1 Emerging Markets Review 3 (2002) Measuring transparency and disclosure at firmlevel in emerging markets Sandeep A. Patel*, Amra Balic, Liliane Bwakira Standard & Poor s, New York, NY, USA Received 31 January 2002; received in revised form 30 June 2002; accepted 6 September 2002 Abstract Transparency and disclosure are integral to corporate governance. In this paper, we use a new dataset to analyze Transparency & Disclosure scores (T&D score) in 19 emerging markets for 354 firms representing 70% of S&PyIFCI Index market capitalization over the 3 years ending in We analyze differences across countries, economic sectors and trend over the 3 years. We find that the Asian emerging markets and South Africa have significantly higher transparency and disclosure compared to the Latin American, Eastern European, and Middle Eastern emerging markets. The gap between the Asian emerging markets and South Africa over other emerging markets has increased over the last 3 years. We do not find any significant differences in T&D scores among economic sectors. Changes in the T&D scores over the last 3 years, however, differ by economic sectors for the 6 markets with the largest investable market capitalization andyor number of observations, viz. Brazil, Poland, South Africa, India, Thailand, and Korea. We then study the relationships between T&D scores and cross-holdings for the 6 emerging markets. For the 6 markets except Korea, correlation between cross-holdings and T&D scores is negative. For the 6 markets except South Africa, correlation between price-to-book ratios and T&D scores is positive. We conclude with a discussion on further research Elsevier Science B.V. All rights reserved. Keywords: Emerging markets; Transparency and disclosure; Stakeholders *Corresponding author. Tel.: q ; fax: q address: (S.A. Patel) /02/$ - see front matter 2002 Elsevier Science B.V. All rights reserved. PII: S Ž
2 326 S.A. Patel et al. / Emerging Markets Review 3 (2002) Introduction Transparency and disclosure are integral to corporate governance. Higher transparency and better disclosure reduce the information asymmetry between a firm s management and financial stakeholders equity and bond holders, mitigating the agency problem in corporate governance. We document significant cross-country differences in transparency and disclosure among 19 large and liquid emerging markets countries. Our results suggest that firms with higher transparency and disclosure are valued higher than comparable firms with lower transparency and disclosure. Our results provide empirical support to the academic, practitioner, and regulatory focus on transparency and disclosure. Financial literature has analyzed the agency problems arising from the asymmetric information between a firm s management and financial stakeholders for well over 75 years, with an increasing focus over the last 25 years. The practitioners, large institutional equity investors in particular, have also demonstrated increasingly active participation in creating a level playing ground between the management and financial stakeholders. One of the main functions of regulators is to ensure an investment environment where gains from private information are minimized ex-ante and penalized ex-post. The focus on transparency and disclosure has increased in the wake of recent events beginning with the Asian crisis in the later half of 1997 and continuing with the recent discussions in the US equity markets. Our results are based on a newly compiled dataset on Transparency & Disclosure scores (T&D score) at Standard & Poor s. The T&D score analyze the latest available annual reports for over 1600 large and liquid companies in over 30 countries and assess the level of transparency by searching company annual reports for the inclusion of 98 possible information items ( attributes ) broadly divided into three sub-categories: Ownership structure and investor relations Financial transparency and information disclosure Board and management structure and process This new dataset enables us to add a broad international dimension to the growing empirical evidence on the effect of corporate governance on firm valuation. We begin by describing the dataset in Section 1. Section 2 compares the differences in transparency and disclosure levels at the end of the year 2000 among emerging markets, regions, and economic sectors. Our analysis of the cross-sectional differences introduces the trends in the transparency and disclosure over the last 3 years, presented in Section 3. We then examine the correlation of transparency and disclosure with the ownership structure and the valuation of firms in Sections 4 and 5, respectively. The last section provides summary observations and directions for further research. 2. Transparency & disclosure scores The agency problem in corporate governance can be mitigated in practice in several ways: by a vigilant board of directors, by timely and adequate disclosure of
3 S.A. Patel et al. / Emerging Markets Review 3 (2002) financial information, and possibly by a transparent ownership structure clarifying the conflict of interests in allowing majority shareholders or large creditors to manage the company. Standard & Poor s has introduced a methodology to assess the level of transparency and disclosure along these three dimensions. The methodology, as briefly described in Box 1 Box 1Methodology for standard & Poor s T&D score The T&D score are developed from the analysis of the latest available annual reports, and assess the level of transparency and disclosure of companies in emerging markets (Asia, Latin America, Central and Eastern Europe, and Africa) as well as developed markets (Europe, developed Asia and the US). Transparency and disclosure is evaluated by searching company annual reports (both English and local language) for the information of 98 possible attributes broadly divided into the following three subcategories: (a) Ownership structure and investor relations (28 attributes); (b) Financial transparency and information disclosure (35 attributes); (c) Board and management structure and process (35 attributes). Each question is scored on a binary basis to ensure objectivity, and scores for the three broad subcategories and an overall score are developed from scores on individual questions. Example questions (1) Ownership structure and investor relations Does the annual report contain: (a) A description of the share classes? (b) A review of shareholders by type? (c) A description of the voting rights? (2) Financial transparency and information disclosure Does the annual report contain information on: (a) The company s accounting policy? (b) Consistency of company accounting with the international accounting standards (IAS or US GAAP)? (c) Efficiency indicators (return of assets, return on equity, etc.)? (3) Board and management structure and processes Does the annual report contain: (a) A list of board members? (b) A list of board committees? (c) Audit committee? (d) Details of directors remuneration and details of performance related pay for directors? (e) Related party transactions? The Standard & Poor s T&D score will eventually cover approximately 1600 companies covering the Standard & Poor s Global 1200 Index and an additional 400 companies representing the leading companies in S&PyIFCI emerging markets index. The S&P Global 1200 represents leading global companies and includes the S&P 500, 150 companies in Japan, and 350 companies in Europe. These 1600 companies cover over 40 markets and represent approximately 70% of the world s tradable market capitalization., is to search the company annual reports for 98 possible transparency and disclosure attributes. A T&D score is developed for each company from an objective and binary evaluation of the number of attributes present in the annual report. This paper analyzes the T&D scores for 354 companies in 19 emerging markets
4 328 S.A. Patel et al. / Emerging Markets Review 3 (2002) representing 70% of the S&PyIFCI Index market capitalization at the end of For the companies in our sample, we also have the cross-holdings and valuation information available from the emerging markets database developed by the International Finance Corporation (IFC) and now owned by Standard & Poor s. Table 1 provides the list of the emerging markets analyzed by region, the number of companies by market, and proportion of S&PyIFCI Index market capitalization covered by our sample. Our research covers 200 companies in Asia, 80 companies in Latin America, 53 companies in Europe and the Middle East and 21 companies in South Africa. Of the major investable markets in S&PyIFCI Index, results for Russia and Taiwan are not presented. In Russia, heavy concentration of the investable stock market in a few stocks translates into a very small sample size, whereas in Taiwan, heavy reliance on local language reporting limited our ability to control the quality of results. The range of market capitalization covered by our study varies by countries. In Asia, the market capitalization covered ranges from 67% for Pakistan to 85% for the Philippines. In Latin America, the market capitalization covered ranges from 51% for Brazil to 83% for Argentina. In Europe and the Middle East, the market capitalization covered ranges from 64% in Turkey to 88% in Hungary. The percentage of market capitalization covered is higher than 80% in 5 countries, and is higher than 70% in 14 countries. 3. Differences in transparency and disclosure scores by countries, regions, and economic sector Table 1 also shows that the variation in the T&D score for the three regions is high: Asia has the highest score of 43; the Europe and Middle East score of 36 is higher than the Latin America score of 29. The Asia T&D scores possibly reflect the efforts to improve corporate governance by local regulators and multi-laterals in the wake of the Asian crisis beginning in the later half of These scores are expressed as percentage of information attributes present in annual reports, and exhibit a low level of transparency and disclosure among emerging markets. Even for South Africa, the country with the highest T&D score, annual reports contain information on only 55% of the attributes. The number of companies disclosing information on more than 60% of the attributes is 15, approximately 4% of our sample. Table 2 presents the distribution of T&D scores by economic sector. In relation to the variation in T&D scores among countries and regions, the distribution of T&D scores by economic sectors is less interesting. The only outlying sector is Utilities with an average T&D score of 34, compared to the average score of 43 for information technology, and of 42 for Health and Telecommunications. This difference in T&D scores by economic sectors might be related to the ownership structures: utilities in emerging markets are largely state owned and recently privatized, the Health Care sector has a history of ownership by foreign companies, telecommunications services stocks have foreign listings, and the information technology sector is largely owned by first generation entrepreneurs.
5 Table 1 Distribution of T&D score for 19 emerging markets at the end of 2000 Country Number of Investable Percentage of Average Number of companies with scores companies market S&PyIFCI transparency capitalization market and Lower than Between 40 Between 60 Higher than (million US$) capitalization disclosure 40 and 60 and covered score Asia China India Indonesia Korea Malaysia Pakistan Philippines Thailand Latin America Argentina Brazil Chile Mexico Peru Europe, Middle East Czech Republic Hungary Israel Poland Turkey South Africa Total T&D score are developed by Standard & Poor s to analyze the information available in annual reports on the ownership structure, financial transparency, and board and management structure and process. The table also shows the number of companies analyzed, total investable market capitalization, and the percentage of S&PyIFCI market capitalization covered in our analysis by country and region. S.A. Patel et al. / Emerging Markets Review 3 (2002)
6 Table 2 Distribution of T&D score by ten GICS* economic sectors at the end of 2000 GICS sector Number of Investable Average Number of companies with scores companies market transparency capitalization and Lower than 40 Between 40 Between 60 Higher than (million US$) disclosure and 60 and score Energy Materials Industrials Consumer discretionary Consumer staples Health care Financials Information technology Telecommunication services Utilities Total The table also shows the number of companies analyzed and total investable market capitalization of the companies in our analysis by economic sector. *GICS refers to the Global Industrial Classification Standard co-developed by Standard & Poor s and MSCI. 330 S.A. Patel et al. / Emerging Markets Review 3 (2002)
7 S.A. Patel et al. / Emerging Markets Review 3 (2002) Table 3 Levels of T&D score at the end of 1998, 1999, and 2000 Country Number of Investable market Average transparency companies capitalization and disclosure (million US$) score Change in score over 1999 over Asia China y1 India Indonesia Korea Malaysia Pakistan Philippines y1 2 Thailand Latin America Argentina y3 y2 Brazil Chile y1 2 Mexico Peru Europe, Middle East Czech Republic y7 y1 Hungary y1 0 Israel Poland Turkey y1 0 South Africa The table also shows changes in T&D score from 1998 to 1999 and to Trends in transparency and disclosure scores The discussion in Section 2, with the supporting numbers in Tables 1 and 2, shows that the level of transparency and disclosure in emerging markets at the end of 2000 was low, despite the increased attention on corporate governance following the Asian crisis. Has the increased attention improved the level of transparency and disclosure improved over the years? This section analyzes the results presented in Table 3 on the time-series of T&D scores by country and region. Table 3 shows that the T&D scores for Asia and Europe-Middle East were about the same at the end of 1998, at 37 and 35, respectively. Latin America had the lowest T&D score at 29, and South Africa had the highest T&D score of 49 at the end of The T&D scores for Europe-Middle East and Latin America have changed little over the 3 years analyzed in this study. South Africa, on the other hand, has improved transparency and disclosure despite its relatively higher level of T&D scores in Poland and Brazil also provided examples of improving
8 332 S.A. Patel et al. / Emerging Markets Review 3 (2002) Table 4 An analysis of the change in T&D score from 1998 to 2000 by economic sector for 6 large emerging markets exhibiting large increases in T&D Panel A: Number of companies analyzed by country and economic sector Brazil India Korea Poland Thailand South Africa Total Energy Materials Industrials Consumer Discretionary Consumer Staples Health care Financials Information Technology Telecommunication services Utilities Total Panel B: Change in T&D score from 1998 to 2000 by country and economic sector Energy y Materials Industrials Consumer Discretionary y y Consumer Staples 9 7 y Health care Financials Information Technology y Telecommunication services Utilities y Total The 6 markets analyzed are: Brazil, Poland, South Africa, India, Thailand, and Korea. transparency and disclosure, increasing the average T&D score by 8 and 4% points, respectively. Companies in the Asian emerging markets, especially in the 4 crisis countries Indonesia, Korea, Malaysia and Thailand improved transparency and disclosure over the 3 years. Companies in Korea, in particular, increased the level of transparency and disclosure, as demonstrated by the rise of the average T&D score by 13% points between 1998 and Average T&D scores of the Indian companies improved by 8% points between 1998 and 2000, highlighting the positive effect of the new regulatory requirements on corporate governance charters.
9 S.A. Patel et al. / Emerging Markets Review 3 (2002) Fig. 1. Do the minority shareholders receive adequate information when the need for information it higher? Correlation between cross-holdings (proportion of the company owned by government, other large companies, and strategic investors) and T&D score examined graphically. The correlation is negative for 5 out of 6 countries studied, suggesting that minority shareholders receive in the presence of large investors in a company. We observed earlier that the T&D scores at the end of 2000 do not differ much by economic sector. Are the changes in T&D scores between 1998 and 2000 also similar by economic sector? Table 4 focuses on 6 large markets, viz. Brazil, Poland, South Africa, India, Thailand, and Korea, with relatively large improvements in T&D scores between 1998 and 2000 to analyze the trends in T&D scores by economic sector. Table 4 is divided in two panels; each panel presents numbers in a country by economic sector matrix. Panel A shows the number of companies in our sample and Panel B shows changes in T&D scores between 1998 and Panel B shows that the Industrials sector experienced the largest increase in the average T&D score of 15% points, followed by Telecommunications Services and information Technology Sectors. The utilities and energy sectors posted relatively
10 334 S.A. Patel et al. / Emerging Markets Review 3 (2002) Table 5 Correlation between cross-holdings and T&D score with different thresholds to screen out cross-holdings outliers Observations screened out when cross-holdings value is less than Brazil y0.43 y0.59 y0.46 y0.42 y0.22 y0.14 Poland y0.42 y0.2 y0.2 y0.24 South Africa y0.06 y0.47 y0.47 y0.48 y0.41 y0.44 India y0.17 y0.41 y Thailand y0.07 y0.42 y0.42 y0.46 y0.46 y0.47 Korea y0.02 y0.25 How sensitive is the correlation between cross-holdings and T&D score to the outliers? Sensitivity of the correlation is analyzed when six different threshold values, ranging from 0 to 0.25, of cross-holdings are screened out from the sample. The results suggest that the magnitude of correlation is sensitive to the cross-holdings outliers, but support the observation that cross-holdings and T&D score are negatively correlated. modest increases in T&D scores of 3 and 4%, respectively. Panel B also shows that except for a few companies in Brazil that experienced a significant decline, increase in transparency and disclosure levels have improved from 1998 to 2000 across countries and sectors. The results presented in Sections 2 and 3 describe the differences in transparency and disclosure levels at the end of 2000 as well as differences in the time trend in the transparency and disclosure levels among countries, regions, and economic sectors. In the following sections, we study the correlation of T&D score with the ownership structure and valuations. 5. Ownership structure and transparency and disclosure score Previous research has examined the effect of ownership structure on corporate governance, and observed that the presence of a large shareholder or creditor has ambiguous effect on the rights of minority shareholders. Our research focuses on a narrower aspect of corporate governance, viz. transparency and disclosure, and establishes that concentration in ownership is harmful to the minority shareholders as it reduces transparency. In particular, we examine whether a company with a low float, that is, a company owned by government and strategic investors is less transparent than a company with high float. Fig. 1 shows the relation between float and T&D scores, for the 6 large markets, viz. Brazil, Poland, South Africa, India, Thailand, and Korea, with relatively large improvements in T&D scores between 1998 and For all countries except Korea, cross-holdings (1 minus float) and T&D scores are negatively correlated. The negative correlations range from 0.42 for Thailand and Poland to 0.51 for India. As the graph for India shows, however, the results are sensitive to outliers. To heuristically understand the effect of outliers on our results, Table 4 presents correlation between cross-holdings and T&D scores when companies below six different levels of cross-holdings, ranging between 0.0 and 0.25, are excluded (Table
11 S.A. Patel et al. / Emerging Markets Review 3 (2002) Fig. 2. Does higher transparency and disclosure affect a company s valuation? Correlation between T&D score and price-to-book ratios is examines for 6 large emerging markets. The correlations show a positive impact of T&D score on valuation for the Asian emerging markets, but show a negative impact for Brazil and Poland. Figure show that price-to-book outlier each in Brazil and Poland influences the correlation between T&D score and price-to-book. 5). Table 4 confirms that cross-holdings outliers influence the correlation between cross-holdings and T&D scores. Table 4 also confirms, with 27 negative correlations out of 36 correlations presented, that cross-holdings (float) and T&D score are negatively (positively) correlated. Our analysis suggests that, on average, minority shareholders receive less information when large investors own a larger proportion of the company. Is the low level of transparency and disclosure priced in the market? The next section examines the correlation between price-to-book ratios and T&D scores to analyze the premium placed in the market for better disclosure. 6. Price-to-book ratios and T&D scores Figs. 2 and 3 present the scatter plots and correlations between T&D scores and price-to-book ratios. Correlations in Fig. 2 have a pattern for the Asian markets,
12 336 S.A. Patel et al. / Emerging Markets Review 3 (2002) Fig. 3. Does higher transparency and disclosure affect a company s valuation? When the outlier priceto-books values are removed from analysis, correlation between T&D score and price-to-book ratios is positive for 5 of the 6 large emerging markets examined. The correlations show a positive impact of T&D score on valuation of companies. price-to-book is positively correlated to T&D scores as expected, but for Brazil, Poland, and South Africa, correlation between price-to-book ratio and T&D scores is negative. An examination of Fig. 2 reveals some outlier values for price-to-book ratio. Fig. 3 replicates the analysis in Fig. 2 for the price-to-book values less than 4. Fig. 3 shows that price-to-book and T&D scores are positively correlated for 5 of the 6 countries, suggesting that the market places a premium on better transparency and disclosure. 7. Conclusion This paper introduces a new dataset on transparency and disclosure for emerging markets, examines differences in the levels of transparency and disclosure among countries, regions, and economic sectors and provides an exploratory analysis of the
13 S.A. Patel et al. / Emerging Markets Review 3 (2002) correlation of transparency and disclosure with ownership structures and valuations. Our results show that the Asian emerging markets exhibit greater transparency and disclosure following recent currency, banking, and equity market crises. Our analysis suggests that float is positively correlated with transparency and disclosure. Valuation is also positively correlated with transparency and disclosure, consistent with the notion that market places a premium on companies with lower asymmetric information problem. We present our findings tentatively, as our analysis is exploratory, and as we examine bi-variate correlations. In the future, we plan to document the effect of transparency and disclosure on valuations in a multi-variate analysis with country, sector, liquidity, and float as control variables. As the new dataset expands in country and time-series coverage, researchers can empirically address a wider range of issues in global corporate governance. Acknowledgments We thank Nick Bradley, George Dallas, and our colleagues in the Standard & Poor s Governance group for the collaboration in developing the conceptual framework for the Transparency & Disclosure score. We thank our colleagues at Compustat, especially Martin Fasang, for painstakingly collecting the Transparency & Disclosure data on a global sample of companies. The authors also thank Shan Manikkalingam and Jacqueline Meziani for discussions and updates on academic as well practitioner research. Sandeep Patel, the primary author, is responsible for the remaining errors and omissions. This paper does not express official opinions of Standard & Poor s the primary author bears that responsibility as well.