Corporate communication of financial risk
The authors are thankful for the comments made by participants at the 2007 AFAANZ annual conference where an earlier version of this paper was presented and the suggestions of the discussant at that conference, Associate Professor Alan Ramsay as well as the valuable comments from the journals’ anonymous reviewers.
Abstract
This study provides insights on the Financial Risk Management Disclosure (FRMD) patterns of Australian listed resource companies for the 2002–2006 period leading up to and immediately following adoption of the International Financial Reporting Standards (IFRS). Regression analysis demonstrates that corporate governance and capital raisings of firms are significant and positively associated with FRMD patterns. In contrast, overseas stock exchange listing of firms is significantly negatively associated with FRMD patterns. The findings show that the introduction of IFRS changes corporation’s willingness to communicate risk information.
1. Introduction
Extractive resource companies are subject to a range of financial risks that arise as a result of extensive exploration, production and financing activities. Financial risks include foreign exchange, commodity price, credit, liquidity and interest rate risks (AASB, 1999, 2004a). Financial risk management is concerned with the identification of these financial risks by both the management of the firm and the board of directors and the assessment of exposures to ensure operations are not jeopardised through financial mismanagement. Inadequate financial risk management has contributed to the collapse of several mining companies1 in Australia. Effective financial risk management includes adequately communicating exposures or likely exposures to stakeholders (ASX Corporate Governance Council, 2007a).
The board requires management to conduct its financial risk management activities in accordance with Corporation Law, corporate governance codes and board approved limits of authority. Ultimately the board is responsible for seeing that there are appropriate policies in place dealing with risk oversight and management and internal control (ASX Corporate Governance Council, 2007b). Financial risk management focuses on the unpredictability of financial and commodity markets and seeks to minimise potential adverse effects on the financial performance of companies (AASB, 1999, 2004a).
The significance of financial risks to resource companies and their disclosure policy in respect of those risks is dependent on a complex array of factors including interest rates and the currencies of borrowings, level of cash, liquid investments and borrowings and their term and maturity, and proportion of investments and borrowings derived from foreign capital markets (AASB, 1999, 2004a). Adoption of the International Financial Reporting Standards (IFRS) on 1 January 2005 in Australia has had a profound impact on the recognition, measurement and disclosure of financial instruments (Honey, 2004; Jubb, 2005, 2006). Several key IFRS including AASB 1322Financial Instruments: Disclosure and Presentation and AASB 139 Financial Instruments: Recognition and Measurement changed the quantum of existing liabilities and equity and resulted in the recognition of new liabilities and equity in the balance sheet (Ahmed and Goodwin, 2006). Resource firms commonly participate in hedging of commodity prices, interest rates and foreign exchange rates and often utilise complex financial derivatives to hedge their exposure to financial risk (PwC, 2005). These firms regularly seek access to capital markets to fund new developments or acquisitions and may use derivative financial instruments as a direct or indirect consequence of entering into these funding arrangements (PwC, 2005). These observations support the focus of this study on financial risk management disclosures made by companies within the mining and petroleum (oil and gas) sub-industries.
Section 2 outlines the research questions and significance of the study, corporate financial risk management practices and implications of the introduction of IFRS on reporting of these financial risk management practices. Section 3 covers the theoretical position of the study and hypotheses development and Section 4 discusses the research approach. Section 5 provides the results of the empirical analysis whereas Section 6 concludes the study.
2. Research questions and significance of the study
A conceptualised financial risk management framework is provided as Figure 1. Australian listed resource firms’ management are required to understand and communicate a complex set of issues with respect to financial risk management including risk identification, measurement, monitoring and internal control mechanisms, how, why and to whom the financial risk management policies and procedures are to be communicated and the accounting and capital management implications of these risk management arrangements.
Conceptualised financial risk management framework.
As shown in Figure 1, the communication of information relating to the hedging of risk exposures, the nature of the entity’s financial risk exposure, the significant areas of financial risk concentration, the avoidance of undue concentrations of risks and an entity’s maximum financial risk exposure provide valuable information to an entity’s stakeholders.
The focus of this study is to first quantify the extent of financial risk management disclosures within the annual reports of Australian listed resource companies longitudinally over the period encompassing the 2002–2006 financial years inclusive. The study then relates financial risk management disclosures to firm specific variables incorporating corporate governance and capital management.
This study assists in determining the extent of financial risk management disclosure communication in annual financial reports. Financial derivatives and hedge arrangements are commonly used in the resources industry as a means of increasing certainty with regard to future cash flows, to manage risks and to lock in a minimum cash flow and income stream for producers and their financial intermediaries (Berkman et al., 2002). However, a poor understanding of these instruments or ineffectiveness of hedge arrangements imposes risks on the company (Hancock, 1994; Nguyen and Faff, 2002, 2003; Benson and Oliver, 2004). These risks could include large fair value movements of the hedged item and hedging instrument taken to the income statement where hedge effectiveness tests and documentation requirements have not been met, volatility of financial statement elements with consequent impacts on key financial ratios, compliance with debt covenant terms and credit ratings (Honey, 2004). Financial risks can be exacerbated through operational activities. For instance, hedge-book commitments with financial intermediaries may not be met following a marked downgrade in mineral or petroleum reserves. Chalmers and Godfrey (2000, 2004) and Lopes and Rodrigues (2006) argue that disclosure of financial instrument information generally and financial risk information specifically within listed company annual reports is inadequate, typically vague in nature with broad statements on accounting policies provided but with little application to firm specific circumstances.3
The Australian Stock Exchange (ASX) Corporate Governance Council released revised best practice governance principles and recommendations in August, 2007 (ASX Corporate Governance Council, 2007b). Under ASX Listing Rule 4.10.3, companies are required to disclose the extent to which they have followed these best practice recommendations in their annual reports for the financial years commencing on or after 1 January 2003. Where companies have not addressed all of the recommendations, they must provide reasons for not following them. The Council (ASX Corporate Governance Council, 2007b, p. 3) states that ‘effective corporate governance structures encourage companies to …. provide accountability and control systems commensurate with the risks involved’ and ‘meeting the information needs of a modern investment community is also paramount in terms of accountability and attracting capital’. Risk management, effective oversight, internal control and financial reporting integrity are integral components of these best practice principles and recommendations.4 However, the Council notes that in 2006, in excess of 30 per cent of Australian listed companies did not disclose information about their risk management policies (ASX Corporate Governance Council, 2006). Submissions from Australian corporations to the Council regarding specific reporting of material business risks raised several concerns that clearly influence managerial financial risk disclosure patterns (ASX Council, 2007c). Critics to these Council’s initiatives argue that disclosure of specific risks could lead to disclosure of commercially sensitive information prejudicial to the company, competitive damage, competitive disadvantage and expose directors to greater legal liability risk (ASX Council, 2007c).
Financial risk management disclosure practices5 are important to financial reporting users. Extant literature clearly indicates that disclosures of risk information by listed corporations are typically generic in nature with firm management and the board reluctant to disclose specific detail on the risk profile, internal compliance and control, risk oversight function and effectiveness of risk oversight and management of the company.
3. Research proposition and hypotheses development
3.1. Conceptual framework and theory
Determination of the level of detail of financial risk information to be disclosed requires the exercise of judgement by firm management and the board (AASB, 1999, 2004a). The decision to disclose information can be dependent not only on the relative significance of those instruments (AASB, 1999, 2004a) and arrangements to the business objectives of the firm, but also on management’s personal welfare considerations to disclose that information (Jensen and Meckling, 1976; Watts and Zimmerman, 1990). Agency theory provides a conceptual framework for examining financial risk management disclosures in the annual reports of Australian listed resource firms. Extant literature (Welker, 1995; Beatty and Weber, 2003; Douglas, 2003; Emanuel et al., 2003; Monem, 2003; Liang, 2004; Cheng and Warfield, 2005) cites agency theory to explain managerial disclosure decision making. Management and the board, as self-interested agents, typically possess economic information that shareholders or bondholders, as principals do not possess and thus may engage in opportunistic behavior (Jensen and Meckling, 1976; Watts and Zimmerman, 1990).
Prior theoretical research focusing on information asymmetry suggests that full disclosure is in the best interests of a firm. By reducing ex-ante uncertainty through full disclosure, a firm will be able to reduce its cost of capital (Botosan, 1997). However, previous empirical work (Choi, 1973; Frankel et al., 1995; Botosan, 1997; Anderson et al., 2004; Chenhall and Moers, 2007) has supported the theoretical justification for greater disclosure these investigations routinely show firms are reluctant to provide full disclosure. For example, firms do not provide disclosures because of the lack of a structured risk management system or the proprietary nature of specific disclosure items (Verrecchia, 1990; Chalmers and Godfrey, 2004). Empirical studies (Frankel et al., 1995; Chalmers and Godfrey, 2000; Chen and Jaggi, 2000; Cabedo and Tirado, 2003; Eng and Mak, 2003; Chalmers and Godfrey, 2004; Mitchell, 2006), nonetheless, have indicated various determinants that may influence firms to provide more disclosure on specific issues.
3.2. Hypotheses development
The first research question addressed in this study is whether the extent of financial risk management disclosures has increased from the pre-IFRS period to the post-IFRS adoption period. Both AASB 1033 Presentation and Disclosure of Financial Instruments (pre-IFRS) and AASB 132 (post-IFRS) require disclosure of information relating to the extent of currency risk, price risk, market risk (or fair value interest rate risk), credit risk, liquidity risk and cash-flow (or cash-flow interest rate) risk (AASB, 1999, 2004a). These standards require disclosure of information about the nature and extent of an entity’s use of financial instruments, the business purposes they serve, the risks associated with them and managements policies for controlling those risks (AASB, 1999, 2004a). Further, AASB 139 (introduced on adoption of IFRS) requires an entity to document its risk management strategy for a particular hedging relationship and its effectiveness in offsetting the exposure to changes in the hedged items fair value or cashflows attributable to the hedged risk (AASB, 2004b). Both AASB 132 and AASB 139 mandate measurement of derivative and available-for-sale financial instruments at fair value which could potentially contribute to volatility of current earnings, retained profits and total equity. The implementation of IFRS requirements under AASB 139 creates additional pressure for resource firms to disclose information relating to their financial risk management strategies. The pressure to disclose more information is internally generated via the documentation, reporting and transparency requirements by senior management and the board of directors and externally generated through important stakeholder groups such as investors and auditors demanding explanations for major accounting adjustments following implementation of IFRS. For instance, the impact of hedging arrangements on reported profit and net assets is likely to be a major factor in driving disclosures of risk related information in respect of these instruments within the annual report, particularly if the at-risk or flexible component of remuneration is tied in with reported profits. Given the risk of corporate collapses6 in the event of mismanagement of hedge related risks, investors in particular are demanding disclosure of far more information on the nature of these risks and how management are dealing with these risks. It is likely that changes to accounting policies and associated documentation and system requirements in respect of financial instruments have changed the mindset of executives and the board of directors to one of disclosing more with consequent changes in the recording and reporting of key financial transactions and associated risks.
Further, audit scrutiny leading up to and immediately post-IFRS adoption may result in an increase in both mandatory and discretionary disclosures. The extent of disclosures may ultimately be dependent on cost-benefit decisions made by management. For instance, Graham et al. (2005) found that more than four in five CFO respondents to a survey on disclosure decisions that the cost of capital or reduction of information risk was a motivation for voluntary disclosures. Many surveyed CFOs stated that reducing investor uncertainty about the firm’s future prospects was the most important motivation to make voluntary disclosures. However, Graham et al. (2005) suggested that CFOs may limit voluntary disclosures on the basis of setting a precedent that would be difficult and costly to maintain in the future. Further, Mallin et al. (2004) indicate that fund managers believe early disclosure in relation to financial instruments under FRS13 Derivatives and Other Financial Instruments – Disclosures7 may have been undertaken for commercial reasons by increasing certainty and information flow to capital markets or to reassure investors of exposure to risk. This can focus management in adhering to mandatory disclosures and increase the disclosure of additional, non-mandatory information. These assertions are supported by Dunne et al. (2003) who stated that the adoption of FAS 133 Accounting for Derivative Instruments and Hedging Activities in the US on 15 June 2000 imposed greater discipline on risk management as firms were compelled to communicate risk management strategies in respect of derivatives more clearly. The introduction of accounting standards dealing with hedging activities in the UK and the US has clearly compelled firm management to disclose more information regarding risk and risk management. Consequently, the adoption of IFRS in Australia is also likely to lead to an increase in risk and risk management disclosures within the annual report particularly since IFRS involves introduction of new standards (e.g. AASB 139) and substantial changes to a range of existing standards.
Litigation was posited by Graham et al. (2005) as a reason why managers may disclose less information. The reason for this is that management may have concerns regarding potential legal liability if disclosed statements are not complete or accurate. Litigation risk may therefore impede disclosure of risk related information leading up to formal IFRS adoption. Further, Graham et al. (2005) suggest agency costs may provide an over-arching reason explaining the lack of full disclosure. Management may have career concerns and external reputation can be an important driver in order to meet earning benchmarks which may in turn constrain voluntary disclosures. Despite the interplay between costs and benefits of disclosure, overall it can be concluded that the implementation of IFRS fundamentally increases financial risk management disclosures. Thus, the study tests the following hypothesis:
H1: There is a positive association between the adoption of IFRS and the extent of financial risk management disclosure levels (mandatory and discretionary) by Australian listed resource firms.
The second area of research in this study is the significance of associations between financial risk management disclosures and corporate governance structure, capital raisings and overseas listing status. It is postulated that financial risk management disclosures will vary considerably based on firm specific variables including corporate governance structure and capital management characteristics such as capital raisings and overseas listings (Douglas, 2003; Mallin et al., 2004; Abraham and Cox, 2007).
Recent corporate governance advocates (Eng and Mak, 2003; Beekes and Brown, 2006; Taylor et al., 2008) have strongly suggested a firm’s corporate governance structure is an important determinant of a firm’s transparency policy. Over the past decade, various legal and regulatory bodies such as The Group of 100, the ASX Corporate Governance Council and CLERP 9 in Australia have emphasised the importance of corporate governance as a mechanism to enhance the quality of financial reporting (Brown and Tarca, 2005). The heightened regulatory environment is forcing companies to focus more on corporate governance and in particular, transparency and disclosure. Corporate governance policies, systems, tools and charters are designed to ensure that financial risks are identified, assessed, addressed and monitored to enable achievement of corporate objectives. An effective financial risk management framework forms the foundation of control8 of hedging arrangements, capital raisings, access to domestic and foreign capital markets and control over areas of financial risk concentration. Firms with an effective corporate governance structure in place are therefore expected to disclose more information of a discretionary nature as well as disclose mandatory information in relation to financial risk management. It is hypothesised that the extent of information disclosed concerning financial risk management is positively related to the strength of the firms’ corporate governance structure:
H2: There is a positive association between the strength of corporate governance structure and the extent of financial risk management disclosures (mandatory and discretionary) by Australian listed resource firms.
Elements of a firm’s capital management policy such as capital raisings and overseas listings are additional possible determinants of financial risk management disclosure practices. Capital market considerations including the cost of capital, availability and choice of external financing and analyst following are important drivers of management’s voluntary disclosure practices (Healy and Palepu, 2001). Healy and Palepu (2001) state that contracts between the firm and its creditors (debt contracts) and contracts between management and shareholders (compensation contracts) and political and legal issues such as management’s concern regarding taxation, reputation and regulation drive managements motives for making financial disclosure decisions. Botosan (1997), Nikolaev and Van Lent (2005) found that firms can achieve lower costs of capital through voluntarily increasing their disclosures of credible information.
Dhanani (2003) examines exchange rate risk management of a large UK listed mining company and posits that foreign exchange rate risk management is important for multinational corporations in that this risk may adversely impact on gearing ratios when denominated in the parent currency and a translational profit and loss risk. Companies listed on multiple exchanges do so to raise capital and to increase the overall investment and business profile of the company (Dhanani, 2003). Multi-listed companies will be subject to greater regulation associated with the listing rules of each jurisdiction and will be subject to potentially a wider range and more complex suite of risks. Companies with multi-jurisdictional listing are expected to have more sophisticated risk management policies and procedures and to disclose more information concerning these financial risks. To formally test the association between the extent of financial risk management disclosures and capital raisings or overseas listing by the firm, the following hypotheses are constructed:
H3: There is a positive association between the occurrence of capital raisings and the extent of financial risk management disclosures (mandatory and discretionary) by Australian listed resource firms.
H4: There is a positive association between those firms that are listed in more than one jurisdiction and the extent of financial risk management disclosures (mandatory and discretionary) by Australian listed resource firms.
4. Research method
Data are obtained from the population of annual reports of 111 Australian listed extractive resource firms that were engaged in production activities at any time over a 4 year longitudinal timeframe encompassing the 2002–2006 years, 3 years pre-IFRS and one year post-IFRS adoption.9 Tests of means formed the prime technique for evaluating hypothesis 1, whereas ordinary least squares regression (OLS) is employed to test Hypotheses 2–4.
| Item No. | Description of the corporate governance items |
|---|---|
| CG1 | Is the chairman of the board an independent director? |
| CG2 | Are the roles of the chairman and chief executive officer performed by different persons? |
| CG3 | Is the board of directors largely (>70 per cent) made up of independent directors? |
| CG4 | Does the nomination committee have a policy for the appointment of directors? |
| CG5 | Has the board adopted a formal code of conduct that deals with personal behaviour of directors and key executives relating to insider trading, confidentiality, conflicts of interest and making use of corporate opportunities (property, information, position)? |
| CG6 | Does the company have a formal plan, policy or procedures in respect of equity (shares and options) based remuneration paid to directors and key executives? |
| CG7 | Does the company have a remuneration policy that outlines the link between remuneration paid to directors and key executives and corporate performance? |
| CG8 | Does the audit committee have at least one member that has financial expertise (i.e. is a qualified accountant or other financial professional with experience of financial and accounting matters)? |
| CG9 | Has the board adopted a formal integrated risk management policy that deals with risk oversight and management and internal control? |
| CG10 | Has the CEO/CFO stated that the company’s risk management, internal compliance and control systems are operating effectively and efficiently? |
| CG11 | Does the company have an audit committee charter? |
| CG12 | Does the company have a formal written continuous disclosure policy? |
| CG13 | Does the company have a finance committee, charter or policy? |
- The 13 corporate governance items used to construct the corporate governance score (CGS) were derived from the Australian Stock Exchange Council’s best practice corporate governance principles and recommendations released on 31 March 2003.
Second, capital raisings and overseas listing are the two aspects of a firm’s capital management structure that are possible determinants of financial risk management disclosures in this study. Capital raisings and overseas listings are each treated as a dichotomous variable with a score of one allocated to an equity, debt or hybrid capital raising in that year or listing overseas as well as on the ASX.
Aside from the dependent and independent variables, the study also includes the standard control variables of firm size, leverage, sub-industry and shareholder concentration in the statistical analysis (Ahmed and Courtis, 1999). The size of the firm is measured as the natural logarithm of total assets to reduce the impact of skewed data in the statistical analysis. Consistent with many past studies, firm leverage or debt to equity plus debt ratio is measured as the square root of total liabilities divided by total equity plus total liabilities. Sub-industry refers to mining or the oil and gas sub-industries and is included as a control variable to capture operational differences between these sub-industries. Shareholder concentration is measured by the proportion of ordinary share capital owned by the top 20 shareholders.
5. Results
Analysis of the data shows that mandatory financial risk management information typically disclosed includes a description of the extent of currency, price, credit and interest rate risk and whether management have policies and procedures in place to deal with financial risk mitigation (Table 2). Far less information relating to the financial assets exposed to credit risk and areas of significant concentration of credit risk is disclosed. The more commonly disclosed discretionary items include information relating to how interest rate risk and credit risk arose. Substantially less information relating to internal controls to mitigate financial instrument risk, financial risk sensitivity analysis and liquidity risk, and how it arose and is being managed, is disclosed.
| FRMD | MandFRMD | discFRMD | CGS | Size | Leverage | Top20 | ROA | |
|---|---|---|---|---|---|---|---|---|
| Mean | 43.719 | 57.783 | 24.478 | 59.380 | 18.442 | 5.665 | 61.522 | −6.334 |
| SE | 0.865 | 0.846 | 1.043 | 1.159 | 0.098 | 0.103 | 0.991 | 1.268 |
| Median | 40.741 | 61.538 | 21.429 | 61.538 | 18.282 | 5.795 | 62.105 | 1.276 |
| SD | 17.810 | 17.422 | 21.481 | 23.871 | 2.012 | 2.120 | 20.407 | 26.117 |
| Kurtosis | −0.217 | 0.366 | 0.181 | −0.707 | 1.027 | 0.265 | −0.796 | 1.207 |
| Skewness | 0.382 | −0.423 | 0.964 | −0.344 | 0.456 | 0.106 | −0.102 | −1.315 |
| Minimum | 0.000 | 0.000 | 0.000 | 0.000 | 10.136 | 0.878 | 12.040 | −77.056 |
| Maximum | 88.889 | 92.308 | 92.857 | 100.000 | 24.893 | 13.986 | 99.850 | 27.045 |
| Count | 424 | 424 | 424 | 424 | 424 | 424 | 424 | 424 |
- FRMDI, Financial Risk Management Disclosure Index; MandFRMDI, Mandatory Financial Risk Management Disclosure Index; DiscFRMDI, Discretionary Financial Risk Management Disclosure Index. CGS, corporate governance score, leverage = square root of debt/(debt + equity), size is measured as the natural log of total assets, and top20 refers to the percentage shareholding in the firm by the top 20 shareholders; ROA, pretax profit/total assets truncated at the fifth and 95th percentile.
Descriptive statistics provided as Table 2 indicates that the mean disclosure of mandatory, discretionary and total financial risk management information for all sample firms is 57.78, 24.47 and 43.71 per cent, respectively. These data show great diversity of disclosure of financial risk information. For instance, disclosure of total financial risk management information ranges from 0 to 88.88 per cent. Sample firms generally exhibit a moderate corporate governance structure, based on the CGS, with a mean of 59.38 per cent. Simple correlations between FRMDI and each of the independent and control variables are computed using Pearson’s product-moment correlations (see Table 3).
| FRMD | mandFRMD | discFRMD | CGS | Capital raisings | Overseas Listing | Size | Leverage | Sub-industry | Top20 | ROA | |
|---|---|---|---|---|---|---|---|---|---|---|---|
| FRMD | 1.000 | ||||||||||
| mandFRMD | 0.860* | 1.000 | |||||||||
| DiscFRMD | 0.912* | 0.582* | 1.000 | ||||||||
| CGS | 0.579* | 0.498* | 0.527* | 1.000 | |||||||
| Capital raisings | 0.190 | 0.144 | 0.183 | 0.094 | 1.000 | ||||||
| Overseas listing | 0.065 | −0.018 | 0.123 | 0.163 | −0.004 | 1.000 | |||||
| Size | 0.677* | 0.501* | 0.698* | 0.612* | 0.135 | 0.262 | 1.000 | ||||
| Leverage | 0.415** | 0.327*** | 0.405** | 0.211 | 0.159 | −0.055 | 0.314 | 1.000 | |||
| Sub-industry | −0.097* | −0.090 | −0.084 | −0.197* | −0.049 | −0.030 | −0.135 | 0.105 | 1.000 | ||
| Top20 | 0.204 | 0.135 | 0.230 | 0.109 | 0.032 | 0.027 | 0.321 | 0.183 | 0.342*** | 1.000 | |
| ROA | 0.288 | 0.224 | 0.295 | 0.320 | −0.080 | 0.192 | 0.500 | −0.028 | −0.101* | 0.211 | 1.000 |
- Pearson correlation matrix for all sample firms and for all years. FRMDI, financial risk management disclosure index; MandFRMDI, mandatory financial risk management disclosure index; DiscFRMDI, discretionary financial risk management disclosure index. CGS, corporate governance score, leverage = square root of debt/(debt + equity), size is measured as the natural log of total assets, and top20 refers to the percentage shareholding in the firm by the top 20 shareholders, ROA, pretax profit/total assets truncated at the fifth and 95th percentile. Associations * and ** are statistically significant at the 1 and 5 per cent levels, respectively. Associations *, ** and *** are statistically significant at the 1, 5 and 10 per cent levels, respectively.
Table 3 shows that FRMDI is moderately positively correlated with the independent variable—CGS and firm size consistent with the hypotheses. Larger firms tend to be correlated with stronger corporate governance structures and higher financial risk disclosures. There is a positive and statistically significant (at the 1 per cent level) between a firm’s strength of corporate governance structure and FRMD (0.579), consistent with Hypothesis 2. Firm size is also positive and significantly associated with FRMS (0.677) and in turn, firm size and CGS are strongly positively correlated (0.612). Capital raisings and overseas listing status are not significantly associated with FRMD. Leverage is positively and significantly associated with FRMD at the 5 per cent level. Correlations between ROA, sub-industry or shareholder concentration and FRMDs are not statistically significant.11
A paired t-test is performed to test for differences between the means of the FRMDI for consecutive financial years over the study period. The results are shown in Table 4, Panel A.
| Year 1 | Year 2 | Year 3 | Year 4 | |
|---|---|---|---|---|
| Panel A: Total disclosure (FRMDI) | ||||
| Mean | 37.496 | 40.917 | 42.661 | 53.832 |
| Variance | 276.642 | 263.633 | 269.344 | 305.505 |
| Observations | 105 | 105 | 108 | 101 |
| % change FRMDIt–FRMDIt-1 | 9.125 | 4.262 | 26.185 | |
| Hypothesised mean difference | 0 | 0 | 0 | |
| df | 104 | 107 | 100 | |
| t Stat | −4.220 | −2.717 | −8.329 | |
| p(T ≤ t) one-tail | 0.000 | 0.004 | 0.000 | |
| t Critical one-tail | 1.660 | 1.659 | 1.660 | |
| Panel B: Mandatory disclosure (mandFRMDI) | ||||
| Mean | 51.062 | 55.531 | 57.350 | 67.479 |
| Variance | 280.068 | 262.837 | 264.526 | 276.782 |
| Observations | 105 | 105 | 101 | 101 |
| % change mandFRMDIt-mandFRMDIt-1 | 8.752 | 3.275 | 17.663 | |
| Hypothesised mean difference | 0 | 0 | 0 | |
| df | 104 | 107 | 100 | |
| t Stat | −4.364 | −2.206 | −6.354 | |
| p(T ≤ t) one-tail | 0.000 | 0.015 | 0.000 | |
| t Critical one-tail | 1.660 | 1.659 | 1.660 | |
| Panel C: Discretionary disclosure (discFRMDI) | ||||
| Mean | 24.898 | 27.347 | 29.167 | 41.160 |
| Variance | 397.483 | 426.273 | 419.726 | 545.050 |
| Observations | 105 | 105 | 108 | 101 |
| % change discFRMDIt-discFRMDIt-1 | 9.836 | 6.654 | 41.119 | |
| Hypothesised mean difference | 0 | 0 | 0 | |
| df | 104 | 107 | 100 | |
| t Stat | −2.486 | −1.970 | −7.952 | |
| p(T ≤ t) one-tail | 0.007 | 0.026 | 0.000 | |
| t Critical one-tail | 1.660 | 1.659 | 1.660 | |
- Paired t-test results for mean financial risk management disclosures for all sample firms: both mandatory and discretionary disclosures (Panel A); mandatory disclosures (Panel B) and discretionary disclosures (Panel C). For companies with a 30 June year end, Year 1 is the 2003 financial year and Year 4 is the 2006 financial year. For companies with a 31 December year end, Year 1 is the 2002 financial year and Year 4 is the 2006 financial year. For both June and December balancing companies, years 1–3 are pre-IFRS and Year 4 is post-IFRS.
The difference in means of FRMDI between the years is statistically significant at the 1 per cent level with the largest change (26.18 per cent) in mean FRMDI occurring between year 3 (pre-IFRS adoption period) and 4 (post-IFRS adoption period). Hypothesis 1 is supported by the results. In Table 4 (Panels B and C), paired t-tests are also performed to test whether the mean of the distribution of differences in mandatory FRMDI (mandFRMDI) and discretionary FRMDI (discFRMDI) is significantly different from zero. The increases in mandatory FRMDI from year 1 to 3 during the pre-IFRS adoption period, while being statistically significant at the 1 per cent level, is not as pronounced as the 17.66 per cent increase from year 3 (pre-IFRS) to 4 (post-IFRS). The mean mandatory FRMDI in year 4 is 67.47 per cent as compared with 57.35 per cent in year 3. There is a marked increase in discretionary FRMDI with a 41.11 per cent increase from year 3 to 4 being statistically significant. Firms disclose far more financial risk management information of both a mandatory and discretionary nature in the post-IFRS adoption period compared with the pre-IFRS adoption period, despite the fact that disclosure requirements mandated under AASB 1033 (pre-IFRS) and AASB 132 (IFRS) are very similar. Hypothesis 1 is thus supported. There are a number of possible reasons for the observed disclosure patterns that provide support for Hypothesis 1. First, the introduction of AASB 139 appears to have resulted in more transparent reporting of risk management policies relating to hedging activities, particularly given the requirement to document the effectiveness of hedging arrangements in offsetting risk on an ongoing basis. Second, the introduction of IFRS in Australia itself is akin to the introduction of a new form of regulation that has provided impetus for firm management and the board to refurbish existing treasury policies, create new treasury policies and revisiting accounting policies and practices and modifying them accordingly in order to create greater transparency, reduce uncertainty and increase the flow of information to capital market participants. This greater pressure to be transparent in the post-IFRS adoption environment may in turn have been an important driver of disclosure practices. Firms appear to be engaging in relatively more costly monitoring and specific information gathering activities of financial risk management information in the immediate post-IFRS environment.
To test the association between the dependent variable (FRMDI) and the independent variables (CGS, capital raisings and overseas listing) and control variables, a multiple linear regression model is constructed and performed (Model 1). For the pooled dataset and for each of the 4 years, estimates of the following model12 (Model 1) were obtained:
FRMDI jt = αj + β1 CGS jt + β2 Capital Raisings jt + β3 Overseas Listing jt + β4 Size jt + β5 Leverage jt + β6 Top20 jt + β7 Sub-industry jt + β8 ROA jt + ε j (Model 1)
where FRMDIjt = Financial Risk Management Disclosure Index for firm j in year t; CGSjt = corporate governance composite score for firm j in year t; Capital Raisingsjt = occurrence of equity, debt or hybrid capital raising for firm j in year t; Overseas Listingjt = Firm j is listed on the ASX and at least one overseas exchange in year t; Sizejt = natural log of total assets for firm j in year t; Leveragejt = square root of debt/equity + equity ratio (total liabilities/total equity + total liabilities) for firm j in year t; Top20jt = top 20 shareholders for firm j in year t; Sub-industryjt = firm j engaged in mining in year t (1 = yes, no = 0); ROAjt = Return on assets for firm j in year t, truncated at the 5th and 95th percentiles; αj = intercept; β = estimated coefficient for each item or category and εj = error term.
Using equation Model 1, a pooled regression of the entire 4 year dataset was performed to capture the time effect of adoption of IFRS on extent of disclosure and also to determine the significance of associations between the dependent and independent variables. The results are provided in Table 5. A positive and statistical significant change in FRMDs (mandFRMDs and discFRMDs) occurs between year 4 (post-IFRS) and 1 (pre-IFRS). The change in FRMDs between year 3 and 1 and between year 2 and 1 are not statistically significant. These results demonstrate that the introduction of IFRS has fundamentally increased the extent of financial risk management disclosures of extractive companies, further supporting Hypothesis 1. Further, there is a positive and statistical significant association between FRMD and CGS, capital raisings, size and leverage. A statistically significant and negative association exists between FRMD and overseas listing. Hypotheses 2 and 3 are supported by these results. Hypothesis 4 which postulates a positive association between FRMD and overseas listing is not supported by the results. Similar results are achieved for mandFRMD and discFRMD and the independent and control variables. Overall, these results provide support for the hypotheses. A potential problem with this analysis is that the same company is generally represented four times in the one dataset and repeated measurements of non-independent items may lead to biased regression results.
| FRMD: Coefficients | t Stat | p-value | mandFRMD: Coefficients | t Stat | p-value | discFRMD: Coefficients | t Stat | p-value | |
|---|---|---|---|---|---|---|---|---|---|
| Intercept | −52.918 | −7.666 | 0.000* | −6.058 | −0.742 | 0.458 | −96.431 | −10.913 | 0.000* |
| CGS | 0.179 | 5.510 | 0.000* | 0.191 | 4.985 | 0.000* | 0.167 | 4.026 | 0.000* |
| Capital raisings | 2.675 | 2.218 | 0.027** | 2.095 | 1.469 | 0.143 | 3.213 | 2.082 | 0.038** |
| Overseas listing | −4.223 | −3.182 | 0.002* | −6.128 | −3.904 | 0.000* | −2.455 | −1.445 | 0.149 |
| Size | 4.171 | 9.427 | 0.000* | 2.489 | 4.758 | 0.000* | 5.732 | 10.121 | 0.000* |
| Leverage | 1.472 | 4.944 | 0.000* | 1.095 | 3.109 | 0.002* | 1.823 | 4.782 | 0.000* |
| Sub-industry | 0.238 | 0.159 | 0.874 | 0.040 | 0.023 | 0.982 | 0.422 | 0.220 | 0.826 |
| Top20 | −0.016 | −0.490 | 0.625 | −0.026 | −0.670 | 0.503 | −0.007 | −0.163 | 0.871 |
| ROA | 0.004 | 0.159 | 0.873 | 0.025 | 0.760 | 0.448 | −0.015 | −0.412 | 0.681 |
| Year 2 – Year 1 | −1.247 | −0.755 | 0.451 | 0.274 | 0.140 | 0.889 | −2.659 | −1.257 | 0.209 |
| Year 3 – Year 1 | −0.960 | −0.564 | 0.573 | 0.877 | 0.436 | 0.663 | −2.666 | −1.223 | 0.222 |
| Year 4 – Year 1 | 6.905 | 3.982 | 0.000* | 9.041 | 4.409 | 0.000* | 4.922 | 2.217 | 0.027** |
| Adjusted R2 | 0.575 | Adjusted R2 | 0.380 | Adjusted R2 | 0.545 | ||||
| F Statistic | 53.510 | F Statistic | 24.820 | F Statistic | 47.570 | ||||
| Significance | 0.000* | Significance | 0.000* | Significance | 0.000* |
- The pooled regression equation (using Model 1) is stated as:
- FRMDI jt (mandFRMDIjt; discFRMDIjt) = αj + β1 CGSjt + β2 Capital Raisingsjt + β3 Overseas Listingjt + β4 Sizejt + β5 Leveragejt + β6 Top20jt + β7 Sub-industryjt + Yr1jt + Yr2jt + Yr3jt + Yr4jt + εj [Model 1]
- where Dependent Variable: FRMDI, Financial risk management disclosure index; mandFRMDI, Mandatory financial risk management disclosure index; discFRMDI, discretionary financial risk management disclosure index.; Independent Variables: CGSjt, corporate governance composite score for firm j in year t; Capital Raisingsjt, occurrence of equity, debt or hybrid capital raising for firm j in year t; Control Variables: Sizejt, natural log of total assets for firm j in year t; Leveragejt, square root of debt/debt + equity ratio (total liabilities/total equity + total liabilities) for firm j in year t; Top20jt, top 20 shareholders for firm j in year t; Sub-industryjt, firm j engaged in mining in year t (1 = yes, no = 0); ROA, pretax profit/total assets truncated at the fifth and 95th percentile; αj, intercept; β, estimated coefficient for each item or category; εj = error term. This regression tested the association between financial risk management disclosures for all sample firms (424 observations) pooled over the 4-year period and the independent variables corporate governance (CGS), capital raisings and overseas listing against the control variables of firm size, leverage, top 20 shareholder ownership and sub-industry. Associations * and ** are statistically significant at the 1 and 5 per cent levels.
The multiple regression results on panel data using Model 1 are shown as Table 6. Overall, predictor variables are strength of governance structures, capital raisings, overseas listing status, leverage and firm size in the pre-IFRS adoption period (years 1–3) and firm size and leverage in the post-IFRS adoption period. The regression model accounts for 47.80 per cent (year 3) to 61.3 per cent (year 1) of variability of FRMDs.
| FRMD: Coefficients | t Stat | p-value | mandFRMD: Coefficients | t Stat | p-value | discFRMD: Coefficients | t Stat | p-value | |
|---|---|---|---|---|---|---|---|---|---|
| Panel A: Year 1 | |||||||||
| Intercept | −51.033 | −4.734 | 0.000* | −14.976 | −1.081 | 0.282 | −84.514 | −6.444 | 0.000* |
| CGS | 0.204 | 3.315 | 0.001* | 0.198 | 2.498 | 0.014** | 0.210 | 2.805 | 0.006* |
| Capital raisings | 5.085 | 2.338 | 0.021** | 3.075 | 1.100 | 0.274 | 6.951 | 2.628 | 0.010** |
| Overseas listing | −5.994 | −2.301 | 0.024** | −7.291 | −2.177 | 0.032** | −4.790 | −1.511 | 0.134 |
| Size | 4.162 | 5.782 | 0.000* | 3.141 | 3.395 | 0.001* | 5.110 | 5.837 | 0.000* |
| Leverage | 0.700 | 1.415 | 0.160 | 0.523 | 0.823 | 0.413 | 0.864 | 1.436 | 0.154 |
| Sub-industry | −1.673 | −0.611 | 0.542 | −2.891 | −0.822 | 0.413 | −0.542 | −0.163 | 0.871 |
| Top20 | 0.009 | 0.166 | 0.869 | −0.001 | −0.017 | 0.987 | 0.019 | 0.279 | 0.781 |
| ROA | −0.036 | −0.844 | 0.401 | −0.040 | −0.727 | 0.469 | −0.033 | −0.625 | 0.534 |
| Adjusted R2 | 0.613 | Adjusted R2 | 0.369 | Adjusted R2 | 0.602 | ||||
| F Statistic | 21.618 | F Statistic | 8.603 | F Statistic | 20.642 | ||||
| Significance | 0.000* | Significance | 0.000* | Significance | 0.000* | ||||
| Panel B: Year 2 | |||||||||
| Intercept | −65.913 | −4.807 | 0.000* | −22.918 | −1.410 | 0.162 | −105.836 | −5.752 | 0.000* |
| CGS | 0.166 | 2.917 | 0.004* | 0.160 | 2.363 | 0.020** | 0.172 | 2.252 | 0.026** |
| Capital raisings | 4.837 | 1.990 | 0.049** | 6.699 | 2.324 | 0.022** | 3.109 | 0.953 | 0.343 |
| Overseas listing | −6.536 | −2.424 | 0.017** | −8.675 | −2.713 | 0.008* | −4.550 | −1.257 | 0.212 |
| Size | 5.219 | 5.746 | 0.000* | 3.758 | 3.489 | 0.001* | 6.576 | 5.395 | 0.000* |
| Leverage | 0.347 | 0.501 | 0.618 | 0.045 | 0.055 | 0.956 | 0.627 | 0.674 | 0.502 |
| Sub-industry | 2.036 | 0.685 | 0.495 | 3.214 | 0.912 | 0.364 | 0.943 | 0.236 | 0.814 |
| Top20 | −0.062 | −0.908 | 0.366 | −0.080 | −0.991 | 0.324 | −0.045 | −0.491 | 0.624 |
| ROA | −0.023 | −0.436 | 0.664 | 0.002 | 0.036 | 0.971 | −0.047 | −0.656 | 0.513 |
| Adjusted R2 | 0.537 | Adjusted R2 | 0.340 | Adjusted R2 | 0.474 | ||||
| F Statistic | 16.627 | F Statistic | 7.962 | F Statistic | 13.174 | ||||
| Significance | 0.000* | Significance | 0.000* | Significance | 0.000* | ||||
| Panel C: Year 3 | |||||||||
| Intercept | −66.024 | −4.148 | 0.000* | −16.623 | −0.946 | 0.347 | −111.897 | −5.527 | 0.000* |
| CGS | 0.168 | 2.504 | 0.014** | 0.225 | 3.032 | 0.003* | 0.116 | 1.352 | 0.180 |
| Capital raisings | −1.800 | −0.704 | 0.483 | −0.958 | −0.339 | 0.735 | −2.582 | −0.794 | 0.429 |
| Overseas listing | −5.854 | −2.189 | 0.031** | −8.526 | −2.887 | 0.005* | −3.373 | −0.992 | 0.324 |
| Size | 4.907 | 4.873 | 0.000* | 2.941 | 2.645 | 0.009* | 6.732 | 5.257 | 0.000* |
| Leverage | 1.461 | 2.250 | 0.027** | 0.838 | 1.169 | 0.245 | 2.039 | 2.470 | 0.015** |
| Sub-industry | 0.002 | 0.028 | 0.978 | 0.016 | 0.215 | 0.831 | −0.011 | −0.131 | 0.896 |
| Top20 | 1.777 | 0.578 | 0.564 | 2.707 | 0.798 | 0.427 | 0.913 | 0.234 | 0.816 |
| ROA | −0.015 | −0.228 | 0.820 | 0.004 | 0.062 | 0.950 | −0.032 | −0.396 | 0.693 |
| Adjusted R2 | 0.478 | Adjusted R2 | 0.308 | Adjusted R2 | 0.459 | ||||
| F Statistic | 13.366 | F Statistic | 7.006 | F Statistic | 12.472 | ||||
| Significance | 0.000* | Significance | 0.000* | Significance | 0.000* | ||||
| Panel D: Year 4 | |||||||||
| Intercept | −39.724 | −2.422 | 0.017 | 32.638 | 1.653 | 0.102 | −106.917 | −5.062 | 0.000 |
| CGS | 0.117 | 1.466 | 0.146 | 0.123 | 1.279 | 0.204 | 0.111 | 1.085 | 0.281 |
| Capital raisings | 4.100 | 1.493 | 0.139 | 1.441 | 0.436 | 0.664 | 6.570 | 1.857 | 0.066*** |
| Overseas listing | −0.369 | −0.135 | 0.893 | −2.082 | −0.631 | 0.530 | 1.222 | 0.346 | 0.730 |
| Size | 3.653 | 3.537 | 0.001* | 0.983 | 0.791 | 0.431 | 6.132 | 4.610 | 0.000* |
| Leverage | 3.032 | 4.978 | 0.000* | 2.420 | 3.301 | 0.001* | 3.599 | 4.589 | 0.000* |
| Sub-industry | 0.694 | 0.208 | 0.836 | −1.212 | −0.301 | 0.764 | 2.464 | 0.572 | 0.569 |
| Top20 | −0.080 | −1.102 | 0.273 | −0.091 | −1.047 | 0.298 | −0.069 | −0.742 | 0.460 |
| ROA | 0.113 | 1.656 | 0.101 | 0.140 | 1.707 | 0.091*** | 0.088 | 0.999 | 0.321 |
| Adjusted R2 | 0.486 | Adjusted R2 | 0.177 | Adjusted R2 | 0.522 | ||||
| F Statistic | 12.804 | F Statistic | 3.694 | F Statistic | 14.645 | ||||
| Significance | 0.000* | Significance | 0.000* | Significance | 0.000* | ||||
- The regression equation (Model 1) is stated as FRMDIjt (mandFRMDIjt; discFRMDIjt) = αj + β1 CGSjt + β2 Capital Raisingsjt + β3 Overseas Listingjt + β4 Sizejt + β5 Leveragejt + β6 Top20jt + β7 Sub-industryjt + εj. [Model 1] where, Dependent Variable: FRMDI, financial risk management disclosure index; mandFRMDI, mandatory financial risk management disclosure index; discFRMDI, discretionary financial risk management disclosure index; Independent Variables: CGSjt, corporate governance composite score for firm j in year t; Capital Raisingsjt, occurrence of equity, debt or hybrid capital raising for firm j in year t; Control Variables: Sizejt, natural log of total assets for firm j in year t; Leveragejt, square root of debt/debt + equity ratio (total liabilities/total equity + total liabilities) for firm j in year t; Top20jt, top 20 shareholders for firm j in year t; Sub-industryjt, firm j engaged in mining in year t (1 = yes, no = 0); ROA, pretax profit/total assets truncated at the fifth and 95th percentile; αj, intercept; β, estimated coefficient for each item or category; εj, error term. There are 105 observations in Year 1 and 109 observations in Years 2–4. Associations *, ** and *** are statistically significant at the 1, 5 and 10 per cent levels.
The results support the predictions of a positive association between the strength of corporate governance structure of sample firms (as measured by the CGS) and all financial risk management disclosures, as measured by FRMDI in years 1–3 (pre-IFRS) but not in year 4 (post-IFRS). There is a positive and statistically significant association between the strength of corporate governance and mandatory financial risk management disclosures in years 1–3. There is a positive and statistically significant association between the strength of corporate governance and discretionary financial risk management disclosures in years 1 and 2. Hypothesis 2 is supported in the pre-IFRS adoption period. Resource firms with a strong corporate governance structure (as measured by the CGS) have more extensive processes and systems in place as a catalyst to effectively manage their derivative and hedge positions. This is reflected as enhanced financial risk management disclosures.
A positive and statistically significant association between capital raisings and total, mandatory and discretionary financial risk management disclosures in achieved in years 1 and 2 only, supporting Hypothesis 3 in those years. Further, there is a positive and statistical significant association between capital raisings and discretionary financial risk management disclosures in year 4.
Contrary to expectations, there is a statistically significant and negative association between firms with overseas stock exchange listing or listings and the extent of total and mandatory financial risk management disclosures in years 1, 2 and 3 only. Hypothesis 4 is not supported by these results. Foreign listing is not necessarily an important driver of disclosure policy as the overall financial risk management program of these resource companies focuses on the unpredictability of commodity prices and foreign exchanges which can be managed independently of listing status.
Firm size is the only control variable consistently positively associated with FRMDI at a statistically significant level across all 4 years. Leverage is positively and statistically significantly associated with total, mandatory and discretionary financial risk management disclosures in years 3 (pre-IFRS) and 4 (post-IFRS). Tufano (1996) found a similar relationship between risk management activities and leverage of North American gold mining companies. This association is generally not statistically significant in years 1 and 2. Sub-industry is positively and statistically significantly associated with mandatory financial risk management disclosures in year 1 only. Return on assets is positively and statistically significantly associated with discretionary financial risk management disclosures in year 4 only. Sub-industry and ownership concentration are not significant predictor variables of FRMDs in any of the years.
The preceding multiple regression analysis provided as Model 1 assumes that the corporate governance and capital raisings are exogenously determined. It has been shown that endogeneity or omitted variables such as operational characteristics between firms may cause a bias13 in OLS regressions (Karamanou and Vafeas, 2005; Nikolaev and Vent, 2005; Ashbaugh-Skaife et al., 2006; Chenhall and Moers, 2007; Larcker et al., 2007). Prior empirical studies indicate that corporate governance structure is endogenously determined by firms’ contracting arrangements (Bushman et al., 2004; Ashbaugh-Skaife et al., 2006). Capital management characteristics such as capital raisings may also be endogenously determined (Healy and Palepu, 2001; Nikolaev and Vent, 2005). It is acknowledged that caution should be exercised in inferring a causal link between the extent of financial risk management disclosures and the independent (and control) variables. Furthermore, there could be correlated omitted variables that account for statistically significant associations. For instance, costs of disclosure may be an important issue in driving statistically significant associations. Further, increased disclosures and stronger corporate governance structures may both be the result of regulatory pressures. The evidence suggests that endogeneity may not be a significant factor driving the results.14
The study does attempt to control for the omitted variable problem by examining the association between the change in the levels of governance (for instance, as in Karamanou and Vafeas, 2005), capital raisings events, listing status and change in FRMDs over the study period. The rationale for this approach is that there is less likely to be a corresponding change in any potential omitted variable that is correlated with both the dependent and independent variable or variables. Therefore, a second multiple regression (Model 2, not shown for brevity) is run for consecutive reporting periods comprising year 1 and 2, and year 3 (pre-IFRS) and year 4 (post-IFRS). The results (not shown for brevity) indicate that there is a positive and statistically significant association between the change in total, mandatory and discretionary financial risk management disclosures and change in leverage between year 1 and 2. The change in total and mandatory financial risk management disclosures is positively and statistically significantly associated with the change in top 20 shareholder concentration between year 1 and 2. The change in discretionary financial risk management disclosures is positively and statistically significantly associated with the change in strength of corporate governance structures between year 1 and 2. The results indicate that there is a positive and statistically significant association between the change in total, mandatory and discretionary financial risk management disclosures and change in leverage between year 3 (pre-IFRS) and 4 (post-IFRS). The change in discretionary financial risk management disclosures is positively and statistically significantly associated with the change in strength of corporate governance structures between year 3 and 4.
A sub-sample of 18 companies with an ‘inherent uncertainty regarding continuation of the entity as a going concern’15 audit qualification was also examined. The purpose of this additional analysis was to determine how the financial risk management disclosures of these companies compared with those companies without that audit qualification. Financial risk management data were derived from 30 annual reports for 18 companies (i.e. some companies had an audit qualification over consecutive years) which had an audit qualification. Comparative descriptive statistics is provided in Table 7. Results of a t-test of differences in mean FRMDs of audit qualified and non-audit qualified firms are statistically significant at the 1 per cent level (results not shown for brevity).
| FRMD | mandFRMD | discFRMD | CGS | Size | Leverage | Top20 | ROA | |
|---|---|---|---|---|---|---|---|---|
| Panel A: Going concern qualification | ||||||||
| Mean | 35.062 | 48.718 | 15.952 | 50.256 | 17.144 | 7.584 | 58.910 | −36.047 |
| SEr | 2.230 | 2.537 | 2.690 | 3.252 | 0.319 | 0.533 | 3.964 | 5.274 |
| Median | 31.481 | 46.154 | 7.143 | 53.846 | 17.274 | 7.561 | 55.310 | −36.088 |
| SD | 12.216 | 13.898 | 14.732 | 17.811 | 1.745 | 2.917 | 21.712 | 28.887 |
| Sample variance | 149.220 | 193.158 | 217.042 | 317.214 | 3.045 | 8.511 | 471.398 | 834.448 |
| Kurtosis | −0.194 | 0.265 | −0.512 | −0.350 | 8.376 | −0.109 | −0.821 | −1.322 |
| Skewness | 0.619 | 0.026 | 0.953 | −0.474 | −2.114 | 0.213 | 0.223 | −0.112 |
| Range | 48.148 | 61.538 | 42.857 | 69.231 | 10.049 | 12.447 | 80.250 | 88.065 |
| Minimum | 11.111 | 15.385 | 0.000 | 15.385 | 10.136 | 1.539 | 18.320 | −77.056 |
| Maximum | 59.259 | 76.923 | 42.857 | 84.615 | 20.185 | 13.986 | 98.570 | 11.009 |
| Count | 30 | 30 | 30 | 30 | 30 | 30 | 30 | 30 |
| Confidence level (95 per cent) | 4.561 | 5.190 | 5.501 | 6.651 | 0.652 | 1.089 | 8.107 | 10.787 |
| Panel B: No Going Concern qualification | ||||||||
| Mean | 44.379 | 58.473 | 25.127 | 60.074 | 18.541 | 5.519 | 61.721 | −4.071 |
| SE | 0.907 | 0.881 | 1.098 | 1.217 | 0.101 | 0.100 | 1.024 | 1.234 |
| Median | 40.741 | 61.538 | 21.429 | 61.538 | 18.385 | 5.696 | 62.755 | 2.418 |
| SD | 18.006 | 17.485 | 21.787 | 24.147 | 1.999 | 1.977 | 20.320 | 24.497 |
| Sample variance | 324.222 | 305.711 | 474.681 | 583.092 | 3.994 | 3.908 | 412.910 | 600.081 |
| Kurtosis | −0.255 | 0.476 | 0.083 | −0.713 | 0.498 | −0.548 | −0.778 | 1.973 |
| Skewness | 0.332 | −0.487 | 0.929 | −0.381 | 0.580 | −0.224 | −0.127 | −1.471 |
| Range | 88.889 | 92.308 | 92.857 | 100.000 | 11.517 | 10.672 | 87.810 | 104.101 |
| Minimum | 0.000 | 0.000 | 0.000 | 0.000 | 13.376 | 0.878 | 12.040 | −77.056 |
| Maximum | 88.889 | 92.308 | 92.857 | 100.000 | 24.893 | 11.550 | 99.850 | 27.045 |
| Count | 394 | 394 | 394 | 394 | 394 | 394 | 394 | 394 |
| Confidence level (95 per cent) | 1.783 | 1.732 | 2.158 | 2.392 | 0.198 | 0.196 | 2.013 | 2.426 |
- Financial risk management characteristics of firms with an ‘inherent uncertainty regarding continuation of the entity as a going concern’ (Panel A) compared with firms without a going concern audit qualification (Panel B). mandFRMDI, discFRMDI and FRMDI refer to mandatory, discretionary and total financial risk management disclosures respectively. Also shown for each sub-sample is return on assets (ROA) measured as pretax profits divided by total assets truncated at the fifth and 95th percentiles, firm size measured as the natural log of total assets, leverage measured as the square root of debt divided by debt plus total equity and shareholder concentration (equity interest of the Top 20 shareholders).
Total financial risk management disclosures of audit qualified firms (35.06 per cent) are statistically significantly lower compared with non-audit qualified firms (44.37 per cent). Clearly, those firms with an audit qualification regarding continuation of that entity as a going concern do not have an effective disclosure framework in place. This is reflected in less extensive financial risk management disclosures within the annual reports of these firms. Stakeholders of audit qualified firms are not being provided with complete information regarding the financial risks and associated risk mitigation activities of these companies. There is some evidence of selective disclosure of financial risk information by some firms.16
As expected, audit qualified firms have a weaker corporate governance structure (50.25 per cent for audit qualified firms as compared with 60.07 per cent for non-audit qualified firms) and have considerably more debt in their capital structure with mean square root of leverage of 7.58 compared with 5.51 for non-audit qualified firms. Return on assets of audit qualified firms (-36 per cent) is fundamentally lower than that of non-audit qualified firms (-4 per cent). This difference is statistically significant at the 1 per cent level.
6. Conclusions
Using a sample of 111 Australian listed extractive resource firms, disclosures of financial risk management information increased over the period encompassing 2002–2006 financial years with a significant increase in disclosures of both a mandatory and discretionary nature recorded in the first full year annual report prepared following adoption of IFRS.
Although mandated disclosures of financial risk information are very similar pre-IFRS under AASB 1033 and post-IFRS under AASB 132, there has been a significant increase in disclosures being made by resource companies within the first year IFRS annual report. Hypothesis 1 is supported. There are a number of possible reasons for the observed disclosure patterns. First, the introduction of AASB 139 appears to have resulted in more transparent reporting of risk management policies relating to hedging activities, particularly given the requirement to document the effectiveness of hedging arrangements in offsetting risk on an ongoing basis. Second, the introduction of IFRS in Australia itself is akin to the introduction of a new form of regulation that has provided impetus for firm management and the board to refurbish existing treasury policies, create new treasury policies and revisiting accounting policies and practices and modifying them accordingly in order to create greater transparency, reduce uncertainty and increase the flow of information to capital market participants. This greater pressure to be transparent in the post-IFRS adoption environment may in turn have been an important driver of disclosure practices. Firms appear to be engaging in relatively more costly monitoring and specific information gathering activities of financial risk management information in the immediate post-IFRS environment. In doing so, IFRS provides timely and useful information to investors as well as confirms information that was available pre-IFRS adoption. This conclusion is consistent with recent studies on IFRS adoption in Australia which have found that adoption of IFRS is value relevant to investors (Becis et al., 2007).
Ordinary least squares regression regressions provide evidence of a significant positive association between the strength of corporate governance structure and financial risk management disclosures over the period encompassing the 2002–2006 period. Hypothesis 2 is accepted for the pre-IFRS adoption period but not in the first full year of IFRS reporting. Additional support is provided with the change in strength of governance structures being a positive and significant predictor of the change in discretionary financial risk management disclosures between consecutive reporting periods. Resource firms with a strong corporate governance structure have more extensive processes and systems in place as a catalyst to effectively manage their derivative and hedge positions. This is reflected as enhanced financial risk management disclosures. Over the past 5 years, regulatory bodies including The Group of 100, the ASX Corporate Governance Council and the Australian Securities and Investment Commission (2004) have emphasised the importance of corporate governance as a mechanism to enhance the quality of financial reporting. The common argument promoted by these regulatory bodies is that corporate governance plays a critical role in ensuring the credibility of financial statement information.
Similarly, a positive and significant association was found between FRMDs and the occurrence of a capital raising event in the 2002–2006 period. Resource firms that have raised capital are characterised by more extensive financial risk management disclosures. Hypothesis 3 is accepted for the pre-IFRS adoption period but not in the first full year of IFRS reporting. Financial institutions often require resource companies to implement sufficient hedging to cover repayments of project financing with these conditions being stipulated in debt covenants (PwC, 2005). Companies that raise capital are likely to be more motivated to disclose information concerning financial risk management practices. For example, Jenson and Meckling (1976) propose that more highly leveraged firms incur more monitoring costs and seek to reduce these costs by disclosing more information within annual reports.
Firms with multiple exchange listings are characterised by less extensive financial risk management disclosures. Firms with multi-listing status have lower levels of debt in their capital structure. As leverage is a statistically significant and positive predictor variable of financial risk management disclosure patterns, this would explain the lower level of disclosures by firms listed overseas. Hypothesis 4 was not supported by the results. Firm size, leverage and change in leverage between consecutive reporting periods are positive and significant predictor control variables of financial risk management disclosures. Firms with an inherent uncertainty audit qualification disclose significantly less financial risk information compared with firms without an audit qualification.
Footnotes
Appendix
Appendix: Financial risk management disclosure index
Financial risk management disclosure items
Mandatory
1. Extent of market risk (currency risk or foreign exchange risk) in relation to the use of financial instruments [1033.5.1,132.52(a)(i), 7.32, 7.33(a)].
2. Extent of market risk (commodity price risk) in relation to the use of financial instruments [1033.5.1.2(a)(iii), 132.52(a)(iii), 7.32, 7.33(a)].
3. Extent of credit risk in relation to the use of financial instruments [1033.5.1.2(b), 132.52(b), 132.77].
4. Extent of liquidity risk in relation to the use of financial instruments [1033.5.1.2(c), 132.52(c)].
5. Extent of interest rate risk in relation to the use of financial instruments [1033.5.12(a)(ii), 132.52(a)(ii), 132.52(d), 132.68].
6. An entity shall describe its financial risk management objectives and policies and procedures for controlling risks associated with financial instruments, for example, reporting of risks, policies and practices for dealing with risks [1033.5.1.1, 132.56, 132.57, 7.32, 7.339b)].
7. Interest rate risk – maturity dates and/or contractual repricing [1033.5.4(a), 1033 5.4.9(a)(b), 132.67(a), 132.69, 132.70].
8. Interest rate risk – effective interest rates [1033.5.1.2(a), 1033.5.4(b), 132.67(b)].
9. Indicates which of its financial assets and financial liabilities are exposed to interest rate risk [1033.5.4.4, 132.71].
10. Indicates which of its financial assets are exposed to credit risk [1033.5.5, 132.76].
11. Areas of significant concentrations of credit rate risk [1033.5.5(b), 132.76(b)].
12. Master netting arrangements to mitigate exposure to credit loss [1033.5.5.5, 132.81].
13. Maximum exposure to credit risk [1033.5.5(a), 132.76(a)].
Discretionary
14. Discussion of controls put in place to manage financial instrument risk exposure.
15. An entity shall disclose a sensitivity analysis for each type of market risk to which the entity is exposed at reporting date showing how profit or loss and equity would have been affected by changes in the relevant risk.
16. Methods and assumptions used in preparing the sensitivity analysis.
17. How credit risk arose.
18. In respect of credit risk exposure, a description of collateral held as security and other credit enhancements.
19. Exposure to liquidity risk in relation to the use of financial instruments and how it arose.
20. Disclosure of a maturity analysis for financial liabilities that shows the remaining contractual liabilities.
21. How interest rate risk arose.
22. An entity shall describe the methods used to measure risk arising from use of financial instruments.
23. Summary quantitative data about entity’s exposure to any risk in respect of financial instrument use.
24. Amount of change in the fair value of loan or receivable attributable to changes in credit risk of financial asset.
25. Amount of change in the fair value of any related credit derivatives or similar instruments since loan or receivable was designated.
26. Amount of change in the fair value of financial liability attributable to changes in credit risk.
27. The difference between the financial liabilities carrying amount and the amount the entity would be contractually required to pay at maturity to the holder of the obligation.
Mandatory financial risk management information comprises a discussion of the extent to which the entity is exposed to foreign exchange, commodity price, credit, liquidity and interest rate risk, a reference to the firm’s financial risk management objectives, effective interest rates, maturity dates and the financial assets and liabilities exposed to interest rate risk, financial assets exposed to credit risk and areas of significant credit risk concentration. Mandatory financial risk management information was obtained from the relevant accounting standards on financial instrument disclosures – AASB 1033 (pre-IFRS) and AASB 132 (post-IFRS). The mandated disclosures of derivative and hedge accounting information under AASB 1033 and AASB 132 are very similar. Discretionary financial risk management information was derived from extant literature (for example, Chalmers and Godfrey, 2004) and AASB 7 Financial Instruments: Disclosures (effective 1 January 20071) disclosure requirements (AASB, 2005).
