Determinants of Financial Instruments Disclosure Quality among Listed Firms in Malaysia*.

Mohamat Sabri Hassan# Norman Mohd Saleh and Mara Ridhuan Che Abd Rahman School of Accounting Faculty of Economics and Business Universiti Kebangsaan Malaysia Abstract A lack of proper reporting guidelines on the reporting of the market value of financial instruments may lead to poor disclosure of the value of firms financial instruments (and net worth). This poor disclosure may subsequently mislead the investors in making their investment decisions. This paper investigates the disclosure quality of financial instruments disclosure of Malaysian firms listed in the Bursa Malaysia. In this paper we explore the association between the disclosure quality of financial instruments information and the firm characteristics. We measure disclosure quality based on a disclosure index which is based on seven categories of information required in Malaysian Accounting Standards Board (MASB) 24 Financial Instruments: Disclosure and Presentation. Our results indicate that on average the disclosure quality among Malaysian firms is low. However, the level of disclosure is increasing, especially in the period immediately after the issuance of MASB 24. We find that firm size, debt to total assets, and risk management committee are associated with disclosure quality of financial instruments. Further, we also find that post period is highly related with disclosure quality. This indicates that the implementation of financial instruments disclosure standards does influence firms to provide high quality of reporting.

Keywords: financial instruments, disclosure quality, firms characteristics, disclosure index, Malaysia

We gratefully acknowledge the financial assistance provided by Universiti Kebangsaan Malaysia and the Ministry of Higher Education of Malaysia under research grant EP-020-2005 and UKM-OUP-EP-16/2007. # Correspondence author: School of Accounting, Faculty of Economics and Business, Universiti Kebangsaan Malaysia, 43600, Bangi, Selangor, Malaysia. E-mail: sabri1@ukm.my, Tel: +603 8921 5731, Fax: +603 8921 3162.

Electronic copy available at: http://ssrn.com/abstract=1157788

INTRODUC TION This paper investigates the quality of financial instruments disclosure of Malaysian firms listed in the Bursa Malaysia.1 The case of Enron, Worldcom and some other firms in the U.S. and recently, Transmile Bhd.2 in Malaysia, have led many stakeholders to question the quality of financial reporting and the effectiveness of monitoring mechanisms on the management. In this paper we explore the association between the disclosure quality of financial instruments information and the firm characteristics. We examine the disclosure quality of financial instruments information for a sample of Malaysian public listed companies for the period of 1999, 2000, 2002 and 2003. Disclosure quality is measured based on a disclosure index which is based on seven categories of information required in Malaysian Accounting Standards Board (MASB) 24 Financial Instruments: Disclosure and Presentation. The standard was issued in 2001 and became the only standard available for firms to disclose issues related to financial instruments in the annual report. The standard was developed based on the IAS 32 Financial Instruments: Disclosure and Presentation. The MASB 24 describes specific requirements for disclosure of financial instruments and specific information to be disclosed. The objective of this standard is to enhance disclosures related to financial instruments. This disclosure would help financial statement users to understand the importance of on-balance sheet items or off-balance sheet items in assessing the firms financial position, performance and cash flows. We therefore, question the quality of financial instruments information, disclosed in the financial statements prior the issuance of MASB 24. Without a proper standard, firms have the tendency to provide minimal information about their activities involving financial instruments particularly when these activities lower the net worth of the firm. We also examine the characteristics of firms that provide quality financial instrument disclosure. This paper contributes to the existing literature in several ways. First, the paper provides evidence on disclosure quality of financial instruments immediately prior to and after the adoption of MASB 24. Prior study in Malaysia was limited to financial derivative disclosure prior to the MASB 24 (Norkhairul Hafiz, 2003). Second, while a majority of prior research tends to examine the amount (volume) of disclosure, this paper attempts to measure disclosures quality. We measure disclosure quality using a disclosure index developed based on the disclosure and presentation required by the MASB 24. Third, we examine the association between our measure of disclosure quality and various firm characteristics. These characteristics represented by size, performance, type of auditor and risk management committee. To our knowledge, this is the first study that examines the role of risk management committee in
1 2

Bursa Malaysia is the Malaysian Stock Exchange Transmile Bhd (an air cargo listed company in Bursa Malaysia) was reported to have accounting irregularities in overstatement of revenues in 2004, 2005 and 2006 by RM622 million. This case has led several more listed companies in Malaysia being investigated.

Electronic copy available at: http://ssrn.com/abstract=1157788

determining the quality of financial instruments disclosure. Lopes and Rodrigues (2007) do examine the role of corporate governance on disclosure, however it was limited to proportion of independent directors. Fourth, we provide evidence on the disclosure practice among firms prior and after the issuance of the respective accounting standard, which are absent in prior studies. We believe this study would provide evidence for standards setters and regulators for future directions in developing accounting standards. The issue is particularly relevant for Malaysia due to the impending adoption of IFRS 139 Financial Instruments: Measurement and Recognition. The study is important since it will provide evidence on the management behavior during the period of flexibility in disclosure of financial instruments. The remaining sections of the paper are as follows. Section two and three discuss background and prior research undertaken, respectively. Section four develops empirical predictions used in this study. Section five describes methodology undertaken and results are presented in section six. Our conclusions and recommendation are presented in section seven.

BACKGROUND Financial instruments3 expose firms to financial, economic, and operational risks. Changes in market conditions or the financial position of the parties to the financial instruments or transactions expose firms to financial and economic risks. These risks are credit risk4, interest rate risk5, foreign exchange risk6, market risk7 and liquidity risk8. Firms generally use the most common and practical methods to reduce or eliminate the risks. These include limiting the exposure to both individual counterparties and the number of specific instruments held, or through hedging the risks with sophisticated instruments such as forward contracts or swaps. The second type of risk is known as operational risk. These risks are fraud, failure to collect the amount due and human error (Sarwal, 1989). These risks can be reduced through internal control. Banks and financial institutions introduced derivative instruments to help firms manage their exposure to these risks. It has been documented in the U.S. that derivatives are used by large corporations to reduce their exposure to a variety of risks (Gczy, Minton and Schrand, 1997).
3

MASB 24.6 defines a financial instrument as any contract that gives rise to both a financial asset of one entity and a financial liability or equity instrument of another enterprise. 4 The risk that a borrower will not able to meet its obligations. The risk can be classified into country risk, industry risk, counterparty risk, settlement risk and transfer risk. 5 The risk of loss through mismatching the interest bases of assets and liabilities. The risk can be classified further into net interest risk, spread risk and basis risk 6 The risk of loss as a result of an unfavourable movement in exchange rates. 7 The risk of loss resulting from changes in the market value of negotiable instruments due to factors other than interest and exchange rates. 8 The risk can be classified as cash liquidity or market liquidity. Cash liquidity is the risk of loss resulting from the inability to meet financial obligations as they arise, due to a lack of liquid resources. Market liquidity refers to the risk of loss from not being quickly able to sell financial instruments at full market value, when required.

Competition among banks and financial institutions led to the development of innovative derivative instruments. To enable firms to better manage the risks and uncertainties, financial institutions in particular, have developed a variety of complex financial instruments (Scott, 1997). These innovative instruments are based on four basic derivative instruments, including forward contracts, future contracts, options and swaps. A recent market survey by the International Swaps and Derivatives Association (ISDA) indicates that the notional amount outstanding of global credit derivatives increased by 32% in the first six month of year 2007. The volume globally totalled US$45.46 trillion at middle 2007. Investors have been alerted to the importance of transparent financial reporting of risk and uncertainty as recent significant losses experienced by prominent companies, such as Barings Plc., Proctor and Gamble, and Gibson Greeting, resulted from the inappropriate use of derivatives. Since then, financial reporting has witnessed an increase in the disclosure of risk information by U.S. and U.K. companies. Most accounting standard setters (particularly in the U.S.), the International Accounting Standard Board (IASB) and those in the U.K. have been forced to respond by requiring more disclosures. The Financial Accounting Standards Board in the United States is more advanced in regulating the accounting treatment for financial instruments compared to the rest of the world. The first accounting pronouncement issued by the FASB pertaining to financial instruments was issued in 1990. However, in Malaysia, the accounting standard pertaining to financial instruments only available in 2001. MASB 24 Financial Instruments: Disclosure and Presentation was issued in 2001 to enhance financial statement users understanding of the significance of on-balance sheet and off-balance sheet financial instruments to an enterprises financial position, performance and cash flows. The standard prescribes certain requirements for presentation of on-balance sheet financial instruments and identifies the information that should be disclosed about both recognized and unrecognized financial instruments. The standard requires firms to i) classify financial instruments into liabilities and equity, ii) classify related interest, dividends, losses and gains, and iii) the circumstances in which financial assets and financial liabilities should be off-set. Firms are also require to disclose i) factors that affect the amount, timing and certainty of an enterprises future cash flows relating to financial instruments, ii) the accounting policies applied to those instruments, iii) the nature and extent of an enterprises use of financial instruments, iii) the purposes of using financial instruments, iv) the risks associated with the financial instruments and v) the managements policies for controlling those risks. For the purposes of this study, MASB 24 is assumed to be a high quality disclosure standard. This is a reasonable claim because of the extensive nature of the disclosure requirements, designed to overcome the lack of guidance with regard to recognition and measurement. Therefore, firms that prepare their annual reports based on this standard are said to provide high quality financial instruments information. Correspondingly, failure to comply with this standard would suggest that financial instruments disclosures are of low quality.

PRIOR RESEARCH Disclosure Quality: The Definition The annual report is one of the channels available for firms to report their financial performance. However concern about the usefulness of financial information has caused pressure groups to lobby accounting standard setters to require greater detail and more extensive information especially concerning derivative financial instruments so that high quality accounting standards are produced. High quality standards should lead to high quality financial reports, and as a result investors confidence in the credibility of financial reporting is enhanced (Levitt, 1998). Therefore, firms that comply with the standards would be expected to produce high quality accounting information. The term quality has been used interchangeably with the term transparency. Because the concepts of quality and transparency are elusive (Kothari, 2000), different interpretations have been placed on the meaning of high quality financial information. Ball, Robin, and Wu (2002), Ball, Kothari, and Robin (2000), and Lang, Raedy and Yetman (2003) assess quality based on the timeliness9 of the recognition of economic income in accounting income. Bradshaw, Richardson, and Sloan (1999) examine quality based on the level of accruals, while Lang et al. (2003) look for evidence of earnings management, and of a higher association of earnings with share price. Pownall and Schipper (1999) refer to financial statements as being of high quality if they possess three attributes: transparency, full disclosure and comparability. 10 Transparent financial statements are statements that reveal the events, transactions, judgments, and estimates underlying the statements, and their implications (Pownall and Schipper, 1999, p. 262). Transparency allows users to see the results and implications of the decisions, judgments and estimates of statement preparers. Full disclosure relates to the provision of all information necessary for decision-making, thereby providing reasonable assurance that investors are not misled. Finally, comparability means that similar transactions and events are accounted for in the same manner, both cross-sectionally among firms and over time for a given firm. Most literature on disclosure quality uses either a disclosure index or disclosure ratings produced by the Financial Analysts Federation (FAF), the Association for Investment Management Research (AIMR) and the Center for International Financial Analysis and Research (CIFAR) to measure disclosure quality as defined by Pownall and Schipper (1999). While these views of quality focus on the financial statements as a whole, the definition of Pownall and Schipper (1999) can be readily adapted to individual disclosures within the financial statements. For this reason, their interpretation of quality is used in this study. That is, this study defines financial information as being of high quality when it possesses the attributes of transparency, full disclosure and comparability.
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Ball et al. (2000) define timeliness as the extent to which current-period accounting income incorporates currentperiod economic income. This definition is consistent with Lang et al. (2003) and Ball et al. (2002). 10 Different definitions of accounting quality abound because, as Ball et al. (2002) claim, quality is an elusive concept especially where there are a great number of uses of accounting information.

Disclosure Quality and Firms Characteristics. Prior research examines the usefulness of financial information by investigating the extent of firms disclosures and the quality of accounting information disclosed in annual reports. Studies that relate the level of disclosure to firm characteristics include in Firth (1979), Cooke (1989, 1991, and 1992), Imhoff (1992), Malone, Fries, and Jones (1993), Singhvi and Desai (1971), Heflin, Shaw, and Wild (2001) and Wallace and Naser (1995). These studies provide evidence of the association between disclosure level and firm characteristics such as firm size, listing status, firm auditor, scope of business, risk of trading and industry type. Most studies in this area use a disclosure index to measure disclosure level or disclosure quality. Overall, prior literature find there is a significant relationship between firm disclosure level or quality and the traditional characteristics of firms such as the size of firms (Singhvi and Desai, 1971; Firth, 1979; Cooke, 1989; Cooke, 1992; Imhorff, 1992; Wallace and Nasser, 1995), performance (Singhvi and Desai, 1971; Wallace and Naser, 1995), leverage (Imhorff, 1992; Malone et al., 1993). Consistent with agency theory, evidence from prior studies also suggests that general disclosure level or quality also related to the number of shareholders in the firm (Malone et al. (1993) and the listing status of the firms (Singhvi and Desai, 1971; Firth, 1979; Cooke, 1992; Malone, 1993). These results indicate that firms react to the demand for more information by the stakeholders. The current study takes into account the traditional characteristics of firms to test the consistency of basic relationships found in prior literature in Malaysian environment.

Disclosure Quality of Financial Instruments Information. While the majority of studies discussed in previous sections examine the quality of all financial information disclosed in the annual reports or other media, limited studies have documented disclosure quality with regard to specific information, particularly financial instruments. Four Australian studies on the quality of derivative disclosure have been conducted by Hassan, Percy and Goodwin-Stewart (2006-2007), Chalmers and Godfrey (2004 and 2000) and Chalmers (2001). However, most of these studies examine disclosure quality during voluntary regime. Chalmers and Godfrey (2000) explore the disparity between the accounting treatments of derivative instruments encouraged by AASB 1033 Presentation and Disclosure of Financial Instruments issued in 1996 and firms current accounting practices based on the 30 June 1998 financial statements of Australias largest 500 firms. This study indicates that the quality of the disclosures were less than satisfactory. Chalmers (2001) examines Australian firms derivative instruments disclosures over three phases, namely a pure voluntary disclosure phase, a coercive voluntary disclosure phase, and a mandatory voluntary reporting period. The study examines the firms response to information demands in a changing regulatory environment from 1992 to 1998. Chalmers used a voluntary reporting disclosure index to capture derivative disclosures. The index was constructed using the
6

disclosures suggested in the Australian Society of Corporate Treasurer's Industry Statement11 and ED65: Presentation and Disclosure of Financial Instruments. The results indicate that firms were responsive to quasi-contractual disclosure regulation since the number of firms registering a positive voluntary reporting disclosure index increases from phase to phase. The release of ED65, combined with the increased probability of the development of AASB standard on this issue, has been found to be influential in achieving enhanced reporting of derivative instruments. Chalmers and Godfrey, (2004) extend the above studies by examining the voluntary disclosure practices for the period 1992 to 1996. This study provides evidence on factors that drive the response in voluntary derivative financial instruments disclosure. They argue that the firms reputation and legitimacy are affected by its response to the new disclosure requirements. Results from this study indicate that voluntary derivatives financial instruments disclosure is associated with reputation consideration, namely firms affiliations with professional bodies, size of the firm, type of industry and extent of media attention. Hassan et al. (2006-2007) extend the above studies by examining the transparency of derivative disclosures among firms in the extractive industries prior to the adoption of international accounting standards in Australia. The study examines the association between their measure of transparency and various firm characteristics. Unlike the above two studies, Hassan et al. (2006-2007) measure transparency based on the re-issued AASB1033 Presentation and Disclosure of Financial Instruments disclosure requirement. Results from this study indicate that large firms and firms with high price-earnings ratios and debt to equity ratios provide more transparent derivatives disclosures. A most recent study on financial instruments was reported in Lopes and Rodrigues (2007). Similar to our study, Lopes and Rodrigues (2007) examine determinants of voluntary financial instruments disclosure among Portuguese companies. This study examines the disclosure based on an index developed according to the IAS 32 Financial Instruments: Disclosure and Presentation and IAS 39 Financial Instruments: Measurement and Recognition requirements. The study provides evidence that size, type of industry and auditor listing status are significantly related with disclosure. We adopt similar approach to measure disclosure quality. However, our index is based on the MASB 24 (equivalent to IAS 32) only. This is due to the impending of adoption IAS 39 (IFRS 139) in Malaysia. Therefore, our study is relevant to investigate management behavior due to the flexibility of disclosure financial instruments. While Lopes and Rodrigues (2007) examine 55 listed firms in 2001, our study provide evidence on the disclosure practice of Malaysian listed firms before and after the MASB 24 become mandatory. In Malaysia, Norkhairul Hafiz (2003) provides evidence on the association between voluntary disclosure of derivative financial instruments and two firm characteristics; namely size of the firm and foreign activity level. A disclosure index based on the MASB ED 24 Financial Instruments: Disclosure and Presentations was used to measure the level of voluntary disclosure. Overall, the study provides evidence that the level of voluntary disclosure of derivative financial instruments is low. This may be due to the lack of control mechanism in
11

The industry statement was issued in March 1995 and requested firms to include information on derivatives in their financial statements.

Malaysia. Therefore the development of accounting standard for derivative instruments should be accelerated. The study also provides evidence that the level of voluntary disclosures among companies with high percentage of foreign subsidiaries is low compared to companies with low percentage of foreign companies. Further, the study provides evidence that there is no difference between the level of voluntary disclosure of derivative financial instruments between companies with substantial foreign sales and low percentage of foreign sales and between companies with large assets and small assets. This is due to the conflicts of interest between the management and the stakeholders. The current study acknowledges the contribution of Norkhairul Hafiz (2003), however his study only focus on part of the ED24 disclosure requirement. Moreover, similar to the above Australian and Portugal studies, Norkhairul Hafiz (2003) provides evidence on the level of disclosure before the standard become mandatory. Therefore, the results might be bias towards certain firms that are capable in term of money and human resource. Hence, further study is required to provide evidence on the disclosure quality during the mandatory regime so that a better conclusion can be made on this topical issue. Therefore, the current study will extend the above studies by examining the disclosure quality among listed firms in Malaysia prior and after the MASB 24 was issued. Results from this study are important since it provides evidence on the disclosure quality among firms in the developing country where the compliance with the accounting standards is not always rigidly enforced (Hope, 2003).

HYPOTHESES DEVELOPMENT One of the characteristics that have been extensively related to disclosure policy is size of firm. There are many reasons why large firms might disclose more information (Cooke 1991). Singhvi and Desai (1971) indicate that larger firms are expected to provide more transparent information as they incur lower costs of accumulating detailed information, they have more marketable securities and they have greater ease of financing. In addition to that, larger firms tend to provide greater transparency to reduce political costs (Cooke, 1989). Cooke (1989, 1991), Firth (1979), Singhvi and Desai (1971), Wallace et al. (1994), Wallace and Naser (1995), Ahmed and Nicholls (1994), Riahi-Belkaoui (2001) Ali, Ahmed and Henry (2003), Norkhairul Hafiz (2003), Chalmers and Godfrey (2004), Hassan et al. (2006-2007) and Lopes and Rodrigues (2007) provide evidence that firm size is positively associated with disclosure level or high disclosure quality. This leads to our first hypothesis:

Hypothesis 1: The quality of financial instruments information disclosed in the annual report is positively associated with size of the firms.

Prior studies also provide evidence that performance of the firms also affects the disclosure quality. A profitable firm may provide more detailed information to communicate good news to investors in order to improve firm value (Ali et al., 2003) and to boost management
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compensation (Wallace et al., 1994). However, while Ali et al. (2003) provide evidence of a positive relationship between profitability and compliance level, Wallace and Naser (1995) identify a negative relationship between these variables. However, specific to the existing study, Hassan et al. (2006-2007) provide evidence that high performance extractive firms provide more transparent (refer to high disclosure quality) derivatives disclosure. Therefore our second hypothesis is: Hypothesis 2: The quality of financial instruments information disclosed in the annual report is positively associated with performance of the firms. Auditors play an important role in determining the quality of information disclosed by their clients. Therefore, large audit firms are said to have an association with high quality reporting. DeAngelo (1981) and Fama and Jensen (1983) indicate that this is because large audit firms tend to be have many clients, and have incentives to maintain independence from their clients. Therefore, they tend to report mis-statements and non-compliance with mandatory reporting requirements. Moreover, the reputations of large audit firms are diminished when their clients provide low quality annual reports (Ali et al., 2003 and Chalmers and Godfrey, 2004) or when they commit fraud or mislead by certifying the annual reports of their clients (Owusu-Ansah, 1998). The best example of this is the collapse of Arthur Anderson, the auditor of Enron. Therefore, larger audit firms tend to influence their clients to provide high quality information. However, empirical studies provide inconclusive results. Singhvi and Desai (1971), Ahmed and Nicholls (1994), Wallace and Naser (1995) and Lopes and Rodrigues (2007) found that auditor size is positively associated with disclosure level. However, no significant association is documented in Firth (1979), Malone at al. (1993), Wallace et al. (1994), Ali et al. (2003) and Hassan et al. (2006-2007). This leads to our third hypothesis: Hypothesis 3: The quality of financial instruments information disclosed in the annual report is positively associated with size of the auditor.

Financial Instruments expose firms to financial, economic and operational risks. To reduce or eliminate the risks, firms may use derivative instruments (Hassan, 2004; Gczy, Minton, and Schrand, 1997). However, due to their nature, derivative financial instruments also may expose firms to risks. Barings Plc., Proctor and Gamble and Gibson Greetings are among corporations that had significant losses due to the inappropriate use of derivatives (Hassan, 2004). Since then, financial reporting has witnessed an increase in disclosure risk information in US and the UK. This is because failure to appreciate risk issues may give rise to serious consequences (Fraser and Henry, 2007). Some of the firms may take a pro active action to protect their investors by establishing effective internal control and good corporate governance. Internal audit functions and audit committee are becoming increasingly involved in risk management (Fraser and Henry, 2007). However, it is not clear whether these internal monitoring bodies are the optimal means of dealing with risk management issues (Fraser and Henry, 2007). In addition to audit committee some firms do establish a risk management committee. Similar to audit committee, risk
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management committee (RMC) will ensure management not to involve with high risk activities and also will ensure firms to provide high quality of financial instruments information in their annual report. Generally, the purpose of the committee (on behalf of the shareholders) is to assist firms in understanding and managing risk. However, compared to audit committee, the establishment of the risk management committee within a firm shows the concerted effort of the firms to address risk issues. Therefore, this committee has the obligation to provide proper disclosure about the risk of financial instruments and derivative contracts to the shareholders, whom they are accountable for. Further, the RMC is said able to direct the identification, prioritization and management of risk and to support internal audit as compared to the audit committee (Fraser and Henry, 2007). We expect the quality of disclosure in firms with risk management committee is more than the firms without such committee. Research in risk management committee at the moment is scarce. This is because, in normal circumstances, the role of risk management falls under the jurisdiction of audit committee. Therefore our fourth hypothesis is: Hypothesis 4: The quality of financial instruments information disclosed in the annual report is positively associated with the existence of risk management committee in the firm.

METHODOLOGY Sample selection Sample for our study are firms that are listed on the main board of Bursa Malaysia, in 1999, 2000, 2002 and 2003. Financial data is gathered from the Datastream and in case of unavailable data, we refer to annual reports of the respective firms. We select year 1999 and 2000 to represent the period prior to the issuance of MASB 24, and 2002 and 2003 to represent the period after the issuance of MASB 24. There were 203 firms listed in the main board of Bursa Malaysia in 1999. Accordingly, the same company will represent the sample for 2000, 2002 and 2003. The sample was further reduced by excluding companies: i) that are not in Datastreams list and neither their annual reports are available, ii) that change their financial date, and iii) with no available or incomplete data. Table 1 summarises the sample selection procedure. Table 1: Summary of sample selection procedure
Selection criteria Listed firms in Main Board - Firms that change financial date - Firms that not in the Datastream @ annual reports not available - Firms with data not available @ incomplete Total number of firms use for the study No of firm 812 10 85 233 484

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Disclosure Quality Users of financial statements employ several techniques when evaluating accounting information. Among these techniques they may include an assessment of the quality of the information (Imhoff, 1992). Prior studies have measured quality based on the corporate disclosure practices provided by the Financial Analysts Federation (FAF) and the Association for Investment Management and Research (AIMR) or a self-constructed disclosure index developed based on voluntary and/or mandatory disclosures. In this study we measure quality based on an un-weighted index developed based on the information require by the MASB 24. The Malaysian Accounting Standards Board (MASB) is responsible for developing and promulgating approved standards. Once an MASB standard becomes an applicable accounting standard, firms are expected to comply with its requirements. For the purposes of this study, MASB 24 is assumed to be a high quality disclosure standard since it is based on the standard issued by the IASB12. This assumption is reasonable because of the extensive nature of its disclosure requirements designed to overcome the lack of guidance with regards to recognition and measurement (Hassan, 2004). Table 2 presents a list of information required by the MASB 24 that forms an index of disclosure for financial instruments. We examine the notes to the financial statements to develop the index. We group the information into seven components, namely i) Disclosure of Risk Management Policies Information, ii) Terms, Conditions and Accounting Policies Information, iii) Interest Rate Risk Information, iv) Credit Risk Information, v) Fair Value Information, vi) Hedge of Anticipated Transaction and vii) other disclosures. A score of 1 is assigned to an item of each component disclosed, and 0 otherwise. Similar to Hassan et al. (2006-2007) and Lopes and Rodrigues (2007), we divide the component score by the number of items in that component, so that each component of score adds equally to the total score (Cooke, 1991). Then, we divide the total score for each firm by the number of possible score for a firm to represent the disclosure quality. However, firms are not penalised for not disclosing the information which are not relevant to them. The disclosure quality (DQ) is measured as below:

DQ

Firms actual disclosure score Firms total possible disclosure score

12

Starting from 2006, the MASB has to issue accounting standards that based on the IFRS.

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Table 2: Component s of financial instruments disclosure index Reference Disclosure of Risk Management Policies Information q Describe firms financial risk management objective & policies q Objectives for holding or issuing derivative financial instruments
q

Score

Para 49 & 50 Para 49 & 50

Policy for hedging each major type of forecasted transaction

1 2

Component score Terms, Conditions and Accounting Policies Information q a) Extent and nature of the underlying financial instruments, b) including significant terms and conditions that may affect the amount, timing, and certainty of future cash flows.
q

Para 55(a)

2*

a) Accounting policies and method adopted, b) including criteria for recognition and the basis of measurement applied

Para 55(b)

2* 4

Component score Interest Rate Risk Information q Contractual repricing or maturity dates for interest rate risk
q

Para 64 (a) Para 64 (b)

1 1 2

Effective interest rates

Component score Credit Risk Information q The amount that best represents financial assets maximum credit risk exposure
q

Para 74 (a)

Significant concentrations of credit risks for each class of financial assets

Para 74(b)

1 2

Component score Fair Value Information q Fair value information for each class of financial asset and financial liability (recognised and unrecognised).
q

Para 86

When it is not practicable to determine the fair value (within the constrain of time @ cost), a) the fact should be disclosed with b) information about principal characteristics of the underlying financial instrument that are pertinent to its fair

Para 86

2*

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value
q

a) Method adopted and b) any significant assumptions made in determining fair value.

Para 88

2*

Financial Assets carried at an amount in excess of fair value q The carrying amount and the fair value of either the individual asset or appropriate groupings of those individual assets.
q

Para 97 (a)

a) The reasons for not reducing the carrying amount, b) including the nature of the evidence that provides the basis for managements belief that the carrying amount will be recovered.

Para 97 (b)

2* 8

Component score Hedge of Anticipated Transaction q a) A description of the anticipated transaction, b) including the period of time until they are expected to occur.
q q

Para 100 (a) Para 100 (b) Para 100 (c)

2* 1 2* 5

A description of the hedging instruments. a) Amount of any deferred or unrecognised gain or loss and b) the expected timing of recognition as income or expense.

Component score Other disclosures q The total amount of change in the fair value of FA & FL that has been recognised as income or expense for the period.
q

Para 103 (a) Para 103 (b)

The total amount of deferred or unrecognised gain or loss on hedging instruments other than those relating to hedges of anticipated future transactions, & a) The average aggregate carrying amount during the year of recognised FA and FL b) the average aggregate principal, stated, notional or other similar amount during the year of unrecognised FA & FL, c) the average aggregate fair value during the year of all FA & FL, particularly when the amounts on hand at the balance sheet date are unrepresentative of amounts on hand during the year.

Para 103 (c)

3*

Component score 5 * A score of one is allocated for each item disclosed in the notes to the financial statements.
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Independent Variables Size of the firm is one of the characteristics that have been found to be consistently related to disclosure policy. Although there are several ways to measure size, the current study measures size based on total assets. This measures of size is used in many studies such as Singhvi and Desai (1971), Firth (1979), Wallace (1988), Cooke (1989), Imhoff (1992), Malone et al. (1993), Chalmers and Godfrey (2004), Hassan et al. (2006-2007) and Lopes and Rodrigues (2007). Because of the variability in the level of total assets between firms, we follow prior research and transform the size variable into its natural log in order to normalize the distribution. Performance of the firms has also been identified as a factor impacting disclosure quality. Following Hassan et al. (2006-2007), we include profit before tax over total assets (PTA) and price earnings ratio (PE) to represent firms performance. The former measures current performance while the latter provides a measure of the markets perception of a firms expected future performance. Similar to prior studies, size of the auditor is a dummy variable that takes the value of 1 if the company is audited by a Big 4, and 0 otherwise. The Big 4 auditors are Pricewaterhouse-Coopers, Deloitte Touche Tohmatsu, Ernst and Young and KPMG. We extend previous studies by including additional variables. These are risk management committee, a dummy variable (YRafter) to represent the effect of the disclosure practice before and after the MASB 24 issued and also debt to total assets ratio to represent leverage. We include DTA as a control variable since prior studies (Ahmed and Courtis, 1979; Malone et al., 1993; Hassan et al., 2006-2007) indicate that firms with high leverage tend disclose greater financial information. Risk management committee (RMC) will represents one of the corporate governance characteristic. This is relevant to this study since the committee will ensure management not to involve with high risk activities and also will ensure firms to provide high quality of financial instruments information in their annual report. We examine the association between the disclosure quality of financial instruments disclosure and firm characteristics using the model specified in Equation 1: DQ = a 0 + a1Size + a 3 PTA + a 4 PE + a 5 DTA + a 6 Audit + a 7 RMC + a 8YRafter + e (1) Where; Size PTA PE DTA Audit RMC YRafter

= log of total assets = Profit before tax over total assets = Price earnings ratio = Debt to total assets ratio = Dichotomous variable 1 for firm that audited by Big 4, 0 otherwise = Dichotomous variable 1 for firm with RMC, 0 otherwise = Dichotomous variable (1 to represent year after 2001, 0 otherwise) = Error term
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RESULTS Descriptive Results Disclosure Quality Table 3 presents results of average disclosure quality for the period under study. On average, the disclosure quality of financial instruments information is low. Column 6 Table 3 indicates that the level of quality in disclosure (hereinafter called the level of disclosure) is 33.49%. However the level of disclosure has increased from 25.67% in 1999 to 58.88% in 2003. This indicates that the level of disclosure among Malaysian firms is low during the period before the standard become mandatory. Table also 3 indicates that, on average there is a steady increase on the level of disclosure for each component of information required by the MASB 24 over the period after the standard became mandatory. Comparing each component, the result reveals that Malaysian firms tend to disclose more information on Terms, Conditions and Accounting Policies and Interest Rate Risk components. On average, the level of disclosure for each component is 91.17% and 87.09% respectively. The level of disclosure for Terms, Conditions and Accounting Policies Information component has increased from 84.30% (1999) to 98.55% (2003). The score is higher then the rest of information required by MASB 24. This is followed by the Interest Rate Risk Information. The level of disclosure for Interest Rate Risk Information also increased from 73.97% (1999) to 97.93% (2003). Comparatively the level of disclosure for each information has increased dramatically in 2003 above its DQ, except for Credit Risk Information (42.6%), Hedge of Anticipated Transaction Information (15.21%) and Other disclosures (25.62%). The lower level of Hedge of Anticipated Transaction Information was documented may be due to the fact that the number Malaysian firms actively hedge their anticipated transaction is low or non existence. This is because firms are not ready to take the risks in such activity. While the level of disclosure for other information is steadily increased from 1999 to 2003, our study indicates that the level of fair value information decreased from 16.40% (1999) to 16.34% (2000). However, it has dramatically increased from 50.72% (2002) to 68.24% (2003).

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Table 3: Mean disclosure components of the listed companies in Malaysia for the period 1999, 2000, 2002, 2003 and pooled year 1999 121 2000 121 2002 121 2003 121 Pooled 484

Sample Disclosure Quality of Financial Instruments Disclosure of Risk Management Policies Information Terms, Conditions and Accounting Policies Information Interest Rate Risk Information Credit Risk Information Fair Value Information Hedge of Anticipated Transaction Other disclosures Descriptive statistics

0.2567 0.0289

0.2925 0.0455

0.4840 0.5372

0.5888 0.6405

0.3349 0.3110

0.8430 0.7397 0.0000 0.1640 0.0198 0.0017

0.9008 0.8512 0.0289 0.1634 0.0281 0.0298

0.9174 0.9132 0.2975 0.5072 0.1339 0.0793

0.9855 0.9793 0.4256 0.6824 0.1521 0.2562

0.9117 0.8709 0.1880 0.3793 0.0835 0.0917

Table 4 presents the descriptive statistics for the dependent and independent variables. Table 4 indicates that on average the level of financial instruments disclosure among Malaysian firms is 33.49%. However, the highest score of disclosure is 97.14% and the minimum is 3.57%. This indicates that on average Malaysian firms are not ready to provide high quality financial instruments information. Therefore, regulators have to actively play their role to educate managers to comply with the standards requirements to increase confidence among stakeholders, especially the investors and market participants.

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Table 4: Descriptive Statistics Mean DQ Size PTA PE DTA RMC Audit YRafter 0.3349 20.4722 0.0590 26.1406 0.3881 0.2231 0.7438 0.5000 Median 0.2857 20.3641 0.0417 8.1804 0.3547 0.0000 1.0000 0.5000 Maximum 0.9714 24.3034 4.4149 3500.000 4.1225 1.0000 1.0000 1.0000 Minimum 0.0357 17.6478 -1.0918 -865.2174 0.0009 0.0000 0.0000 0.0000 Std Deviation 0.1760 1.1724 0.2327 209.1645 0.2990 0.4168 0.4370 0.5005

Correlation Matrix Table 5 reports the Pearson correlation matrix for the dependent and independent variables. Table 5 indicates that DQ, size, PTA, PE, DTA and RMC are correlated to at least with one of other variable. Nevertheless, the highest coefficient recorded is 0.526 for RMC and YRafter. This suggests that multicollinearity is unlikely to be a major problem. This is followed by the correlation coefficient for DQ and YRafter (0.343).

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Table 5: Pearson Correlation Matrix

DQ DQ Size PTA PE DTA RMC Audit Dearn YRafter 1.0000 0.191** 0.034 -0.016 0.159** 0.308** -0.001 0.038 0.343** 1.0000 0.002 -0.030 0.041 0.101* -0.070 0.043 0.040 1.0000 -0.013 -0.017 0.013 -0.056 0.250** -0.050 1.0000 -0.001 0.026 -0.016 0.138** 0.014 1.0000 -0.064 -0.030 -0.016 -0.130** 1.0000 0.008 0.056 0.526** 1.0000 0.021 -0.076 1.0000 0.000 1.0000 Size PTA PE DTA RMC Audit Dearn YRafter

**. Correlation is significant at the 0.01 level (2-tailed). *. Correlation is significant at the 0.05 level (2-tailed). Multiple Regression Results Table 6 presents the results for the regression analysis of the association between disclosure quality and firm characteristics13. Our study indicates that size of the firms, DTA and RMC are significantly related with disclosure quality of financial instruments information at p < 0.001. As predicted, the size of firms is positively related to disclosure quality and is highly significant at p < 0.001(Hypothesis 1). This indicates that large firms tend to disclose more financial instruments information compared to small firms. This is consistent with prior studies of Wallace and Naser, 1995; Riahi-Belkaoui, 2001, Ali et al., 2003; and more recent studies by Hassan et al., 20062007 and Lopes and Rordigues (2007). As argued in agency theory this may due to large firms tend to incur lower information processing costs as well as higher political costs that encourage them to disclose greater information. Our study also indicates that DTA and RMC are positively related with disclosure quality of financial instruments information. The significance of RMC indicates that results in our study support hypothesis 4. The result indicates that the risk management committee plays an
13

Otherwise indicated, due to the present of heterocedasticity, the regression results are based on the Whites HeterocedasticityCorrected Standard Errors (White, 1980).

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important role to ensure management or firms to provide high quality of financial instruments information in their annual report. Therefore this study supports the argument for establishing the risk management committees so that it can improve the effectiveness of systems operation (Fraser and Henry, 2007). In addition to the above, our study also indicates that firms with high DTA tend to disclose high quality of financial instruments information. This is consistent with the study of Ahmed and Courtis (1999), Malone et al. (1993) and Hassan et al. (2006-2007). Table 6: Results of regression analysis of the association between disclosure quality and firm characteristics (n=484) Coefficient Constant Size PTA PE DTA RMC Audit R2 0.1519 -0.2113 0.0231 0.0247 -1.52E-05 0.1017 0.1284 0.0057 Adjusted R2 Std. Error 0.1363 0.0067 0.0228 3.59E-05 0.0274 0.0222 0.0162 0.1412 t-Statistic -1.5499 3.4698 1.0823 -0.4244 3.7111 5.7761 0.3547 Durbin-Watson stat 0.0000 Prob 0.1218 0.0006** 0.2797 0.6714 0.0002** 0.0000** 0.7230 0.7377

F-statistic

14.2374 Prob(F-statistic)

** indicates significance at p<0.001. The t-statistics are based on White Heteroscedasticity Standard Errors.

Time might play an important role in influencing the disclosure behavior. Therefore, we have extended the above results by including a dummy variable of year to represent year after and before the MASB 24 become mandatory. We include YRafter to the above estimation, where a dichotomous 1 represent year 2002 and 2003 (after the MASB 24 become mandatory), and 0 otherwise. We predict that disclosure quality of financial instruments information is influenced by period of time where the accounting standard issued. Table 7 presents results for equation 1. Our study indicates that disclosure quality of financial instruments information is significantly related with period after the MASB 24 was issued. This result indicates that firms tend to disclose high quality financial instruments after the standard becomes mandatory. Table 7 also
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presents similar to Table 6, where size and DTA are positively related with disclosure quality at p < 0.001. Nevertheless, RMC is consistently positively related with disclosure quality at p < 0.05.

Table 7: Results of regression analysis of the association between disclosure quality and firm characteristics (n=484) Coefficient Constant Size PTA PE DTA RMC Audit YRafter R2 F-statistic 0.2101 -0.2756 0.0237 0.0385 -1.46E-05 0.1187 0.0648 0.0159 0.1012 Adjusted R2 18.0892 0.1985 Std. Error 0.1347 0.0065 0.0242 3.14E-05 0.0274 0.0267 0.0161 0.0178 t-Statistic -2.0453 3.6267 1.5921 -0.4652 4.3271 2.4245 0.9840 5.6924 0.7170 Prob 0.0414 0.0003** 0.1120 0.6420 0.0000** 0.0157* 0.3256 0.0000**

Durbin-Watson stat 0.0000

Prob(F-statistic)

** and * indicate significance at p<0.001and p<0.05 respectively.

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Sensitivity Analysis Ranked regression We have taken several steps to ensure all the assumptions are met. Nevertheless, our residuals for regression results presented in Tables 6 and 7 are not normal despite some transformation done to the non-normal variables. However, we believe that the results are acceptable since the kurtosis and skewness are almost equal to 3 and 0, respectively. However, as suggested by prior study, we also perform the non-parametric estimations on our sample. We repeat the regression analysis using the ranked regression procedure as in Lang and Lundholm (1993), Wallace et al. (1994), Owusu-Ansah (1998), Ali et al. (2003) and Hassan et al. (2006-2007). Similar to the above studies, we replaced the continuous variables (Size, PTA, PE and DTA) with their rank. Results for this analysis are presented in Tables 8 and 9. Tables 8 and 9 indicate that the ranked regression results are consistent with results presented in Tables 6 and 7.

Table 8: Results of regression analysis of the association between disclosure quality and firm characteristics: Ranked Transformation (n=484) Coefficient Constant NSize NPTA NPE NDTA RMC Audit R2 F-statistic 0.1312 -0.1077 0.1748 0.0352 0.0160 0.2116 0.5071 -0.0072 Adjusted R2 12.0046 Std. Error 0.0769 0.0442 0.0465 0.0412 0.0400 0.1193 0.0914 0.12030000 t-Statistic -1.3998 3.9577 0.7563 0.3883 5.2840 4.2510 -0.0788 Durbin-Watson stat 0. Prob 0.1622 0.0001** 0.4498 0.6980 0.0000** 0.0000** 0.9373 1.0199

Prob(F-statistic)

** indicates significance at p<0.001.

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Table 9: Results of regression analysis of the association between disclosure quality and firm characteristics: Ranked Transformation (n=484) Coefficient Constant NSize NPTA NPE NDTA RMC Audit YRafter R2 F-statistic 0.1567 -0.2743 0.1753 0.0456 0.0170 0.2447 0.2668 0.0309 0.3839 Adjusted R2 12.6402 Std. Error 0.0832 0.0438 0.0453 0.0409 0.0402 0.1426 0.0925 0.1033 t-Statistic -3.2966 4.0053 1.0071 0.4143 6.0900 1.8702 0.3341 3.7168 Prob 0.0011 0.0001** 0.3144 0.6788 0.0000** 0.0621# 0.7384 0.0002** 1.0367

0.1443 Durbin-Watson stat 0.0000

Prob(F-statistic)

** and # indicate significance at p<0.001and p<0.10 respectively.

CONCLUSION In this study we examine the disclosure quality of financial instruments information of Malaysian firms listed in Bursa Malaysia. Our study indicates that disclosure quality among Malaysian firms is still low. However, the pattern of disclosure level increases. This study may suggests effective enforcement mechanisms to ensure high quality reporting. Our regression analyses indicate that size, leverage, RMC and the implementation of financial instrument disclosure standard are significantly related with disclosure quality. These results are consistent to prior studies. One implication of this study is to suggest the establishment of risk management committee that would act on behalf of the shareholders in managing and disclosing risk exposure related to financial instruments. However, more research into the best composition of members in the risk management committee, their roles, and specific procedures or process that would enhance risk management is needed in the future.
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