Governance: the Turkish Transparency and Disclosure Survey” Standard &
Poor's states that they view corporate transparency as an important factor affecting a company's attractiveness to
investors, and as a vital element of corporate governance.
3
3
These relationships and the expected benefits of good CG and T&D practices are especially
important for emerging markets like Turkey because they are in dire need of external capital as their
economies are growing faster than that of more developed nations. As a result, it is important to
investigate whether the historical scarcity of external capital flow to Turkey is related to the low
quality of transparency and disclosure in Turkey. This paper is a first step in this direction.
Turkey is a French origin civil law country with concentrated family ownership and low
float rates.4 As such, CG &T&D principles and best-practices have not been adequately followed or
enforced. It also faces a specific type of agency problem that again creates an impediment to
external capital. It has a financial system with many banks owned by business-groups; highly
concentrated, pyramidal, family-based ownership structures characterized by substantive intercorporate shareholdings; and resulting low float rates and dividend payments (see Yurtoglu, 2000
and 2003 for an in-depth description of ownership structures of ISE firms, its drawbacks in terms of
firm value). This kind of a structure leads to expropriation of minority shareholders’ rights by the
ultimate owners even if they don’t hold a significant amount of the cash-flow rights. A recent
(4/12/2005) report of the Institute of International Finance (IIF) discusses the resulting agency
problems and states: “Turkish companies are often controlled through the use of founders’ shares
that carry multiple voting rights and/or board nominating rights. As a result, the protection of
minority shareholder interests rests primarily on full disclosure and accurate financial reporting”.
Hence the T&D component of CG is very important in mitigating the expropriation of minority
shareholders’ rights, an important and costly agency problem in Turkey.
This study is the first attempt to create a summary T&D index for the largest and most liquid
firms trading on the Istanbul Stock Exchange (ISE). We undertook the project in collaboration with
Standard & Poor’s (S&P), a well-known, global rating and financial services company that has been
carrying out large scale research since 2001 to score the Transparency and Disclosure (T&D)
practices of a number of large and liquid firms they follow in the US, Latin America, Europe, Japan,
Russia and some emerging Asian markets. We first customized the 98 attributes used in these prior
4
Yurdiglu (2005) documents that about 80% of the 305 companies have some sort of family ties in the ISE as of 2001.
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surveys and came up with a final set of 106 attributes which not only reflects the expertise of S&P
analysts and researchers, but also fits the regulatory, institutional, cultural, and economic
environment in Turkey. We grouped the 106 attributes into three sub-categories, again using S&P’s
classification scheme: (i) Disclosure of ownership structure and investor relations (OwnStr); (ii)
Financial transparency and disclosure in the financial statements (FinDisc); and (iii) Disclosure of
the board and management structure and processes (Board&Mgmt). Next, the annual reports and the
websites (both English and local language versions) of the 52 largest and most liquid firms listed in
the Istanbul Stock Exchange (ISE) were searched for the inclusion of these information attributes.
Each firm was then graded and ranked in the above-mentioned three categories as well as their
overall T&D quality.5
We find that the transparency and disclosure scores of ISE companies are not impressive,
especially in terms of the board and management structure and processes. Nevertheless,
considerably high scores (7/10) are obtained in the category of financial transparency and
information disclosure and the average T&D score (TDS) of Turkish companies is 5/10, a score
comparable to many countries in continental Europe.
In this paper, we also envision and model CG and T&D as mechanisms as a system of
checks and balances that have evolved to mitigate the agency problems often encountered in the
corporate form. In line with the agent-principal theory, our expectation is that if companies have
effective mechanisms in place, these agency problems -- such as extraction of private benefits by
majority shareholders, consumption of perquisites by entrenched management, under or
overinvestment --and their associated costs will be mitigated. This simple model of incentives for
good CG/T&D practices has been studied extensively. (see for ex., Watts and Zimmerman, 1986;
Healy and Palepu. 2000; Core, 2001; Rahman. 2002). We draw on this body of research for the
second objective of the study: exploring the crossectional differences in quality of disclosure in ISE
firms. We find that larger and more profitable firms, firms with more information asymmetry and
In line with the three categories of information, T&D is defined as adherence to the principles of “full-disclosure” and
“openness and informativeness’’ in public presentation of financial statements as well as the ownership and
board/management structures and processes followed by the company. As such, an attempt to quantify it, like ours,
would not measure the truthfulness of the information disclosed in the financial reports or the actual quality of board
and management structures and investor relations; that is, it does not measure the “CG quality” of the firm.
5
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with higher leverage have higher TDS while free cash flow available to management and the
family-firm dummy variable does not have explanatory power over TDS.
The study has several contributions and is expected to be of interest to regulators,
researchers, managers, and market participants. The rankings provide a first time, objective,
quantitative and verifiable assessment of corporate disclosure practices of listed companies in the
ISE and will be a benchmark for future studies. Hence, this is also the first study that investigates
the relationship between T&D and the firm specific agency conflict proxies in the ISE firms. The
results provide out-of-sample evidence that some firm-specific agency conflict proxies do a good
job in explaining the variation in TDS. 6 Third, since the same attributes and methodology used in
previous S&P studies are used, the findings allow comparisons with the scores previously obtained
in other emerging and developed countries. The rankings based on a universal benchmark are
expected to help investors and other stakeholders in their decision making through a more objective
assessment of differences in the level of reporting quality and hence investment risks across firms,
markets, and sectors. Finally, the T&D rankings will provide a meaningful, objective monitoring
and enforcement tool for local and international regulators.
The remaining part of the paper is organized as follows: Section two discusses prior
research and motivates the study. In section three, we discuss our simple model of the causes and
the consequences of the CG/T&D framework. We also develop our hypothesis in this section. The
sample, data requirements and methods of analysis are described in section four. The results are
presented in section five while section six concludes and presents some ideas for future research.
II. Prior Research and Motivation
In this section we review some other surveys that have attempted to rate the T&D practices
in different countries and the important prior research that examines the country and firm-level
6
An important reason for exploring the TD quality using data from a single country is that multi-country
studies may yield mixed results as a result of their differences in terms of the sizes and liberalization of their
markets and institutions, political and economic risk exposure, the average market capitalization, and their
reporting standards. We use only ISE data in this study to control for these differences that are expected to
affect both the TD scores of firms and the variables we use as agency conflict proxies. Yurtoglu (2003)
specifically states that Turkey is especially suitable for exploring the link with agency costs because it shares
many features of weak CG such as concentrated family ownership, weak regulations and enforcement,
pyramidal business groups and dual class shares.
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determinants of transparency and disclosure. We also summarize the historical legal, political,
economic, regulatory impediments to T&D quality in Turkey that motivate this research.
II. 1. Prior research
This paper is closely related to several surveys that scored the CG and T&D quality in
several countries, carried out by rating firms, academicians and firms collecting and selling financial
data-bases. Most of these studies have also examined the consequences of good CG practices. For
example, Brown and Caylor (2004) relate the Gov-Score, a composite measure of 52 factors
encompassing eight governance categories, to five measures of performance using Compustat and
Crisp data. They find that better governed firms are more profitable, more valuable, less risky, less
volatile, and pay out more cash to the shareholders. Bai et al. (2004), among others, have shown
that the findings are not confined to developed countries. They observe a positive relation between
good CG proxies and market valuation in China. Although similar to this study in many respects,
these studies are related to the quality of CG practices rather than the extent to which the CG
practices and financial data are made public.
Most studies on T&D quality have been carried out by S&P. They have and are still
conducting similar surveys in many other regions of the world, often with collaborating
academicians, as was the case in Turkey. In 2002, Standard & Poor’s Governance Services
published its first T&D study, which included companies in the following Standard & Poor’s
indices: S&P/IFC Asia; S&P/IFC Latin America; S&P Asia Pacific 100; S&P/TOPIX 150 (Japan).
Then they conducted a similar survey in Russia in 2002, 2003, and, as a result of continued interest
among investors, in 2004. Furthermore, in 2003, S&P released its study of the S&P Europe 350
companies.7 The T&D survey results are summarized in Table 3 below.
This research is also related to a large body of accounting and finance literature that
investigates the causes and consequences of voluntary disclosure. We explore the former for ISE
The S&P’s Transparency and Disclosure Study will eventually cover about 1600 companies which represent
approximately 70% of the world’s tradable market capitalization.
7
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firms in this study. On the consequences side, and motivated by the theoretical work on
discretionary disclosure (Verrecchia, 1983, Darrough and Stoughton, 1990, and Feltham and
Xie,1994), accounting researchers have focused on the effect of corporate disclosure quality on cost
of capital, performance and other firm specific variables. The theory of discretionary disclosure
predicts that firms will withhold private information when disclosure is costly. Recently, Shin
(2003) shows that a sanitization policy, in which only good news is disseminated, can be supported
in equilibrium. This theory suggests that the reported firm value is upward-biased, with the extent of
the bias negatively related to disclosure quality. As a result, investors will penalize a lower
disclosure quality by charging a higher discount rate to the firms’ cash flows.
There are a few studies that explore the determinants of CG and disclosure practices. Many
studies have found that there is a strong country effect in what companies disclose (see for ex.
Berglof and Pajuste, 2005). The former authors also report that information is more available to
public in larger firms, firms with lower leverage, higher financial performance, higher market-tobook ratios and more concentrated ownership. Black et al. (2005) investigate the cross-sectional
differences in Korean firms’ CG practices and find that firm size, risk, and long-term profitability
and equity finance need are positively related to better CG practices. Voronina et al. (2005) study is
similar to the present study in that they measure both the transparency practices of 102 listed
Russian firms using a checklist of 441 items from IAS in 2001 and also investigates cross-sectional
differences in transparency. They find that use of a Big-5 auditor, foreign listing, firm size,
government shareholdings and independence of CEO and Board Chair are positively associated with
transparency. We draw on the agency research and the above-mentioned empirical studies in our
choice of relevant agency conflict proxies described below in Section III.
II.2.The poor regulatory framework and culture of CG and T&D in Turkey
Turkey has historically had a poor culture of CG and T&D. It has always been a civil law
country and has had a very late start in the liberalization of its economy, the establishment of its
8
stock market (1986), and the setting of its financial reporting standards based on generally
accepted accounting principles and the concept of full and fair disclosure (1994).
The first legislation concerning commercial law was enacted for the first time in Ottoman
Empire in 1850 and was based on the French Code of Commerce of 1807. Under the legal reforms
of 1926, this was replaced by a system based on Swiss Civil Code and Code of Obligations, the
Italian Penal Code, and the German Code of Penal Procedure. Neither these, nor the present Turkish
Code of Commerce dated back to 1957 were based on the generally accepted principles of
accounting and auditing and hence did not regulate financial reporting. They highlight the strength
of the civil law tradition, weak enforcement of the rules and the lack of a disclosure philosophy in
the Turkish business culture.
This legal and cultural infrastructure seems to be an important factor in the historic
difficulty with which Turkish firms have attracted external capital. Table 1 reconstructed from
tables 2 and 8 in La Porta et al. (1997) places Turkey in the French origin legal systems which has
enjoyed the lowest access to external capital or debt markets and the weakest rule of law and
investor rights protection indices among the 3 other civil law and the common law traditions. The
table also depicts that even though GDP growth is stronger in Turkey than in the other legal origins,
access to external capital and measures of investor rights are even lower than the average of the
French origin countries. Hence, while the fast growth rate in the Turkish economy underscores the
need to access external debt and equity capital, the table highlights the difficulty of accessing
external capital when enforcement of the rule of law and protection of investors rights are weak.
The solution to this dilemma through observance of good CG and T&D practices has been a major
motivation for this study.
(Place Table 1 about here)
Recent studies have observed that the weak CG and disclosure tradition in Turkey have
continued until very recently. Ararat and Ugur (2003) describe Turkey’s civil law tradition and its
inefficient and inconsistent regulatory framework and the ensuing paucity of the rule of law and its
enforcement; the concentrated and pyramidal ownership structure dominated by families; the
9
inconsistent and opaque accounting and tax regulations and the investor misinformation caused by
the absence of inflation and consolidation accounting. As a result of this infrastructure, corporate
governance problems are concentrated around weak minority shareholders’ and creditors’ rights,
inconsistent and opaque disclosure policies and lack of voluntary disclosure, and convergence
(inseparability) of ownership and management. These create an environment that fosters corruption,
share dilution, asset stripping, tunneling, insider trading, and market manipulation.
Mc Kinsey has carried out in 2002 a global survey in which investors were asked to identify
their CG priorities for companies and policy makers. The survey covers 201 responses from
institutional investors located in 31 countries. Investor priorities for investments in Turkey show a
similar pattern to the average of all countries surveyed: accounting disclosure, shareholder equality
and property rights are the most important criteria. Table 2 reports the weights assigned by global
institutional investors to the top seven most important CG factors for their investment decisions in
Turkey. The survey results depict that timely, broad, understandable accounting disclosure and
safeguarding of the shareholders’ rights are the most important CG priorities of institutional
investors in deciding whether to invest in Turkish companies.
We expect that the aforementioned bleak picture to change in the near future as a result of
the reforms in the financial reporting and disclosure environment, the recent developments in
Turkish politics, economic reforms, new regulation, and effective enforcement. Some of these
developments have been the accelerated privatization of State Economic Enterprises; the creation of
private pension funds that are expected to serve as institutional investors and enhance monitoring in
public firms; monitoring of banks by BRSA; the CMB’s commitment to the improvement of the
regulatory framework, the CMB’s Corporate Governance Principles, promulgated on a comply or
explain basis, to be effective in 2005 and covering areas of disclosure, minority rights, board
structure and management oversight, and the establishment of the Turkish Accounting Standards
Board and their mandate to converge the local accounting standards to the IFRS by 2005 in line
with the directives of the European Commission. Of course, Turkey’s recent progress in achieving
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full membership of the EU will provide the strongest inertia in establishing the “rule of law” and
ethical conduct in business transactions and improved CG and T&D practices.
III. A Model of Incentives for good CG/T&D and Choice of Agency Cost Proxies:
Our basic model of the relationship between the firm level CG and T&D mechanisms in
place, the conflicts of interest between the stakeholders, firm performance and the local and global
economy are depicted in Figure 1 below. Given the firm as a nexus of contracts prone to
information asymmetry and conflicts of interest between its stakeholders, we envision good
CG/T&D practices as a mechanism of checks and balances that has evolved to mitigate such agency
problems.8 These mechanisms are shaped not only by the legal traditions and regulations in the
firm’s country of domicile, but also by global laws and economy, through international standards
and opportunities that arise and the ensuing need to access foreign capital markets in a globalized
economy. Since undertaking positive NPV projects depends on the firm’s ability to tap the equity
and debt markets, and since capital will flow to the safest and highest return investments, firms have
the incentives to minimize their perceived risk and maximize the return to their capital suppliers by
putting in place optimal CG mechanisms. In this respect, understandable, relevant, transparent,
reliable, timely, and full disclosure of the results of economic activities and the structure and
processes used in its organizational units entrusted to operate in shareholders’ interests, gives the
stakeholders a true and fair view of the firm and the quality of the CG standards it follows. Good
T&D mechanisms are thus set in place to protect the rights of shareholders, creditors and other
outsiders from extraction of private benefits by insiders based on their superior information. This,
in turn, is expected to minimize the informational asymmetry in the firm, increase investor
awareness and trust which will reduce the uncertainty of the returns to its capital suppliers, leading
to lower cost of capital and hence higher firm value (see, for ex., Berglof and Pajuste, 2005).9 This
8
For example, Florackis and Ozkan (2004) cite managerial ownership and compensation, and ownershop concentration
as two corporate governance devices that mitigate agency costs.
9
Another advantage of compliance with good T&D practices is that it mitigates the political costs of non-compliance
and hence reduces the risk of higher taxes, litigation and too much regulation. Using simultaneous equations to control
Field et al. (2004) find that disclosure deters certain types of litigation.
11
flow from the economic units to capital suppliers can be sustained only in the absence of
appropriation by insiders and other common agency problems. So in our model, best CG/T&D
practices are used by firms not only to signal their quality, but also as monitoring tools to maintain
their good quality.10
Figure 1
FIRM
FIRM
Nexus of
contracts
between
stakeholders
CG-T&D
mechanisms
Accounting
Performance
COUNTRY
GLOBAL
FIRM
Local
Economy
Economy
Market
Performance
Albuquerque and Wang (2005) develop a dynamic general equilibrium model that acknowledges
the implications of agency conflicts, through weak investor protection, for security prices. They find that
countries with weaker investor protection have higher overinvestment, lower values, larger expected
returns and return volatility, and higher interest rates. Ashbaugh et al. (2004) discuss the agency
problems created by the separation of ownership and control and conclude that firms with better
governance present less agency risk to shareholders and thus result in lower cost of equity capital.
Accordingly, we expect to observe higher CG scores in firms that have solved or that are less susceptible
to agency conflicts. Accordingly, we pose the following hypothesis, presented in the alternative form:
10
If taken literally, this model predicts limitless disclosure which is prohibited by its cost. Only to the extent the
aforementioned benefits of disclosure exceed its costs, we expect the firm to increase its voluntary disclosure and
transparency. In addition, excessive transparency may limit the competitive advantage of the firm and the limitations in
place against extraction of private benefits by insiders may reduce the incentives of controlling shareholders to
undertake positive NPV projects and to monitor the managers (see, for ex., Sadka, 2004).
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H1: Firms that have lower potential agency conflicts are expected to have higher T&D scores
and vice versa.
Our proxies for potential agency problems are size (MVE); book-to-market equity ratio;
leverage (TL/TA), our proxy for monitoring by creditors, and free cash-flow, alternatively defined
as scaled operating cash flow (OCF), the cash balance (CB), and OCF minus capital expenditures
and dividends paid out (FCF); and firm performance measured as ROA and ROE.11
We expect larger and more profitable firms to have higher TDS because they are closely
followed by market participants, have more comprehensive disclosure standards in place to
minimize the political costs of noncompliance with GAAP, and can better afford the cost of
voluntary disclosure. Furthermore, profitable firms have less to hide from their constituents. We
also expect firms with higher information asymmetry and the resulting lower growth potential, as
measured by the market-to-book ratio, to disclose more as the management may believe that the
firm is undervalued and disclosure could remedy this unwanted perception. A recent study has
found that voluntary disclosure of prospective information is related to firm size (Hossain et al.,
2005). Similarly, Doyle et al., 2005 document that material weaknesses in internal contol are more
likely for smaller, younger, financially weaker, and fast growth firms.12 Using voluntary segment
disclosure as a proxy for transparency, Sidney and Bertrand (2004) find that concentrated board
ownership is positively related to low disclosure and this effect is stronger when firm performance
is poor. Principal-agent theory provides ample evidence that high leverage firms would have higher
TDS because of higher demand for information and stricter monitoring by the creditors.
Furthermore, we expect family firms with concentrated ownership, likely to expropriate the
minority shareholders’ rights, and firms with large amounts of free cash flows at the disposal of
managers to have lower T&D scores. Finally, we expect firms with less free cash flows at
management’s disposal and thus less management entrenchment and perquisites to be more
transparent.
11
Faulkender, et al. (2005) finds that the extent of the potential disagreement between investors and managers depends
on prior firm performance.
12
Similarly, Bryan and Lilien (2005) report that firms with material weaknesses in internal control are both smaller and
wose performers.
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IV. Sample, Data Requirements and Methods of Analysis
Our sample consists of the 52 largest (based on market capitalization) and most liquid (based
on trade volume) corporations traded in the ISE, 44 of which are currently followed by S&P and
included in their S&P/ IFC Emerging Markets Index. The study analyzes disclosure practices of
these firms from an investor perspective, therefore we have focused on sources of information that
are most readily accessible by local and international investors -- typically the latest available
English language and local language company annual reports and the English and Turkish websites.
The study leverages Standard & Poor’s expertise in corporate governance, index construction, and
financial analysis as we extend their list of 98 best T&D attributes, use their classification of overall
T&D into three subcategories, and utilize their scoring methodology.
Transparency and disclosure are evaluated by searching for the inclusion of best-practice
information items (‘attributes’) in the 2003 annual reports and websites of our sample firms. As
S&P used US disclosure best-practices as an implicit benchmark, their list of 98 attributes used in
prior surveys has been somewhat changed in Russia and Turkey. The list of attributes, included in
Appendix 1, have been extended to 106 information items in the case of Turkey in order to
incorporate some local market, culture, and regulation specific issues such as the CMB’s new CG
principles; concentrated ownership due to family ownership and founders’ shares; cross-holding
relationships between the holding companies and their subsidiaries; high inflation rate, and the
mandate to follow IFRS starting in 2005.
These attributes are grouped into three S&P sub-categories:
1. Ownership structure and investor relations
2. Financial transparency and information disclosure
3. Board and management structure and processes
The inclusion of each attribute is scored on a binary basis as ‘yes’ (included) or ‘no’ (not
included) to ensure objectivity. Each 'yes' answer is equal to one point and the overall T&D score
(TDS) for each firm is calculated as:
TDSi = ∑ ∑ Sjk / TOTS
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j k
where:
i = the firm,
j = the attribute category subscript,
k = the info item subscript, and
TOTS = the total maximum number of yes answers in each category. 13
S=
Companies are then ranked based on their TDS in decile order. An overall ranking will
reflect the total number of the 106 possible attributes included in a company’s annual report and
web site. Individual rankings for each of the three sub-categories are calculated in a similar way by
reference to the maximum possible number of yes answers for each sub-category. Following an
extensive accounting literature on corporate disclosure, we use our T&D rankings to represent the
market participants’ assessments of the completeness, clarity, transparency, and reliability of firms'
disclosure policies.
In the second part of the study, we conduct a cross-sectional analysis of the relationship
between T&D quality, objectively evaluated from mandatory and discretionary information
disclosed in the company annual reports and websites, as described above, and firm-specific proxies
for agency problems commonly used in literature. Both the firm specific financial statement
variables such as leverage, book-value of equity, cash flow information, and the number of shares
and market price data are obtained from the ISE electronic database.
Several methods of analysis are used to estimate the effect of perceived accounting and
financial transparency on firm performance. First, we look at the correlations between our measures
of firm performance and the overall T&D ranking as well as rankings based on its ownership,
financial disclosure and board/management components. Second, we sort our sample firms into 4
quartiles of TDS (T&D score) in descending order and compare the performance measures in the
two extreme quartiles, using difference of means tests. Next, we adopt a cross-sectional regression
framework where we regress our agency cost proxies on overall TDS and the scores obtained in
each of the T&D categories.
In calculating the total possible score for each question, we exclude a third “not applicable” outcome for info items
not applicable to the firm (e.g. whether group policies exist …. for a non-group firm)
13
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V. Results
In Table 3, Panel A (and B), we present a comparison of the average scores of Turkish firms
with those of other geographical regions (European countries in the Europe 300 index of the
S&P/IFC) obtained from S&P’s Transparency and Disclosure Study of 2001- 2002. The comparison
indicates that UK and US composite have the highest rankings globally. Continental Europe and
developed Asia are somewhat lower and emerging Asia and Latin America have the lowest
disclosure scores, particularly in terms of Board and Management disclosure. Turkish companies
have a pattern similar to Emerging Asia but have higher Financial Disclosure, but lower Board &
Mgmt scores. In comparison to European countries’ overall T&D score (6), Turkey has a somewhat
lower average score (5), which is comparable to many continental European countries.
(Place Table 3 about here)
V.1. Descriptive Statistics:
Table 4 presents the descriptive statistics of our sample. The average 2003 TDS overall
scores and average scores in the three T&D categories by type of firm (family vs. non-family)
indicates that the transparency and disclosure scores of ISE companies are not impressive,
especially in terms of board and management structure and processes. The highest scores are
obtained in the category of financial transparency and information disclosure which is not surprising
as most of the attributes in that category are mandatory disclosures required by the CMB’s generally
accepted accounting principles to be followed by publicly traded firms, which more or less follows
IAS. We also include the mean, median, min. and max. values of the above mentioned firm-specific
variables of interest for the year 2003. Turkish companies have slightly negative returns in 2003
due to the continuation of the economic slump of 2002; their return on assets and return on equity
ratios have been moderate about 5-10%; and their mean leverage is about 50%.
(Place Table 4 about here)
V. 2. Evidence on the relation between agency problems and the T& D scores:
In this section, we test if potential conflicts of interest caused by agency problems explain
the differences in the TDS scores by estimating the following regression equation, where i is the
16
firm subscript and there is no time subscript as the regressions are run using only the 2003 values
of the variables. Our agency variables are leverage (TL/TA), market capitalization, book-to-market
ratio. We also include free cash flows (FCF = Operating cash flow -dividends- capital expenditures)
and an indicator variable (FF) for whether the company is a family firm with a highly concentrated
ownership.
TDS i = β0 + β1TL/TA, i + β2 MVE i + β3 MTB i + β4FAM i + β5FCF i + ε i
(2)
(Place Table 5 about here)
Table 5 shows that our model is a valid one with an F-value of 3.669. We find that while neither
free cash flow and the family firm dummy are significant factors, leverage, size and market-to-book are
significant in explaining the variation in TDS. We conjecture that larger firms with higher followings
by investors and with higher political costs of non-compliance with regulation have higher quality
disclosure as expected. On the other hand, the negative relation between MTB and TDS indicates that
riskier, low growth or undervalued firms also disclose more to signal their quality to perhaps counter
the negative assessments of the market participants about their prospects. Size and market-to-book are
also significant in explaining the ownership structure and board and management structure TD scores.
None of the variables tried are significant in explaining differences in financial disclosure scores cause
the information items included in this sub-category are mostly mandatory disclosure items (with the
exception of voluntary early adoption of IFRS, consolidated reporting, and inflation accounting) and
hence there is very little variance in their TDS.
VI. Summary and Concluding Remarks
Collaborating with S&P, we score the T&D practices of 52 large and liquid ISE firms in three
categories of disclosure by searching their 2003 annual reports and websites for the inclusion of 106
information items. We conclude that the T&D quality of Turkish firms are at best moderate. The
highest and lowest scores are observed in the Financial Disclosure and Board and Management
processes categories, respectively. We also find that the variation in the T&D scores of the ISE
companies is not high, especially in the financial disclosure category of T&D, because the companies
17
seem to follow only mandatory reporting requirements. We conclude that their annual reports and
websites are weak in terms of voluntary disclosure. In the exploratory part of our study that
investigates the firm-specific determinants of the TDS, we find that while size, leverage, and marketto-book explain the differences in the scores in the ownership and board and management subcategories, family concentration in ownership and free cash flows at the manager’s disposal do not
seem to explain the variation in TD practices of firms.
We will replicate the study in 2005 during which we expect the T&D scores to improve due
to the required compliance with IFRS and the CMB’s CG principles. Two years data will also help
us uncover any possible lead lag relationships in the link between agency cost proxies and the TD
scores.
18
Table 1
Access to external financing and measures of investor protection in Turkey and by legal origin
_______________________________________________________________________________________________________________________
Panel A: a Aggregate mean values for the Turkish economy and stock market and comparison with different legal origins
Turkey
French Origin Average
Panel C:b External funding at the firm level – median values for Turkish and different legal origin firms on the Worldscope database
Turkey
French Origin Average
Panel D: Tests of means (t-statistics)
a
Panels A and B are reconstructed from La Porta et al. (1977), Table 2, presented for 49 countries and by legal origin.
PanelsA and B are reconstructed from La Porta et al. (1977), Table 8, presented for 49 countries and by legal origin. All values are taken from the
Worldscope database.
b
19
Table 2
The top seven CG factors chosen by institutional investors in 30 countries in 2002
________________________________________________________________________________
CG Factors
Turkey
All 30 countries surveyed
Accounting disclosure
73%
52%
Shareholder equality
64%
47%
Market regulation and infrastructure 55%
43%
Takeover markets
45%
23%
Property rights
45%
46%
Credit information
36%
29%
Board independence
27%
44%
__________________________________________________________________________________
Sources: Mc Kinsey, Investment Opinion Survey, May/June 2002 and Ararat and Ugur (2003).
20
Table 3
Panel A: Comparison of T&D Scores in different geographical regions vs. in Turkeya
Composite
Owner Str.
Fin Disclosure Board&Mgmt # of firms
Score
58
46
73
51
351
Europe
U.K.
70
54
81
70
124
Non-U.K.
51
41
69
41
227
U.S. (annuals)
42
25
66
31
500
U.S. (combined)
70
52
77
78
500
Japan
61
70
76
37
150
Asia-Pacific
48
41
60
42
99
Latin America
31
28
58
18
89
Emerging Asia
40
39
54
27
253
Turkey
41
39
64
20
52
a
Source: T&D scores for the regions are taken from S&P’s Transparency and Disclosure Study, 2002
Country
UK
Austria
Belgium
Switzerland
Deutschland
Denmark
Spain
Finland
France
Greece
Ireland
Italy
Netherlands
Norway
Portugal
Sweden
Europe 350 Region
Number of
Companiesb
133
2
7
20
34
6
15
5
43
2
4
27
26
3
7
16
350
b
Source:The decile scores for the constituents in the S&P Europe 350 (as of
Q4/2001) are from the S&P’s Transparency and Disclosure Study, 2002
Country/Region
UK
S&P 500 (US)
Australia
Continental Europe (excluding UK)
Russia
Average
Decile Score
8
7
7
5
5
Decile Average
Score
8
5
5
5
5
5
5
7
6
4
8
5
6
6
5
7
6
21
Table 4
Descriptive Statistics:T&D Scores and financial profiles of 52 ISE firms in 2003
Excess return are measured as actual returns
_____________________________________________________________________________
Variables
Panel A: T&D Scores:
N
Min.
Max.
Mean
TDS-Overall
52
16,19
71,43
41,11
11,06
TDS-OwnershipStr.
52
3,13
88,00
38,57
18,26
TDS-Fin.Discosure
52
19,44
86,11
64,21
14,25
TDS-Board&Mgmt
52
2,70
54,05
20,42
12,18
Std. Deviation
_____________________________________________________________________________
Panel B: Excess returns, profitability, and leverage:
ExRet'04
52
-19,70
64,52
0,81
10,05
ExRet'03
52
-6,18
17,90
-0,17
3,84
ExRet'02
52
-4,75
12,67
2,02
3,20
Av. ExRet-AllYrs.
52
-5,69
14,43
0,90
3,02
ROA
50
-0,17
0,24
0,065
0,07
ROE
50
-0,332
1,89
0,175
0,274
Market-to-book (MTB)
47
0,009
18,10
1,96
2,76
Debt ratio (DTA)
50
0,02
0,89
0,51
0,24
22
Table 5
Cross-sectional regressions of T&D Scores on size, market-to-book ratio and leverage .
The regression coefficients, their p-values (in parentheses), and the overall F-statistics are
presented for each model specification.
Mode Dependent
Variable
l
Overall
T&D Score
1
a
2
OwnStr
T&D Score
3
FinDisc.
T&D Score
4
BrdMgt
T&D Score
Independent Variablesa
Constant LnMVE M/B
Debt/TAa
Ratio
F-statistic
-13.720
(.397)
2.431
(.005)
-1.151
(.018)
15.236
(.004)
8.607
(.000)
-47.159
(.134)
4.078
(.013)
-2.302
(.014)
13.206
(.169)
4.799
(.007)
36.872
(.146)
1.220
(.336)
-0.790
(.281)
11.123
(.151)
1.479
(0.237)
-40.689
(.068)
2.670
(.019)
-1.469
(.025)
16.490
(.017)
5.965
(0.002)
LnMVE (ln of market capitalization) and TDS scores are measured as of Dec. 31, 2003 (year t) while the
M/B (market value of equity/book-value of equity) and Debt/TA (total liabilities/total assets) ratios that
contain balance sheet data are measured as of Dec. 31, 2002 (year t-1)
23
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25
Appendix I-List of attributes used in the survey
Ownership
1) # of issued and o/s ord shares?
2) # of issued and o/s other shares (pref, non-vot, recap)?
3) Par value of each ord share?
4) Par value of each other share (pref, non-vot, recap)?
5) # of auth but unissued & o/s ord shares?
6) # of auth but unissued & o/s other shares?
7) Top 1 shareholder?
8) Top 3 shareholders?
9) Top 5 shareholders?
10) Top 10 shareholders?
11) # and identity of shareholders holding more than 3%?
12) # and identity of shareholders holding more than 5%?
13) # and identity of shareholders holding more than 10%?
14) Identity of shareholders holding at least 50%?
15) Float %
16) Descriptions of share classes?
17) Review of shareholders by type?
18) Percentage of cross-ownership?
19) Existence of Corp Gov Charter or Code of Best Practice?
20) Reproduction of its Corp Gov Charter/Code of Best practice?
21) Mention of Articles of Association?
22) Details about Articles of Assn. (i.e. Charter Articles of Incorp)?
23) Voting rights for each voting share?
24) How or who nominates directors to board?
25) How shrhldrs convene an EGM?
26) Procedure for putting Inquiry Rights to the board?
27) Procedure for proposals at shareholders meetings?
28) Review of last shrhldrs meeting? (e.g. minutes)
29) Calendar of important shareholder dates?
30) Any (in)formal voting agreements or blocks (relevant to family
ownrship)?
31) Shareholding by senior managers?
32) Ultimate beneficiaries in case of institutional, co. or cross shrholdings?
Financial Disclosure
1) Its accounting policies?
2) Acctg standards it uses for its accounts?
3) Accounts according to the local acctg standards?
4) Accounts according to int'ly recognized acct standard (IAS/GAAP)?
5) B/S according to int'l acctg standard (IAS/GAAP)?
6) I/S according to int'l acctg standard (IAS/GAAP)?
7) C/F according to int'l acctg standard (IAS/GAAP)?
8) Accounts adjusted for inflation?
9) Basic earnings forecast of any kind?
10) Detailed earnings forecast?
11) Financial information on a quarterly basis?
12) Segment analysis (broken down by business line)?
13) Name of its auditing firm?
14) Reproduction of the auditors' report?
15) How much it pays in audit fees to the auditor?
16) Any non-audit fees paid to auditor?
17) Consolidated financial stmnts (or only the parent/holding co)?
18) Methods of asset valuation?
19) Info on method of fixed assets depr?
20) List of affiliates in which it holds a minority stake?
21) Reconciliation of its domestic acctg stds to IAS/US GAAP?
22) Ownership structure of affiliates?
23) Details of the kind of business it is in?
26
24) Details of the products or services produced/provided?
25) Output in physical terms disclosed? (# of users, etc.)
26) Characteristics of assets employed?
27) Efficiency indicators (ROA, ROE, etc.)?
28) Any industry-specific ratios?
29) Discussion of corporate strategy?
30) Any plans for investment in the coming year(s)?
31) Detailed info about investment plans in the coming year(s)?
32) Output forecast of any kind?
33) Overview of trends in its industry?
34) Its market share for any or all of its businesses?
35) List/register of related party transactions?
36) List/register of group transactions?
37) English Annual report on the web site?
Board and Mgmt
1) List of board members (names)?
2) Details about directors (other than name/title)?
3) Details about current employment/position of directors provided?
4) Details about previous employment/positions provided?
5) When each of the directors joined the board?
6) Classification of directors as an executive or an outside director?
7) Named chairman listed?
8) Details about the chairman (other than name/title)?
9) Details about role of the board of directors at the company?
10) List of matters reserved for the board?
11) List of board committees?
12) Existence of an audit committee?
13) Names on audit committee?
14) Existence of a remuneration/compensation committee?
15) Names on remuneration/compensation committee?
16) Existence of a nomination committee?
17) Names on nomination committee?
18) Existence of other internal audit functions besides Audit committee?
19) Existence of a strategy/investment/finance committee?
20) # of shares in the company held by directors?
21) Review of last board meeting? (e.g. minutes)
22) Whether they provide director training?
23) Decision-making process of directors' pay?
24) Specifics of directors' salaries (e.g. numbers)?
25) Form of directors' salaries (e.g. cash, shares, etc.)?
26) Specifics on performance-related pay for directors?
27) Decision-making of managers' (not Board) pay?
28) Specifics of managers' (not on Board) salaries (e.g. numbers)?
29) Form of managers' (not on Board) salaries?
30) Specifics on performance-related pay for managers?
31) List of senior managers (not on the Board of Directors)?
32) Backgrounds of senior managers?
33) Details of the CEO's contractd?
34) # of shares held by managers in other affiliated companie?
35) Whether board members are employees of parent co.? (in case co. is
a consolidated affiliate/subsid.)
36) Whether any grp policies exist re. nature of rltnship btwn parent and
affiliates? (w/respect to CG of affiliates/subsidiaries)
37) Whether any members of senior mngment are related (family, joint
business, etc.) to any major shrholder?
27
Appendix 2
The list of ISE firms included in our survey
Company
Ticker symbol
Ak Enerji Elektik Uretimi Otoproduktor Gurbu A.S. AKENR
Akbank T.A.S.
AKBNK
Akcansa A.S.
AKCNS
Aksa Akrilik Kimya Sanayil A.S.
AKSA
Aksigorta
AKGRT
Alarko Holding A.S.
ALARK
Anadolu Efes Biracilik ve Malt Sanayii
AEFES
Arcelik A.S.
ARCLK
Aselsan Askeri Elektronik Sanayii ve Ticaret A.S. ASELS
Aygaz A.S.
AYGAZ
Beko Elektronik
BEKO
Bosch Fren
BFREN
Brisa Bridgestone Sabanci Lastik San.ve Tic.
BRISA
BSH Profilo Elektrikli Gerecleri
BSPRO
Celebi Hava Servisi A.S.
CLEBI
Cimsa Cimento San ve Tic. A.S.
CIMSA
Dogus Holding
DOAS
Dogan Holding A.S.
DOHOL
Dogan Yayin Holding A.S.
DYHOL
Eczacibasi Ilac San ve Tic. A.S.
ECILC
Enka Insaat ve Sanayi AS
ENKAI
Eregli Demir ve Celik Fabrikalari A.S.
AEFES
Finansbank
FINBN
Ford Otosan Otomobil Sanayi A.S.
FROTO
Haci Omer Sabanci Holding A.S.
SAHOL
Hurriyet Gazetecilik ve Matbaacilik A.S.
HURGZ
Ihlas Holding
IHLAS
Is Gayrimenkul Yatirum Ortakligi A.S.
ISGYO
Kardemir
Koc Holding A.S.
KCHOL
Kordsa Sabanci Dupont Endustri
KORDS
Migros A.S.
MIGRS
Netas Northern Electric Telekomunikasyon A.S. NETAS
Petrokimya Holding A.S.
PETKM
Petrol Ofisi
PTOFS
Sasa Dupont Sabanci Polyester
SASA
T. Garanti Bankasi
GARAN
T. Sise Cam Fabrikalari A.S.
SISE
Tansas Perakende Magazcilik Ticaret A.S.
TNSAS
Tofas Turk Otomobil Fabrikasi A.S.
TOASO
Trakya Cam Sanayil A.S.
TRKCM
Turk Traktor
TTRAK
Tupras Turkiye Petrol Rafinerileri A.S.
TUPRS
Turk Dis Ticaret Bankasi
DISBA
Turk Hava Yollari A.S.
THYAO
Turkcell Iletisim Hizmetleri AS
TCELL
Turkiye is Bankasi A.S.
ISBNK
Ulker
ULKER
Vestel Elektronik Sanayi ve Ticaret A.S.
VESTL
Yapi ve Kredi Bankasi A.S.
YKBNK
Yazici Holding
YAZIC
Zorlu Enerji
ZOREN
Sector Code
55
40
15
25
40
20
30
25
20
55
25
20
25
25
20
15
Sector
Utilities
Financials
Materials
Consumer Discretionary
Financials
Industrials
Consumer Staples
Consumer Discretionary
Industrials
Utilities
Consumer Discretionary
Industrials
Consumer Discretionary
Consumer Discretionary
Industrials
Materials
20
25
35
20
15
40
25
40
25
40
40
15
20
25
30
45
15
10
15
40
25
30
25
20
20
10
40
20
50
40
30
25
40
Industrials
Consumer Discretionary
Health Care
Industrials
Materials
Financials
Consumer Discretionary
Financials
Consumer Discretionary
Fiancials
Financials
Materials
Industrials
Consumer Discretionary
Consumer Staples
Information Technology
Materials
Energy
Materials
Financials
Consumer Discretionary
Consumer Staples
Consumer Discretionary
Industrials
Industrials
Energy
Financials
Industrials
Telecommunication Services
Financials
Consumer Staples
Consumer Discretionary
Financials
55
Utilities