Governance Disclosure Quality in a “Comply or Explain” Governance Regime: Determinants and Validation of Utility

• In Event: Audit Committees and Corporate Governance

Abstract

We measure corporate governance quality based on disclosures of firm’s adoption and tailoring of the suggested best governance practices in the most common corporate governance disclosure system in the world: the “comply or explain” setting. We seek to achieve two goals in this study. First we investigate whether the economic theory based determinants of “comply or explain” governance measures explains more of the cross-sectional differences in disclosures than the same determinants explain of conventional governance measures that solely focused on the composition of board and audit committee (e.g., size, independence, and financial expertise). Given we validate the relative superiority of these measures based on public disclosures we then examine the utility of tailored governance best practices by examining whether our measure is associated with the improved accounting quality (i.e. accrual quality) and long term firm performance. We examine this absolutely and relative to other conventional governance measures. We find that our tailored board score measure varies along the lines that economic theory suggests should determine cross-sectional differences and our board scores are significantly more responsive to such in economic determinants than extant governance measures. Further, our evidence suggests that our board score measures are weakly but negatively associated with accounting accrual quality and strongly positively associated with a common measure of long term firm performance, Tobin’s Q. Our results suggest that, on average, companies take advantage of the flexibility inherent in the “comply or explain” governance regime that allows them to develop the most cost efficient and effective governance for their firm specific setting.

Authors

• Yan Luo, Queen's University

• Steven E Salterio, Queen's University