AN EMPIRICAL INVESTIGATION OF THE CORPORATE DISCLOSURE PRACTICES IN INDIAN SOFTWARE INDUSTRY

Poonam Mahajan Junior Research Fellow Department of Commerce & Business Management Guru Nanak Dev University, Amritsar
poonam_mcs@yahoo.co.in +91-98159-66291

Dr. Subhash Chander Professor Department of Commerce & Business Management Guru Nanak Dev University, Amritsar
subh_chander@rediffmail.com +91-98140-01493

AN EMPIRICAL INVESTIGATION OF THE CORPORATE DISCLOSURE PRACTICES IN INDIAN SOFTWARE INDUSTRY

ABSTRACT This study empirically examines the quantum of corporate disclosure and its association with corporate attributes, such as, age, size, profitability, leverage, listing status, shareholding pattern, audit firm, and residential status of a company. It is based on a sample of 50 companies from the software industry drawn from PROWESS database of the Center for Monitoring Indian Economy (CMIE) for the year 2004-05 on the basis of market capitalization as on march, 31, 2005. An unweighted disclosure index consisting of 90 items of information was constructed, which was used to compute the disclosure score of each selected company. Pearson correlation product moment matrix was used to check the multicolleanarity between independent variables. Multiple regression analysis revealed that significant association exists between size, profitability, and audit firm and disclosure level. However, no significant association was found between disclosure score and age, listing status, leverage, shareholding pattern, and residential status of a company. INTRODUCTION Corporate disclosure and its determinant analysis has become a thrust area of research for various researchers and academicians. Many researchers have contributed towards exploration of this area of research. Still, many questions arise in the mind of an analyst or researcher as to why do different firms in the same industry has varying disclosure practices? The need is to explore the area why extent of information is differing among industries or in same industry? Day by day the concept of disclosure is also changing. Now, it does not mean disclosing immaterial, irrelevant, vague information. Now emphasis is given to the qualitative aspect of information which is relevant to informed investors for making economic decisions. The main reason for this emphasis is that full and complete disclosure is the cornerstone to protect the shareholders rights. Shareholders are the owners of a company and they should be informed about the working prospects of a company. Only through full and complete disclosure can shareholders feel confident that the firm to which they have given their hard earned money is being operated with their best interests in mind. Forward-thinking companies report both financial and regulatory (operational) data to key external and internal constituents. They monitor market and stakeholder reactions to the reported information and then adapt their disclosure in response to such feedback as well as 2

other market, regulatory, and social developments. In return for such transparent, proactive reporting, the companies enjoy benefits such as stronger stakeholder relationships, greater support throughout all operations for reporting initiatives, larger following of investment analysts, easier access to capital, and lower reputation risk. (Price Waterhouse Coopers, 2005, p. 3). With globalization of Indian economy and subsequent entry of foreign institutional investors, there has been demand for more disciplined financial reporting (Mathew, 1999, p.373). Globalization of capital markets has been accompanied by calls for globalization of financial reporting (Healy and Palepu, 2000, p. 42). The challenges faced in the corporate disclosure are now greater than ever (Hutton, 2004, p 8). It has become a precondition for the proper working of the capital markets. It may be viewed as a special protection instrument that investors and creditors (banks in particular) have at their disposal to protect their interest (Farina, 2005, p.6). Better disclosure has a positive impact on the efficient functioning of the capital markets (Patel, Dallas, 2002, p. 5). It is vital for the optimum decision of investors and for a stable capital market (Datt, 1999, p. 660). Greater transparency and better disclosure keep corporate stakeholders better informed about the way company is being managed. The developing nations in need of external finance both from domestic as well as foreign sources are under a great pressure to improve the quality of reporting practices for their economic growth and well being. Todays complex business environment has increased the pressure on companies to be more transparent in their financial reporting. CONCEPT OF DISCLOSURE The subject of corporate disclosure which is also known as Financial Reporting, Corporate Reporting and Disclosure has increasingly gained significance during the recent years. A lot of changes have taken place in economic environment of the country and the corporate sector in particular, due to market oriented policies introduced by the Government since 1991 and emergence of new multilateral trading system under the aegis of World Trade Organization (Committee report on companies bill (1997), 2002, p. 4). The term disclosure can be defined in different ways. Kohlers Dictionary for Accountants defines it as an explanation, or exhibits, attached to a financial statement, or embodied in a report (e.g. auditor report) containing a fact, opinion or detail required or helpful in the interpretation of the statement or report (cooper and Ijiri, 1984, p.176). It means the 3

communication of material and relevant facts concerning financial position and the results of the reporting concerns to various users (Meigs, Johnson and Meigs, 1977, p. 493). The term Disclosure refers to the fact of disclosing any information concerning a company, whether on voluntary or on statutory basis (Farina, 2005, p. 15). Disclosure is a process of providing certain financial information to a wide variety of users, relevant to their data needs, concerning the performance of an entity (Datt, 1999, p. 660). The extent of information disclosure, its adequacy, relevance and reliability are important characteristics of financial reporting practices prevalent in a country. So, in nutshell, disclosure means to convey financial and non-financial information to various users that assist them in taking economic and financial decision of better quality. SIGNIFICANCE OF DISCLOSURE The need for full disclosure is irrefutable in a free enterprise economy (Chander, 1992, p.4). Investors have a very real interest in what companies disclose, in the trustworthiness of the disclosure, and in how and when they disclose (Litan, 2003, p. 8). Better disclosure enhances the quality and level of monitoring of firm by shareholders and strengthens corporate governance. Over the years, the information provided by business organizations has increased in quantity, quality, variety and timeliness (Narayanswamy, 2005, p.55). The working groups on Indian Companies Act stated that other things being equal, greater the quality of disclosure, the more loyal are a companys shareholders (CII report, 1998, p. 7). Besides investors, financial disclosure is significant from the point of view of large number of other potential users, these include in addition to present and future investors, employees, suppliers, creditors, management, customers, financial analysts, advisors, brokers, underwriters, stock exchange authorities, legislators, financial press, reporting agencies, labor unions, trade associations, business researchers, academicians and above all public at large (Datt, 1999, p. 660). The financial sector and capital market reforms over last one decade have resulted in substantial growth in the capital market and at the same time brought transparency in the its operations (Committee report on companies bill (1997), 2002, p. 23). Indian companies, banks and financial institutions can no longer afford to ignore better corporate practices. As India gets integrated in the world market, Indian as well as international investors demand greater disclosure, more transparent explanation for major decisions and better shareholder 4

value (CII report, 1998, p 1). It is the financial reporting behavior of publicly listed companies that is of primary importance to international portfolio investors and creditors (Craig and Diga, 1998, p.248). A communication revolution is on the anvil. Published annual reports are used as a medium for communicating both quantitative and qualitative corporate information to shareholders, potential shareholders (investors) and other users. Although publication of an annual report is a statutory requirement, companies normally voluntarily disclose information in excess of the mandatory requirements. Company management recognizes that there are economic benefits to be gained from a well-managed disclosure policy. Thus, information disclosure in itself is a strategic tool, which enhances a companys ability to raise capital at the lowest possible cost (Healy and Palepu, 1993; Lev, 1992). Thus, disclosure is significant from the point of view of users, companies and the nation on the whole. It reduces uncertainty in the market and helps the users in selecting the best portfolio for their investments. So, corporate disclosure is an essential element for the efficient functioning of the capital market. REVIEW OF LITERATURE Since, the 1960s there has been an increased interest in accounting disclosure studies. A number of studies have been conducted the world over to see the impact of company specific attributes on the extent of the disclosure practices of the companies. A synoptic view of these studies has been presented in table 1: Table 1.
Author

Studies on the extent of disclosure and its association with corporate attributes
Period of study Sample size/Countr y of the study 527 USA 45 India No. of disclosure items in the disclosure index 31 34 Independent variables Statistical techniques used Significant explanatory variables

Cerf (1961) Singhvi (1968)

1960 19631965

Size, Listing Status, and profitability Size, rate of return, earnings margin, audit firm, type of management, number of stockholders

Regression Analysis Univariate

Size, Listing Status Size, management, number of stockholders

Singhvi and Desai (1971)

1965

155 USA

34

Buzby (1974) Buzby (1975) Barrett (1976)

19701971 1970 -1971 19631972

88 USA 88 USA 103 USA, UK, France, Germany, Sweden, Japan, and Netherlands 80 USA 180 UK 103 New Zealand 180 UK 51 India 52 Mexico 90 Sweden

39

Size, number of shareholders, listing status, size of auditing firm, rate of return and earnings margin No variables identified Size, listing status No variables identified

Univariate & Multivariate.

Listing status

Mean and ttest Univariate Descriptive Statistics

38 17

No adequate disclosure by small and medium sized firms in sample. Size Disclosure improved throughout years of study. Wide variances exist between disclosure levels of USA, UK from other five nations. Size, industry Size, listing status Size No significant relation Extent of statutory disclosure is more than voluntary disclosure Size Listing status, size

Stanga (1976) Firth (1979) McNally et al. (1982) Firth (1984) Garg (1986) Chow and Wong-Boren (1987) Cooke (1989)

1972 1973 1976 1979 1977 1979

79 48 41 48 Not specified 24 224

Size, industry Size, listing status, audit firm size, rate of return, growth, audit firm, industry Stock market risk No variables identified Size, leverage, proportion of assets in place Listing status, parent company relationship, size, number of shareholders Size, industry, audit firm Size, listing status, industry Size, profitability, age of a company, and nature of industry Size, listing status, industry Listing status

Univariate & Multivariate Univariate Univariate Linear regression Descriptive Statistics Multivariate (linear regression) Multivariate, three regression models Univariate Univariate & Multivariate. Multivariate

1982 1985

Tai et al. (1990) Cooke (1991) Chander (1992) Cooke (1992) Cooke (1993)

1987 1988 19811985 1988 1988

76 Hong Kong 48 Japan 50 (Public & Private sector each) India 35 Japan 48 Japan

11 106 92 (public), 98 (private) 165 195

Size Size Size, Profitability

Multivariate Univariate

Size, listing status, industry Listing status

Malone et al. (1993)

1986

125 USA

129

Size, listing status, leverage, profitability, audit firm Size, leverage, audit firm, multinationality, qualification of the chief accountant Size, ownership structure, leverage, assets in place, audit firm, listing status Size, listing status, leverage, profitability, audit firm, liquidity Size, leverage, audit firm, relation with parent, qualification of accountants Size, leverage, assets in place, audit firm, listing status Size, country origin, industries, leverage, multinationality, profitability, listing status Company size, leverage, profitability, ownership structure, internationality, auditor size, industry type Foreign registered office, profit margin, earnings return, liquidity ratio, leverage, size, outside shareowners, conglomerates, audit firm Size, change in time

Stepwise regression model Univariate & Multivariate

Listing status, leverage, size

Ahmed and Nicholls (1994) Hossain et al . (1994)

1988

63 Bangladesh

94

Multinationality, accountants qualification, size Size, ownership structure, listing status Size (+), listing status (+), liquidity (-)

1991

67 Malaysia

78

Univariate & Multivariate

Wallace et al. (1994)

1991

50 Spain

16

Multivariate

Ahmed (1996)

198788, 1992-93 1991

118 Bangladesh

150

Regression Analysis

Audit, Multinationality

Hossain et al. (1995)

55 New Zealand 116 (US) 64 (UK) 16(France) 12 (Germany) 18 (Netherland) 161 Switzerland

95

Multivariate

Size, leverage, listing status

Meek et al. (1995)

1994

85

Linear regression

Size, country, listing status

Raffournier (1995)

1991

30

Univariate & Multiple linear regressions

Size, internationality

Wallace and Nasser (1995)

1991

80 HongKong

142

Multivariate

Size, conglomerates, and profits.

Marston and Robson (1997)

19831990

29 India

17

Univariate

Size

Giner (1997)

1989-91

138 Spain

50

Patton and Zelenka (1997)

1993

50 Czech Republic

66

Owusu-Ansah (1998)

1994

49 Zimbabwe

214

Chen and Jaggi (2000)

1993, 1994

87 HongKong

142

Depoers (2000)

1995

102 France

65

Gelb and Zerowin (2000)

19801993

82 USA

AIMRFAF disclosure scores

Size, listing status, profitability, leverage, audit firm, industry, dividend payout Size, performance, risk factors, other monitoring factors (listing status, big six auditing firms, industry) Size, ownership, age, multinational affiliation, profitability, audit, industry, liquidity Independent nonexecutive directors, family control, profitability, leverage, size, audit firm Firm size, foreign activity, ownership structure, leverage, size of auditing, proprietary costs related to competition, labor pressure Informativeness of stock prices

Multivariate

Size, auditing, listing status, and profitability Type of auditor, number of employees

Univariate & Multiple linear regressions

Multivariate

Size, ownership, age, multinational affiliation profitability Independent nonexecutive directors

OLS regression

Multiple linear regression.

Foreign activity and size

Jaggi and Low (2000) Ho and Wong (2001)

1991 1998

28 (from 28 countries) 98 Hong Kong

90 20

Cultural, legal and financial variables Independent nonexecutive directors, audit committee, dominant personalities, family + control variables Size, Financial condition, leverage, share issue, unrelated directors, regulated industries.

Multiple regression model of Collins, Kothari, Shanken, and Sloan (1994) Univariate & Multivariate Multivariate (linear regression)

Stock prices

Common law, culture Audit committee, family

Bujaki and McConomy (2002)

1997

272 Canada

25

Linear regression

Unrelated directors, leverage

Chau and Gray (2002)

1997

62 Hong Kong Singapore

110

Ferguson et al. (2002) Haniffa and Cooke (2002) Archambault and Archambault (2003) Eng and Mak (2003)

1995/96

142 Hong Kong 167 Malaysia 621 (From 33 countries) 158 Singapore

93

Ownership structure, size, leverage, audit firm, profitability, multinationalty, industry Firm type, size, leverage, industry, listing status Corporate governance, cultural and firm specific Cultural, national, financial systems Ownership structure, board composition Global diversification Industry type

Multivariate

Ownership structure

Univariate & Multivariate Linear regression Multivariate

Firm type, leverage (type of disclosure) Family members sitting on board, nonexecutive chairman Many factors

1995

65

1992, 1993 1995

85

84

OLS regression

Cahan, Rahman and Perera (2005) Ahmed (2005)

1998 or 1999 2002

216 (From 17 Countries) 100 (non financial listed companies) India 100 (non financial listed companies) Bangladesh 40 Saudi Arabia

Botosans (1997) index 12

OLS regression Descriptive statistics

Ahmed (2005)

2002

148

Companys trading category

Descriptive statistics

Lower managerial ownership, government ownership, outside directors, lower debt Global diversification, number of analysts size Level of reporting voluntary information is low but variability in disclosure is wide among all sectors in industry. Companys trading category

Alsaeed (2005)

2003

20

Size of firm, age, debt ratio, ownership dispersion, profit margin, return on equity, liquidity ratio, industry type, audit firm size.

Multivariate

Size of firm

Hossain and Taylor (2006)

19921993

261 Bangladesh, India, and Pakistan

94

Size, profitability, debt/equity ratio, presence of debenture in debt, international link of the audit firm, industry type, subsidiary of a multinational company.

Multivariate

Size (total assets), subsidiary of a multinational company (Bangladesh), Presence of debenture in debt, industry type, Size (total sales), profitability (ROA) (India) and assets-inplace, size (total assets), presence of debenture in debt (Pakistan)

A perusal of review of literature reveals that the association between the level or quality of disclosure in corporate annual reports and corporate attributes has been examined in several countries using a disclosure index approach. The disclosure indices constructed to measure the quality and extent of disclosure varies considerably among the different studies, although all share the basic idea of usefulness for the investment decision process. In studies either voluntary or mandatory or both mandatory and voluntary information has been considered. There are some researchers who have measured the extent of disclosure longitudinally to determine whether quality of disclosure has improved over time. Most studies are country specific, although there are studies, which have measured the extent of disclosure among countries. Most disclosure studies have focused on only one year. The numbers of the companies included in the samples in these studies have varied from 28 to 621. No disclosure study other than Malone et al. (1993) was industry-specific. The number of corporate attributes that were examined by researchers as a predictor of the level of disclosure has ranged from 2 to 11. The companies attribute which has proved most popular determinant of corporate disclosure is corporate size as measured by assets, sales and market capitalization. The size of a company has been regularly found to be significantly associated with the extent of disclosure in majority of the studies. This has been followed by profitability ratios, listing status and auditor type. A little used variable is dividend pay out ratio. Some studies have used weighted disclosure indices (weights were assigned by the researchers subjectively or weights were based on preferences elicited by the researchers from surveys of a group or groups of users), whereas other researchers used unweighted disclosure indices. 10

Most of the researchers have used ordinary least square (OLS) regression to establish the relationship between the extent of disclosure and company attributes, while other researchers have used a stepwise (OLS) regression. However, Lang and lundholm (1993), Wallace, Naser and Mora (1994) and Wallace and Naser (1995) used rank (OLS) regression to cater for the monotonic behavior of disclosure indexes following a change in some independent variables. The variety of methods used and results produced are related. The changing feature of prior studies, such as the number of the firms included in the sample, the type and the number of firm characteristics examined, the number of information items that formed the basis of the set of disclosure indices as a dependent variable, the different statistical methodologies used to analyze the data and the different settings (i.e. countries) of the study, have jointly contributed to the mixed results from these studies (Wallace, Naser and Mora, 1994, p. 43). NEED AND OBJECTIVES OF THE STUDY The foregoing review of literature reveals that some studies have been conducted to analyze the various aspects of corporate disclosure practices in India (For details, see Singhvi, 1968; Garg, 1986; Chander, 1992; Marston & Robson, 1997; Ahmed, 2005; and Hossain and Taylor, 2006). Hardly any study has been carried out to explore the research on industry specific disclosure practices in India. This has been taken as only one of the corporate attribute affecting the disclosure practices of firms in a few studies. There has been a maiden study carried out by Malone et al. (1993) in USA to study the disclosure practices in oil and gas industry. Hence, the need to carry out this study was felt. The following are the objectives of this study: 1. To study the extent of disclosure in annual reports of selected companies of Indian software industry. 2. To test the impact of various corporate attributes such as- age, size, profitability, market capitalization, listing status, leverage, ownership pattern, residential status of a company, and audit firm size on the reporting practices of the firms in software industry.

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DATA BASE AND METHODOLOGY The study has been carried out to analyze the disclosure practices of Indian software industry. This industry has been chosen because India is considered to be the most favored destination for offshore IT service delivery. Consequently, global players are also stepping up their presence in India, not only to use the local delivery centers to service their offshore business but also to target the fast-paced Indian IT services market. (Annual report of Satyam Computers Ltd., 2005, p. 40). India is a premiere destination for off shoring IT services. According to NASSCOMs Strategic Review report 2005, the total Indian IT enabled services export market is projected to grow to $ 48 billion by fiscal 2009. According to the June 2004 Gartner Strategic Analysis Report, titled India Maintains Its Offshore Leading Position, India will remain the dominant offshore service provider through 2008. According to this report, no other nation will have a double-digit share of global offshore service revenue (Annual report of WIPRO Ltd., 2005, p. 150). Directionally, the overall trends in Indian software industrys services have remained unchanged in fiscal 2005 as compared to fiscal 2004 (Annual report of Satyam Computers Ltd., 2005, p.40). Data Collection The universe of study constitutes the companies representing software industry sector, selected on the basis of market capitalization, as on March 31, 2005 from PROWESS, the database of CMIE. There were 394 companies representing software industry, to which following filters were applied: 1. The companies whose annual report for the year 2004-05 was not available were eliminated. 2. The company whose information with regard to market capitalization as on March 31, 2005 was not available was also eliminated. 3. The companies, whose information with regard to any financial or non-financial variable was not available, were also eliminated. 4. The companies with financial year-end September 31, 2005 were also eliminated. Thus, as a result of these filters, out of 394 companies, a resultant sample size of 50 companies was selected and studied. The annual reports of the selected companies for the year 2004-05 were the major source of data collection. All the selected companies were requested to mail their annual reports. Out of 12

which only 15 companies responded. The annual reports of some companies were downloaded from the websites of respective companies. The annual reports of companies, which were not available on their websites, were downloaded from website www.sebi.gov.in. The annual reports of financial year 2004-05 were chosen because they were relatively more recent and easier to obtain. The data related to the corporate attributes was taken from PROWESS database of the Center for Monitoring Indian Economy (CMIE). SPSS version 10.05 was used for application of various tests. Disclosure Index Construction A disclosure index is taken as a yardstick to measure the level of disclosure by the listed firms. The construction of the disclosure index is based on the information that firms supply in their annual financial reports to shareholders. Annual financial report is taken as one of the best media for dissemination of useful information relevant for economic decision making to investor. The quantum of disclosure in the annual reports of the Indian software industry has been studied by framing a disclosure index comprising of 90 items of information. The items of information for constructing an index of disclosure was selected on the basis of review of literature on corporate disclosure, criteria laid down by ICAI for selecting the best presented published accounts and scanning the annual reports of the companies which have been awarded by ICAI for their best presented published accounts in 2005. The unweighted index was used for the purpose of present study. The contents of each annual report were compared to items listed in disclosure index and coded as 1 if disclosed or 0 if not disclosed. For each item, a disclosure index was computed as the ratio of the actual score given to the firm divided by maximum score. Empirical studies also provide substantial evidence in favor of usage of unweighted disclosure index (For details see, Cooke, 1989; 1992; Tai et al., 1990; Chander, 1992; Ahmed and Nicholas, 1994; Hossain et al., 1994; Wallace et al., 1994; Hossain et al., 1995; Chen and Jaggi, 2000; and Archambault and Archambault, 2003). Ahmed and Courtis (1999, p.36) write that the approach based on unweighted items has become the norm in annual report studies, because it reduces subjectivity. The disclosure score for each company has been calculated as follows: DISCLOSURE SCORE (%) = (Actual Disclosure/Total Possible Disclosure) x 100

13

Model Development In order to study the impact of various corporate attributes, Multiple Regression Analysis has been used. The model employed to test the relationship between specific-related variables and level of disclosure is presented below: Y = 0 + 1X1 + 2 X2 + 3 X3 + 4 X4 + 5 X5 + 6 X6 + 7 X7 + 8 X8 + Where Y X1 X2 X3 X4 X5 X6 X7 X8 = = = = = = = = = = = Disclosure score; Age of a company (from year of incorporation till March 2005); Listing status of a company (A group company=1, others=0); Shareholding Pattern (Promoters share in shareholding); Leverage (Debt to Equity ratio); Size of a Company; Profitability of a Company; Audit firm size ( Big 6 audit firms = 1 & Others= 0); Residential status of company (Foreign=1, Indian=0); Slopes of the independent variables while 0 is a constant or the value of Y when all values of X are zero; The error term, normally distributed about a mean of 0

Hypotheses Development
1. Size of the company There are several studies which have found a significant association between the size of the company and the extent of disclosure in the corporate annual reports in both developed and developing nations (Singhvi and Desai, 1971; Buzby, 1974; Chow and Wong-Boren, 1987; Cooke, 1989; Wallace, Naser and Mora, 1994). However Stanga (1976) found that the size of the company did not significantly explain an association with the level of disclosure and its variability. Larger companies may be hypothesized to disclose more information in their company annual reports than smaller companies for a variety of reasons. Firstly, the cost of disseminating and accumulating detailed information may be relatively low for the larger corporation than the smaller corporations (Cerf, 1961; Singhvi & Desai, 1971; Buzby, 1975; and Firth, 1979) and large companies have the resources and expertise to produce more information in their companys annual reports (Ahmed & Nicholls, 1994; and Hossain & Adams, 1995) and

14

hence, little extra cost may be incurred to increase disclosure. In addition, larger corporations may collect more information to be used for their internal management systems. Secondly, larger firms tend to go to the stock market for financing more often than those smaller firms and as a result may disclose more information in their annual reports for their own interest. Thirdly, Wallace and Naser (1995) state the impacts that large companies can have on the economy can be considerable as these companies account for a significant proportion of goods and services produced, consumption of raw materials and number of people employed. As such, large companies are likely to come under the scrutiny of various interested parties and hence tend to disclose adequate information in their annual reports. Fourthly, smaller firms may feel that their information disclosure activities could endanger their competitive oppositions with respect to other larger firms in their industry. As a result, smaller companies may tend to disclose less information than large companies. Fifthly, it has been suggested that the annual reports of large corporation are more likely to be scrutinized by financial analysts than those of smaller firms and investors may interpret nondisclosure as bad news, which could adversely affect firm value. So, larger firms may have an incentive to disclose more information than smaller firms. Sixthly, larger corporations are likely to have a higher level of internal reporting to keep senior management informed and therefore are likely to have relevant information available (Cerf, 1961; Buzby, 1975; and Owusu-Ansah, 1998). Cerf (1961), however, notes that the accumulation of such information is no guarantee that it will be presented in the annual report. Finally, Firth (1979) argued that large firms tend to be in the public eye and attract more interest from government bodies, and thus may disclose more information to enhance their reputation and public image on one hand and to allay public criticism and government intervention in their affairs on the other hand. This is analogous to arguments concerning political visibility put forward by Watts and Zimmerman (1986) although the latter authors are concerned not with disclosure but the choice of accounting policies. There are several measures of size available. In this study, sales turnover, total assets, and market capitalization are used as surrogates of a companys size. The foregoing discussions lead to development of the following hypothesis: H1: The size of a company as measured by assets, or sales, or market capitalization has a positive impact on its disclosure score. 15

2.

Profitability of a company

Profitability has also been used by number of researcher as an explanatory variable for differences in disclosure levels. Companies having higher profitability may disclose more information in their corporate annual reports than the companies with lower profitability (or losses) for a number of reasons. Firstly, if the profitability of a company is high, management may disclose more detailed information in their corporate annual reports in order to experience the comfort of communicating it, as it is a good news. On the other hand, if profitability is low, management may disclose less information in order to cover up the reasons for losses or lower profits. However, Cerf (1961) postulates that a company that is less profitable may disclose more information to explain the reasons for the lower profitability. The companies are interested in keeping the market informed to avoid the under valuation of their shares. Secondly, for profitable companies, if the rate of return on investment is more than the industry average, the management of a company has an incentive to communicate more information, which is favorable to it as the basis of explanation of good news and is likely to disclose more information in their corporate annual reports as a result. Wallace and Naser (1995) argue that a profitable company is more likely to signal its good performance to the market by disclosing more information in its annual report. The empirical studies, however found mixed results. Among these researchers, Singhvi (1967); Singhvi and Desai (1971); Wallace (1987); Wallace, Mora and Naser (1994); Wallace and Naser (1995); and Raffournier (1995); found a positive association between profitability and the extent of disclosure whereas Belkaoui and Kahl (1978) found a negative association between variables. Spero (1979) found that there existed a positive association for French companies and no significant association for the British and Swedish companies in that study. Others, (McNally et al., 1982; Raffournier, 1995; and Owusu-Ansah, 1998) found no significant relationship. Researchers have used a number of measures to determine the associations between profitability and disclosure levels. In the present study, return on assets, returns on sales, return on net worth, and return on capital employed have been used as a determinant of measuring the association between profitability and level of disclosure. The following specific hypotheses have been formulated and tested:

16

H2: The profitability of a company as measured by ROA, or ROS, or ROCE, or RONW has a positive impact on its disclosure score. 3. Leverage of a company Several studies investigated the relationship between leverage (book value of debt to shareholders equity or book value of debt to total assets) and disclosure, with the general view that companies with a higher level of leverage disclose more information. The general agency relationship can also be applied to the relationship between managers and debt providers. Debt providers may be concerned about possible wealth transfers to shareholders; that is, managers are more likely to favor the interests of shareholders to the detriments of the providers of debt (Francis & Wilson, 1988). Ahmed (1996) suggests that the agency costs of debt are higher for companies with more debt in their capital structure and an increased level of disclosure may reduce these costs. While increased disclosure may not necessarily be part of a contractual agreement. Wallace et al., (1994) opine that a company with a higher gearing level has a greater obligation to satisfy the needs of its long-term creditors for information and may therefore provide more information in its annual reports than a more lowly geared company. However, the empirical evidence has generally not supported this theory (e.g. Chow & Wong-Boren, 1987; Wallace et al., 1994; Hossain & Adams, 1995; Raffournier, 1995; Wallace & Naser, 1995). A possible explanation for these findings might be that debt holders are in a position to demand additional information other than that contained in the annual report and are therefore not as reliant on the disclosures made in the annual report. As these previous studies have considered different countries and utilized differing methods, there is a value in considering leverage in this study. Therefore, the following hypothesis is tested in this study: H3: The leverage of a company has a positive impact on its disclosure score. The Debt to Total Equity has been used as a surrogate to measure the leverage of a company in the present study. 4. Audit Firm Size A number of studies test the relationship between audit firm size and the level of disclosure. Large audit firms are widely scattered across the world, while small audit firms operate domestically. The classification of audit firms into two groups draws on the assumption that large firms have more concern for their reputation and, therefore, are more willing to 17

associate with firms that disclose more information in their published financial reports. On the other hand, small audit firms do not possess the power to influence the disclosure practices of their clients. Rather, they attempt to meet the needs of their clients in order to retain them (Firth, 1979; Wallace and Naser, 1995). Empirical evidence on the relationship between audit firm size and the disclosure extent is rather ambiguous. Naser et al. (2002) observed a positively significant relationship. Wallace et al. (1994) found it positive but insignificant. In contrast, Wallace and Naser (1995) noticed a significantly negative relationship between the disclosure level and firm size. Therefore, the following hypothesis has been formulated and tested in this study: H4: The audit firm size of a company has a positive impact on its disclosure score. Audit firms of 394 companies from software industry (PROWESS) were divided into large (Big 6: Price Waterhouse, A F Furguson, S B Bilimoria, S R Batliboi, Delloitte, Haskins and Sells, B S R & Co.,) and small firms (other than above Big 6). This variable has been used as a dummy. The companies being audited by Big 6 audit firms were assigned 1 and others 0. 5. Age of a Firm Camferrman and Cooke (2002) identified a number of new variables, such as the age of a company to be investigated by future studies. The rationale for selecting this variable lies in the possibility that old firms might have improved their financial reporting practices over time. The older the firm, the scope for disclosure also broadens. It helps in understanding variations among disclosure practices of different firms in same industry. Therefore, the above arguments led to the formulation of following hypotheses: H5: The age of a firm has a positive impact on its disclosure score. The age of a firm is computed from the year of its incorporation till March 31, 2005. 6. Residential status of a firm Subsidiaries of multinational corporations operating in developing countries are expected to disclose more information and observe higher standards of reporting for a number of reasons; Firstly, they have to comply with the regulations of not only their host country but also the parent company where substantially higher standards of reporting and accounting are maintained. Secondly, they are usually equipped with more advanced accounting software tools, efficient audit staff, competent and efficient management and staff, and so, have the potential to disclose more information without any incremental processing costs. Thirdly, they 18

are under closer scrutiny of various political and pressure groups within the host country that view them as sources of economic exploitation and agents of imperialist power (Ahmed and Nicholls, 1994). Hence, they have an incentive to disclose more information in order to avert any pressure for excessive control for exploitation. Wallace (1987) and Ahmed and Nicholls (1994) used multinational company influence as an explanatory variable in developing their models and the latter found it to be the most significant variable explaining disclosure levels. Therefore, the following hypothesis has been formulated and tested in this study: H6: The residential status of a company has a positive impact on its disclosure score. The influence of residential status is operationalized by means of dummy variable, with 1 for multinational companies and 0 for domestic companies. 7. Listing Status of a firm The listing status of a firm also influences the disclosure level of that firm. Every Indian company listed on a stock exchange has to comply with its listing agreement. The companies whose shares are actively traded have always been scrutinized sharply by the market as a whole and investors in particular. Empirical evidence also suggests a significant association between disclosure level and the listing status of a firm (Singhvi and Desai, 1971; Cooke, 1989; Cooke, 1992; Malone et al., 1993; and Wallace et al., 1994). So, the above discussions led to the formulation and testing of the following hypothesis: H7: The listing status of a firm has a positive impact on its disclosure score. The companies trading on stock exchanges in India have been categorized as category A, B1, B2, S, and T. The impact of listing status of a firm on extent of disclosure level has been examined by introducing dummy variable, with 1 if firm falls under A category and 0 otherwise. 8. Shareholding Pattern This variable has been selected on the ground that the extent of disclosure may differ among firms in response to the proportion of shareholders interest. Shareholding pattern here means the percentage of common shares held by promoters. Fama and Jensen (1983) theorized that a low concentration of ownership causes conflict of interest between the principal (shareholders) and the agent (management). To alleviate the potential for higher agency costs, more disclosure of information is expected. McKinnon and Dalimunthe (1993) empirically 19

examined the nature of relation and found support for this idea in a study covering some Australian companies. So, the following hypothesis has been formulated and tested: H8: The promoters interest in the shareholding of a company has a positive impact on its disclosure score.

RESULTS AND DISCUSSIONS

The results and discussions have been divided into two parts. In the first part, the extent of disclosure of companies in the software industry has been analyzed. The impact of corporate attributes on corporate disclosure has been examined in the second part. Part I) Extent of Corporate Disclosure of the Companies in the Software Industry The extent of disclosure of companies in the software industry has been examined with the help of disclosure score. The percentage of disclosure score has been computed for every selected company from the software industry. The range of disclosure level of the companies in the software industry varies between 32.2% and 71.1%. The picture of the extent of corporate disclosure of companies in the software industry is highlighted in the table 2. Table 2 examines that the highest level of the disclosure is maintained by Wipro Technologies Ltd. And Infosys Ltd. (71.1%), followed by Rolta India, Info Tech Enterprises (67.8%) and IFlex solutions Ltd. (65.6%). The companies namely, Silicon Valley Info Tech Ltd (32.2%), followed by Orient Information Technologies Ltd. (37.8%), T-Spiritual Ltd, Micro-Tech (India) Ltd., I-Gate Global Solutions Ltd. (38.9%) and Pentamedia Graphics Ltd (41.11%) are at the lowest level of corporate disclosure ranks. The variation in the disclosure level may be due to the fact that a few of the companies from the Indian software industry are known for their wealth creation. They try to disclose the information even beyond the level required by statutory provisions of Indian law. These companies have large overseas operations and their shares are listed on the international stock exchanges. So, in order to meet the regulatory requirements of listing agreements of other nations, they have to widen the scope of disclosure level. That is why the level of disclosing voluntary information is also high in the case of companies like Wipro Ltd., Satyam Computers Ltd. and Infosys Ltd.

20

Table 2 Extent of corporate disclosure of 50 Indian companies in Software Industry

Sr. No. 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 Name of Company Micro Technologies (India) Ltd. P S I Data Systems Ltd. Orient Information Technology Ltd. Geodesic Information Systems Ltd. B S E L Infrastructure Realty Ltd. Helios & Matheson Information Technology Ltd. Kale Consultants Ltd. Four Soft Ltd. N I I T Technologies Ltd. Nucleus Software Exports Ltd. Cambridge Solutions Ltd. G T L Ltd. Hinduja T M T Ltd. Datamatics Technologies Ltd. Megasoft Ltd. Aztec Software Services Ltd. & Technology Disclosure Score (%) 38.89 51.11 37.78 53.33 48.89 51.11 50 50 47.78 57.78 50 48.89 58.89 48.89 45.56 50 50 53.33 65.56 58.89 41.11 48.89 50 32.22 45.56 Sr. No. 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 Name of Company CMC ltd Sonata Software Ltd Tata Consultancy Services Ltd I-Gate Global Solutions Ltd N I I T Ltd Rolta India Ltd Wipro Ltd Blue Star Infotech Ltd Cranes Software Intl. Ltd Visualsoft Technologies Ltd Financial Technologies (India) Ltd Infotech Enterprises Ltd Patni Computers Ltd Geometric Software Solutions Co. Ltd T-Spiritual World Ltd. Mphasis BFL Ltd Zensar Technologies Ltd Ramco System Ltd Subex System Ltd Satyam Computers Ltd Infosys Ltd Hexaware Technologies Ltd Flextronic Software Systems Ltd Tata Elxci Ltd Tata Infotech Ltd Disclosure Score (%) 47.78 51.11 53.33 38.89 51.11 67.78 71.11 53.33 48.89 45.56 46.67 67.78 60 52.22 38.89 58.89 50 43.33 57.78 62.22 71.11 48.89 62.22 47.78 57.78

Spanco Telesystems & Solutions Ltd. H C L Technologies Ltd. I-Flex Solutions Ltd. Polaris Software Lab Ltd. Pentamedia Graphics Ltd. Aftek Infosys Ltd Aptech Worldwide Ltd Silicon Valley Infotech Ltd. Mascon Global Ltd

21

Part II)

Impact of the Corporate Attributes on the Corporate Disclosure

Since, wide variations have been observed in the disclosure score of the selected companies from the Indian software industry. So, it becomes imperative to know the reasons of such variations. The reasons might be company specific. So an attempt has been made to find the effect of corporate specific variable on the disclosure score. Assessing the validity of the model Before proceeding to the results of regression analysis, it was instructive to check the existence of multicollinearity among the explanatory independent variables. Multicollinearity or collinearity, the situation where two or more of the independent variables are highly correlated, can have damaging effects on the results of multiple regression. The correlation matrix is a powerful tool for getting a rough idea of the relationship between predictors. The suggested rule of thumb is that, if the pair-wise or zero-order correlation coefficient between two regressors is high, say , in excess of 0.8, then multicollinearity is a serious problem. (Gujarati, 2006, p. 359). The solution to it is to drop that variable and then run regression analysis with rest of the variables. Another way to check the multicollinearity is to compute the average VIF (Variance inflation factor). As a rule of thumb, if the VIF of a variable exceeds 10, which will happen if R2 exceeds 0.80, that variable is said to be highly collinear (Gujarati, 2006, p. 362). Correlation Analysis To examine the correlation between the dependent and independent variables and with the dependent variables, Pearson product moment correlation (r) was computed. A correlation matrix of all the values of r for the explanatory variables along with dependent variables was constructed and is shown in table 3: TABLE 3
Independent variables
Age Listing Status

Correlation Matrix
Promoter Share Market Cap Leverage Asset s ROS Audit Firm Residentia l Status DIS

Age 1.00 Listing status .316* 1.00 Promoter share .310* .102 1.00 Market cap .291* .25 .015 1.00 Leverage .407** .301* .407** .256 1.00 . Assets -.113 156 -.146 .124 -.117 . ROS .264 .246 .040 .194 125 Audit firm size .521** .409** .534** .183 .901** Residential .630** .140 .161 .354* .269 DIS -.05 -.172 -.134 -.007 -.106 *, ** and # : significant at 1%, 5% level and 10% level (respectively).

1.00 -.234 -.147 -.033 -.109

1.00 .152 .013 -.04

1.00 .306* -.100

1.00 .101

1.00

22

Table 3 shows that correlation exists between age, listing status, market capitalization, residential status, audit firm, leverage, and shareholding pattern at 1% and 5% level. Collinearity is an issue in case of leverage and audit firm size. Regression Analysis A regression analysis has been run in two stages. Firstly, multiple regression analysis was run, wherein no concluding results could be found out or in other words, no variable except audit firm size could significantly explain variations in the disclosure level. Afterwards, in the second stage, step-wise regression analysis was run, wherein few variables were dropped from the model and a combination of various variables were applied to see the effect of these combinations on the disclosure level. Multiple Regression Analysis The results from the multiple regression analysis have been presented in Table 4. Three separate determinants of firm size (sales, assets, and market capitalization) as well as four different measures of profitability (ROS, ROA, ROCE, and RONW) were used. Each surrogate to represent size and profitability was used only once in a model. This led to the creation of twelve regression equations, the results of which has been presented in table 4:

23

TABLE 4
*

REGRESSION RESULTS (MULTIVARIATE ANALYSIS)

Age .91 1.50 .95 1.61 1.13 1.10 .648 1.17 1.71# 1.68# 1.17 1.77# Listing .75 .97 .96 1.01 .49 .461 .50 .49 1.14 1.11 1.13 1.14 Promote r .24 .00 -.072 -.128 .057 .054 .003 -.034 -.04 -.033 -.079 -.156 Lev -.18 -.59 -.28 -.43 -.36 -.50 -.20 -.39 -.36 -.59 -.35 -.39 Mkt Cap X X X X X X X X .142 .166 1.033 -.214 Asset x x x x 1.32 1.34 1.82# 1.11 x x x x Sales 1.37 .47 1.32 .14 x x x x x x x x ROA 1.239 x x x 1.065 x x x 1.437 x x x ROS X 1.70# X X X 1.67# X X X 1.65# X X ROC E x x .856 X x x .822 X x X 1.012 X RONW x x x 1.136 x x x .789 x x x 1.004 AUD 4.30* 4.50* 4.68* 4.54* 4.40* 4.39* 4.60* 4.39* 4.62* 4.60* 4.75* 4.60* RES -2.8 -.28 -.43 -.02 -.33 -.04 -.47 -.26 -.25 -.25 -.43 -.13 R2 54.7 52.8 55.1 53.7 54.5 56.7 55 52.61 52.6 52.6 54.4 53.7 Adj. R2 44.5 43.6 46.4 44.7 45.6 45.7 48.3 46.2 43.3 43.3 45.5 44.7 F (Sig) 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 DW 1.997 2.041 2.069 2.037 2.074 2.072 2.082 2.07 2.033 2.033 2.079 2.028

**

, and #: significant at 1%, 5% level and 10% level (respectively).

Constan

Dis Dis Dis Dis Dis Dis Dis Dis Dis Dis Dis Dis

t 15.025 14.915 16.193 15.093 15.973 15.968 16.668 16.107 14.808 14.807 16.032 15.006

Table 4 reveals that for all models audit firm size was found to be significant at 1% level. ROS was significant at 10% level when applied in combination with all surrogates of size. Other profitability surrogates could not significantly explain variations in the disclosure level. The age of a firm was found to be significant at 10% level in explaining variations in disclosure, when applied in combination with market capitalization, ROA, ROS and RONW, the surrogate of size and profitability. Other variables could not find any place in explaining significant variations in the disclosure level. So, out of 12 models, the model, which is satisfying validity requirements and having improved adjusted R2 has been chosen and selected as a valid model. The model with combination of Age, Listing status, promoter share, leverage, assets size, ROCE (measure of profitability), audit firm size and residential status has 0.55 (Adjusted R2), F value is significant at 0.00 level of significance and DW is 2.082. But in this model, only audit firm size and firm with large asset size is found to be significant. The firms with large assets size and being audited by big six audit firms have more extent of disclosure. These are significant at 10% and 1% level of significance. Other variables were found to be insignificant. Step-wise Regression Analysis The step-wise regression was applied by eliminating different independent variables having insignificant effect on disclosure. The problem of multicollinearity between independent variables namely, leverages and audit firm size was resolved by eliminating leverage (the insignificant variable). A stepwise regression model separately applied showed that all size measures are significantly influencing the level of disclosure. Size measured in terms of assets is significant at 1% and other two measures at 5%. Of the four performance measures, only ROS was found to be significant at 5% level of significance (see table 5). Rest of the specific variables other than audit firm size could not statistically significantly influence the extent of disclosure and hence have been excluded.

TABLE 5
Dependent Variable Disclosure Disclosure Disclosure Constan t 30.654 29.904 29.374 Mkt Cap x x 2.096**

STEPWISE REGRESSION MODEL

Asset 3.143* x x Sales X 2.527** X ROS 2.083** 2.208** 2.187** AUD 5.102* 5.154* 5.270* R2 . 547 . 527 . 509 Adj . R2 . 528 . 496 . 477 F (Sig) 0.043 0.000 0.042 Avg. VIF 1.087 1.074 1.064 DW 2.063 2.002 1.995

**

, and #: significant at 1%, 5% level and 10% level (respectively).

All the three models were found to be valid. But as the Adjusted R2 is improved in the first step-wise regression equation, i.e. 0.528, so, this model has been chosen. The results of stepwise regression analysis reveal that the F-ratio is significant at 5% level of significance. The results statistically support the significance of the model. R 2 (.547), which is a respectable result, implies that independent variables explain 54.7 percent variance in disclosure score. The multicollinearity doesnt exist if average VIF is 1 or is near about 1. The problem of multicollinearity doesnt exist in the model, being satisfied by average VIF, which is approximately 1. Additionally, to test the assumption of independent errors (autocorrelation), the Durbin-Watson statistic was used. The value of this statistic closer to 2 is considered as better, and for this data the value is 2.063, which is very close to 2. Hence, the assumption has almost been accomplished. In sum, the diagnostics indicate the model to be valid and reliable. Testing the Hypothesis The results from the step-wise regression analysis shows that firms with large assets size are more in the eyes of general public and are required to disclose more information. Although in the table 5, all size measures found to be significant in explaining the extent of disclosure, but the total assets explain more variation in the disclosure practices of the firms in software industry. So, H1 is accepted in favor of the hypothesis that all the surrogates of the size of a company have a positive impact on their disclosure score. Out of profitability measures, ROS explains more significant variations in disclosure than firms with more ROA, RONW, and ROCE. So, H 2 is accepted in favor of the hypothesis that the profitability of a company as measured by ROS has a positive impact on the disclosure score. And it is rejected for other surrogates of the profitability. The companies in the software industry have more extent of disclosure as these are globally recognized for their aim 26

of wealth maximization. As wealth maximization depends on the market value of the share, which in turn depends on the cost of equity and dividend policy of the company, which depends on the profitability of a concern. All profitability measures found to be positively associated with disclosure score. Hence, the wealth maximization objective is being achieved by the companies in the software industry. But ROS found to have statistically positive relationship with the disclosure level. It helps the management, providing insight into how much profit is being produced per unit of sales. It indicates that the software industry is growing more efficiently. So, the results move in hypothesized direction The firms being audited by big six-audit firm, who are having international links too, disclose more extent of information than others. H4 is accepted in favor of positive impact of audit firm size on the disclosure score. The residential status of a firm, leverage of a company has negative association (though insignificant) with the level of disclosure. It shows that the Indian companies have to comply with the legal provisions of Indian legislation and hence have more mandatory disclosure than foreign companies. The companies having more debt content have policy of disclosing only mandatory information because the companies disclose to the maximum extent only when they have more share of public in the share capital. So, all other variables dont explain significant variations in the level of disclosure except audit firm size. Table 5 shows that the other variables like age of a company, listing status of firms and shareholding pattern have positive association with extent of disclosure though not significant. It explains that companies listed in A category at BSE, disclose more extent of information. It appears that all the companies in software industry are young in age. So, age did not emerge as a significant factor influencing the level of disclosure. The companies in which the promoters have high stake in capital structure have less extent of disclosure. Wallace et al. (1994) observed no significant association between shareholding pattern and the level of disclosure. The results are evidenced by literature and are in hypothesized direction. So all hypothesis except H1, H2, H4 are rejected.

27

CONCLUSION This study provides an evidence of the extent of corporate disclosure in Indian software industry. The analysis reveals that the extent of disclosure within the software industry varies within 32.2% to 71.1% (approximately) for period of study. It implies that though all the companies disclose mandatory information as required by law, but at the same time, a large number of companies disclose more than required by legal provisions. These companies are globally recognized and have overseas operations too. These companies are also known for maximization of the shareholders wealth. That is why these companies try to be more transparent in the eyes of domestic as well as foreign investors and have better disclosure level. It has also been observed that the extent of disclosure is influenced by size (as measured by total assets), profitability (as measured by return on sales) and the audit firm size of a company. The companies with large assets size, higher profitability and audited by big audit firms have tendencies to be more transparent and hence disclose more information. However age of a company, shareholding pattern, listing status, leverage and residential status dont significantly influence the level of disclosure.

28

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