Three Essays on Market Risk Disclosures

219 Pages·2015·2.52 MB·English

School of Accounting

Three Essays on Market Risk Disclosures: Corporate Governance, Investment
Efficiency and Implied Cost of Equity Capital: Evidence from Gulf Cooperation
Council Countries (GCC)

Ahmed Khamis Hamdan Al-Hadi

This thesis is presented for the of the Degree of
Doctor of Philosophy
of
Curtin University

July 2015
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DECLARATION
To the best of my knowledge and belief this thesis contains no material previously published
by any other person except where due acknowledgement has been made. This thesis contains
no material which has been accepted for the award of any other degree or diploma in any
university.

NAME: AHMED bin KHAMIS bin HAMDAN AL-HADI

Signature:
………………………………………………………………………………

Date:

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ABSTRACT
Market risk exposures have grown considerably in financial firms during the last few years in
the Gulf Corporation Council (GCC). With an increase in the growth and size of this market,
it has become increasingly important to understand economic consequences behind these
exposures. Extant literature lacks adequate research in this area and studies globally and in
emerging types markets such as the GCC countries are scarce. This thesis is a rigorous
empirical investigation of the interaction of three aspects of market risk disclosures
determinants and consequences of GCC listed financial firms: corporate governance,
investment efficiency and the implied cost of capital. Using a unique hand-collected dataset
from 2007 to 2011, I developed mandatory and discretionary market risk disclosures indices
based on the form (qualitative and quantitative) and number of market risk exposures (e.g.
interest rate risk, foreign currency risk and equity risk) disclosed in annual reports by GCC
financial firms. Then, based on this index, I generate discretion (disaggregation) in
mandatory market risk disclosures (extent and quality) variable proxies.
First, incorporating elements of agency theory, legitimacy theory, stakeholder theory, and
resource-based dependency, I investigate the impact of a separate risk committee on the
extent and quality of market risk disclosures. In particular, I test whether the extent and
quality of market risk disclosures correspond to the existence of a separate risk committee,
the risk committee characteristics and tests whether the role of a risk committee in affecting
market risk disclosures varies with different stages in the firm life cycle. I find that firms with
a separate risk committee are associated with greater extent and higher quality market risk
disclosures. Furthermore, I find that risk committee qualifications and size have a significant
positive impact on the market risk disclosures. Additional analysis shows that a risk
committee plays a more crucial role in improving the market risk disclosures of mature firms
than that of young firms.
Second, I investigate the association between discretion in mandatory market risk disclosures
and investment efficiency. I find both under- and over-investment are significantly negatively
associated with discretion in mandatory market risk disclosures. Further, firms that follow
both voluntary disclosure and discretion in mandatory risk disclosure enjoy better investment
efficiency. Results are consistent with the theory that discretion in disclosures provides
managers with alternative channels to provide more firm specific information, which reduces
both adverse selection and moral hazard problems and thus improves investment efficiency.
Third, I investigate the association between disaggregation in mandatory risk disclosures,
auditor conservatism and the implied cost of equity capital. Disaggregation of disclosures
specifically for market risk exposures of financial firms are informative and reveal more
private risk information components. I find that the implied cost of equity capital is
significantly negatively associated with discretionary disaggregation in mandatory market
risk disclosures. Furthermore, the interaction between auditor conservatism and firms'
disaggregation provides greater reduction to the implied cost of equity capital. These findings
are robust when subjected to a series of sensitivity tests.
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ACKNOWLEDGEMENTS
I am immensely very grateful to the almighty Allah, who Has given me the mental strength
and ability to complete this dissertation. And to my Prophet Mohammed (PBUH) who
encourages us to seek for education.
I am indebted to my PhD supervisor Associate Professor Dr Grantley Taylor and Co-
supervisor Professor John Evans for their enthusiasm, guidance and feedback in enabling me
to complete this thesis in a timely manner. In particular Grantley showed his willingness,
time, enthusiasm, meaningful suggestions and sincere academic guidance which take me on
as a doctoral student.
I am indebted greatly to my mother and father who grow me and made me a man who can
live away from the homeland. I am also grateful to my faithful wife and my two children
(Sultan and Rosan) for taking the painful experience of staying away from me for such a long
time. I am also thankful to all of my brothers and sisters and all other family members for
their supports. Without them the completion of this dissertation would have taken much
longer time.
I would like to thank Professor Mahmud Hossain for their support and suggestions;
particularly he first made initial enquiries into the doctorate program and Dr. Ahsan Habib
and Mostafa Monzur Hasan for their helpful comments and supports. In addition, I thank all
CBS coordinators and staffs and Curtin School of Accounting staffs who extended their
helping hands and guidance in times of need and support. Further, I would like to thank my
my government (Sultanate of Oman), employer (Ministry of Higher Education) and Oman
General Consulate for their support and sponsorship for my doctorate especially Dr. Hamed
Al Alwai- Oman Culture Attaché. Also I would like to thank The Research Council (TRC)
for their sponsorship and support. I would like thank the Minister Dr. Rawya bin Saud Al –
Busaidi and Dr. Abdulla bin Mohammed Al Sarami- Undersecretary of Ministry of Higher
Education for their continues support.
I offer my truthful thanks to my brothers; Faisal Al Siyabi, Mohammed Al Mawali, Abdull
Hakim Al Hinahi, Ahmed Al Monthri, Baban Ibrahim, OSSWA, Mohammed Al Zakwani,
Aysha Al Hajari, Dr. Salem Al N’abi, Dr. Abdulla Al Tobi, Yousif Al Kusaimi, Khamis Al
Fazari, Fahad Al Amari, Abdual Al Fatah Al Shikaili, Bader Al Wihabi and Anwar Al Alawi
for their help, company and joy, humour and laughter they brought during tough times and
the PhD journey.
Finally I dedicate this work to my father’s soul (Allah blessed him), my great mother and my
patient wife and to my kids.

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CONTENTS
CHAPTER 1 .............................................................................................................................................. 1
THREE ESSAYS ON MARKET RISK DISCLOSURES: CORPORATE GOVERNANCE,
INVESTMENT EFFICIENCY AND IMPLIED COST OF EQUITY CAPITAL ................................. 1
1. INTRODUCTION ...................................................................................................................... 1
2. OBJECTIVES OF THE STUDY ................................................................................................ 6
3. SUMMARY OF RESULTS AND SIGNIFICANCE CONTRIBUTIONS ................................ 7
3.1 Objective 1: Market risk disclosures, corporate’s life cycle and board risk committee ........... 7
3.2 Objective 2: Discretion in market risk disclosures and investment efficiency ......................... 9
3.3 Objective 3: Disaggregation in Market Risk Disclosures, Auditor Conservative and the
Implied Cost of Capital ................................................................................................................. 11
4. ASSUMPTION AND LIMITATIONS ..................................................................................... 14
5. OVERVIEW OF THE THESIS ................................................................................................ 17
CHAPTER 2 ......................................................................................................................................... 19
THE GCC ENVIRONMENT, MARKET RISK: CONCEPTUAL AND INSTITUTIONAL
BACKGROUND AND LITERATURE REVIEW ............................................................................... 19
1. INTRODUCTION .................................................................................................................... 19
2. GCC: POLITICAL AND ECONOMIC ENVIRONMENT AND CAPITAL MARKETS ...... 19
2.1 Sultanate of Oman ................................................................................................................... 22
2.2 Qatar ........................................................................................................................................ 22
2.3 Kingdom of Bahrain................................................................................................................ 23
2.4 Kuwait ..................................................................................................................................... 23
2.5 Kingdom of Saudi Arabia (K.S.A) .......................................................................................... 24
2.6 United Arab Emirates (U.A.E): ............................................................................................... 24
3. MARKET RISK: CONCEPTUAL AND INSTITUTIONAL BACKGROUND ..................... 25
3.1 Qualitative and Quantitative Market Risk Disclosures: .......................................................... 30
3.2 Qualitative Market risk Disclosures based on IFRS7: ............................................................ 30
3.3 Quantitative Market risk Disclosures: formats: ...................................................................... 31
4. THEORETICAL FRAMEWORK ............................................................................................ 34
4.1 Information asymmetry ........................................................................................................... 35
4.2 Agency Theory ........................................................................................................................ 36
4.3 Interaction of Mandatory and Voluntary disclosures: ............................................................. 38
5. LITERATURE REVIEW ......................................................................................................... 41
5.1 Consequences of Market Risk disclosures studies .................................................................. 41
5.2 Determinants of Market risk disclosures studies .................................................................... 58
6. SUMMARY OF CHAPTER 2 ...................................................................................................... 67
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7. CONCLUSION ............................................................................................................................. 68
CHAPTER 3 ......................................................................................................................................... 69
DATA SOURCES AND SAMPLE DESIGN ...................................................................................... 69
1. INTRODUCTION .................................................................................................................... 69
2. DATA SOURCE ....................................................................................................................... 70
3. SAMPLE SELECTION ............................................................................................................ 71
4. CHAPTER SUMMARY ........................................................................................................... 74
CHAPTER 4 ......................................................................................................................................... 75
MARKET RISK DISCLOSURES, CORPORATE’S LIFE CYCLE AND BOARD RISK
COMMITTEE ....................................................................................................................................... 75
1. INTRODUCTION .................................................................................................................... 75
2. LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT ........................................... 78
2.1 Risk Committee (RC).............................................................................................................. 78
2.2 Market Risk Disclosures ......................................................................................................... 79
2.3 Connection between the Risk Committee (RC) and Market Risk Disclosures ....................... 79
2.4 Risk Committee (RC) Characteristics and Market Risk Disclosures ...................................... 81
2.5 Connection of Risk Committee (RC) and Firm Life Cycle with Market Risk Disclosures
(EMRD and QMRD) ..................................................................................................................... 84
3. RESEARCH DESIGN AND MEASUREMENT ......................................................................... 87
3.1 Dependent Variable................................................................................................................. 87
3.2 Independent Variable .............................................................................................................. 89
3.3 Control Variables .................................................................................................................... 91
3.4 Empirical Model ..................................................................................................................... 92
4. EMPIRICAL RESULTS AND DISCUSSION ............................................................................. 93
4.1 Descriptive Statistics ............................................................................................................... 93
4.2 Factor Analysis ....................................................................................................................... 93
4.3 Univariate t-Test ..................................................................................................................... 94
4.4 Correlation Analysis ............................................................................................................... 95
Regression Analysis ...................................................................................................................... 95
4.5 Association between Risk Committee (RC_D) and Extent and Quality of Market Risk
Disclosure (EMRD and QMRD) ................................................................................................... 95
4.6 Association between Risk Committee (RC) Characteristics and Extent and Quality of Market
Risk Disclosure (EMRD and QMRD) .......................................................................................... 99
4.7 Additional Analysis: Risk Committee, Firm Life Cycle, and Market Risk Disclosures
(EMRD and QMRD) ................................................................................................................... 101
4.8 Endogeneity Test: Two Stage Least Square (2SLS) ............................................................. 106
5. CHAPTER SUMMARY ......................................................................................................... 109
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CHAPTER 5 ....................................................................................................................................... 112
DISCRETION IN MANDATORY RISK DISCLOSURES AND INVESTMENT EFFICIENCY ... 112
1. INTRODUCTION .................................................................................................................. 112
2. THEORETICAL BACKGROUND AND HYPOTHESIS DEVELOPMENT .......................... 114
2.1 Discretion in Mandatory in Market Risk Disclosure: Theory ............................................... 114
2.2 Investment Efficiency: Theory .............................................................................................. 115
2.3 Hypothesis Development ...................................................................................................... 116
3. RESEARCH DESIGN AND MEASUREMENT of VARIABLES ........................................... 118
3.1 Dependent Variable: Proxy for Investment Efficiency ......................................................... 118
3.2 Independent Variable ............................................................................................................ 119
Market Risk Disclosures: DMRD1 ............................................................................................. 120
Market Risk Disclosures: DMRD2 ............................................................................................. 121
3.3 Control Variables .................................................................................................................. 121
3.4 Empirical Models .................................................................................................................. 122
3.5 Mandatory Market Risk Disclosure, Voluntary Earning Disclosure and Investment Efficiency
.................................................................................................................................................... 123
4. EMPIRICAL RESULTS AND DISCUSSION ....................................................................... 124
4.1 Descriptive Statistics ............................................................................................................. 124
4.2 Correlation Analysis ............................................................................................................. 125
4.3 Regression Analysis .............................................................................................................. 126
4.3.1 Association between Mandatory Risk Disclosures (DMRD) and Investment Efficiency . 126
4.3.2 Existence of Voluntary Disclosure (VD), Mandatory Market Risk Disclosures (DMRD),
and Investment Efficiency .......................................................................................................... 128
4.3.3 Sensitivity Analysis............................................................................................................ 130
4.3.4 Potential Endogeneity between Mandatory Market Risk Disclosures and Investment
Efficiency .................................................................................................................................... 133
4.3.4 Additional analysis ............................................................................................................. 135
5. CHAPTER SUMMARY ......................................................................................................... 135
CHAPTER 6 ....................................................................................................................................... 138
DISAGGREGATION, AUDITOR CONSERVATISM and IMPLIED COST OF EQUITY CAPITAL
............................................................................................................................................................ 138
1. INTRODUCTION .................................................................................................................. 138
2. BACKGROUND AND HYPOTHESES DEVELOPMENT .................................................. 143
3. RESEARCH DESIGN AND MEASURMENT ......................................................................... 147
3.1 Dependent Variable............................................................................................................... 147
3.2 Independent Variable ............................................................................................................ 150
Market Risk Disclosures: DMRD1 ............................................................................................. 150
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Market Risk Disclosures: DMRD2 ............................................................................................. 151
3.3 Control Variables .................................................................................................................. 151
3.4 Empirical Models .................................................................................................................. 153
4. EMPIRICAL RESULTS AND DISCUSSION ........................................................................... 155
4.1 Descriptive Statistics ............................................................................................................. 155
4.2 Correlation Analysis ............................................................................................................. 156
4.2.1 Variables correlation .......................................................................................................... 156
4.2.2 To what Extent does Disaggregation in Mandatory Risk Disclosures have a Negative Effect
on the ICOE? ............................................................................................................................... 157
4.0 Regression Analysis .............................................................................................................. 157
4.1 H : Association between Disaggregated Mandatory Risk Disclosures and Implied Cost of
1
Capital (ICOE) ............................................................................................................................ 157
4.2 H : Interaction between Disaggregation in Mandatory Market Risk Disclosures, Auditor
2
Conservatism and Implied Cost of Capital (ICOE) .................................................................... 160
4.3 Sensitivity Analysis............................................................................................................... 162
4.3.2 Potential serial dependence ................................................................................................ 164
4.3.5 Sample partition into sub-samples ..................................................................................... 166
4.3.6 Potential endogeneity between disaggregated mandatory market risk disclosures and
implied cost of capital: using two-stage least square (2SLS)...................................................... 168
4.3.8 Additional analysis: Royal family members ...................................................................... 174
5. CHAPTER SUMMARY ............................................................................................................. 175
CHAPTER 7 ....................................................................................................................................... 178
CONCLUSION ................................................................................................................................... 178
1. INTRODUCTION .................................................................................................................. 178
2. SUMMARY OF FINDINGS .................................................................................................. 178
3. CONTRIBUTION ................................................................................................................... 180
4. FUTURE IMPLICATIONS .................................................................................................... 182

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LIST OF TABLES
1. Table 2.1: Summary of GCC’s background section 25
2. Table 2.2: Corporate governance codes and provision for risk disclosures 29-30
3. Table 2.3: Summary of consequences market risk disclosures studies 51-57
4. Table 2.4: Summary of determinants market risk disclosures studies. 63-66
5. Table 3.1 Sample Distribution based on Country and Year 72
6. Table 3.2: Sample Distribution based on Industry 72
7. Table 3.3 Sample Selection “Objective 1” 72
8. Table 3.4 Sample Selection “Objective 2” 73
9. Table 3.5 Sample distribution based on country and year “Objective 3” 73
10. Table 4.1 Descriptive Statistics 93
11. Table 4.2: Factor Analysis for Risk Committee (RC) and Audit Committee (AC) 94
12. Table 4.3 Mean Comparison between firm with RC and without RC 95
13. Table 4.4: Pearson Correlation Matrix-Objective 1 97
14. Table 4.5: Association between RC_D and Market Risk Disclosures (EMRD and
QMRD) 98
15. Table 4.6: Association between Risk Committee (RC) Characteristics and Market
Risk Disclosures (EMRD and QMRD) 100
16. Table 4.7: Risk Committee (RC), Firm Life Cycle (RE/TA) and Market Risk
Disclosures (EMRD and QMRD) 102
17. Table 4.8: RE/TA based on Sample Partition: Young, Maturity and Old 103
18. Table 4.9: Risk Committee (RC), Firm Life Cycle (RE/TE) and Market Risk
Disclosures (EMRD and QMRD) 107
19. Table 4.10: Endogeneity Test- 110
20. Table 2: Descriptive Statistics- 125
21. Table 5.2: Pearson Correlation Matrix 127
22. Table 5.3: Association between Discretion in Mandatory Risk Disclosures (DMRD1)
and Investment Efficiency 129
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23. Table 5.4: Association between Interaction of Voluntary Disclosure, Discretion in
Mandatory Market Risk Disclosures (DMRD1) and Investment Efficiency 130
24. Table 5.5: Sensitivity Analysis: Association between Discretion in Mandatory
Market Risk Disclosures (DMRD2) and Investment Efficiency 132
25. Table 5.6: Sensitivity Analysis: Association between Interaction of Voluntary
Disclosure and Discretion of Mandatory Risk Disclosure (DMRD2) and Investment
Efficiency
27. Table 6.1: Descriptive Statistics 156
28. Table 6.2: Pearson Correlation Matrix 159
29. Table 6.3: Disaggregated Market Risk Disclosures and Implied Cost of Equity Capital
161
30. Table 6.4: Disaggregated Market Risk Disclosures (DMRD1), Audit Conservatism
and Implied Cost of Equity Capital 163
31. Table 6.5 Additional tests: Disaggregated Market Risk Disclosures (DMRD2) and
Implied Cost of Equity Capital 165
32. Table 6.6 Additional tests: Disaggregated Market Risk Disclosures (DMRD2), Audit
Conservatism and Implied Cost of Equity Capital 167
32. Table 6.7 Sensitivity tests: Disaggregated Market Risk Disclosures, Audit
Conservatism and Implied Cost of Equity Capital using firm’s specific measures 169
33. Table 6.8 Endogeneity tests 172
34. Table 6.9 Sensitivity tests: Disaggregated Market Risk Disclosures and Implied Cost
of Equity Capital on portfolio based using (Fama and French 1996) Factors: 174
35. Table 6.10: Association between Disaggregation, Audit Conservatism, Non-Royal
family, and ICOE 176

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