J. Account.

Public Policy 32 (2013) 5067

Contents lists available at SciVerse ScienceDirect

J. Account. Public Policy

journal homepage: www.elsevier.com/locate/jaccpubpol

How do rm- and country-level governance

mechanisms affect rms disclosure?
Jrgen Ernstberger a,1, Michael Grning b,c,
a
b
c

Ruhr-University Bochum, Chair of Accounting and Auditing, Universittsstrae 150, D-44801 Bochum, Germany
Ilmenau University of Technology, Chair of Accounting and Management Control, Helmholtzplatz 3, D-98693 Ilmenau, Germany
Frankfurt School of Finance & Management, Accounting Department, Sonnemannstrae 9-11, D-60314 Frankfurt/Main, Germany

a b s t r a c t
This paper examines how a countrys regulatory environment interacts with rms institutional corporate governance arrangements to
affect the disclosure that these rms provide in their annual reports.
Prior literature indicates that rms with stronger corporate governance arrangements demonstrate higher levels of disclosure. We
investigate whether this effect varies with the legal environment.
The transparency-increasing effect of strong corporate governance
might be reinforced by a strong legal environment, suggesting
a complementary relationship between these two factors with
respect to transparency. However, strong corporate governance
arrangements may serve as bonding mechanisms in weak legal environments, suggesting a substitutive relationship between corporate
governance and the regulatory environment. Using a sample of
listed rms from 16 European countries, we nd evidence suggesting that corporate governance arrangements and the legal environment substitute with respect to their effects on corporate disclosure.
2013 Elsevier Inc. All rights reserved.

1. Introduction
This paper examines how a rms corporate governance arrangements interact with its home countrys legal environment to affect its corporate disclosure strategy. Prior literature indicates that strong
corporate governance arrangements may encourage managers to voluntarily disclose additional
information about their rms (e.g., Chen and Jaggi, 2000; Eng and Mak, 2003; Gul and Leung, 2004;
Corresponding author. Address: Ilmenau University of Technology, Chair of Accounting and Management Control,
Helmholtzplatz 3, D-98693 Ilmenau, Germany. Tel.: +49 3677-69 4498; fax: +49 3677-69 4201.
E-mail address: michael.gruening@tu-ilmenau.de (M. Grning).
1
Tel.: +49 234 32 22893; fax: +49 234 32 14142.
0278-4254/$ - see front matter 2013 Elsevier Inc. All rights reserved.
http://dx.doi.org/10.1016/j.jaccpubpol.2013.02.003

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51

Kelton and Yang, 2008). Another stream of literature suggests that country characteristics, such as
their cultural or legal environments, inuence rms disclosure levels (e.g., Jaggi and Low, 2000; Hope,
2003). Our study explores the possible existence of a complementary or substitutive relationship between rms corporate governance arrangements and their legal environment with respect to corporate disclosure, which is assessed in terms of the information that a rm provides to stakeholders in its
annual report.
It is well established that a rms commitment to a high disclosure level reduces the information
asymmetries between its managers and stakeholders and between informed and uninformed investors, thereby increasing the rms stock liquidity (Glosten and Milgrom, 1985; Diamond and Verrecchia, 1991). Empirical studies demonstrate that stronger disclosure practices of a rm are associated
with decreases in its bid ask-spread (Leuz and Verrecchia, 2000), cost of capital (Botosan, 1997) and
cost of debt (Sengupta, 1998) and increases in its stock liquidity and analyst following (Healy et al.,
1999). In recent years, several countries have attempted to secure these potential benets of increased
disclosure by imposing stricter disclosure requirements on rms. For instance, an increasing number
of countries currently require rms to adopt the International Financial Reporting Standards (IFRS),
which seek to increase the transparency of rms for the benet of investors. However, the quantity
and quality of corporate disclosures other than nancial statements are largely dependent on the discretion of each rms management and vary widely across different rms and countries (e.g., Francis
et al., 2005).
We investigate how rms disclosure levels are inuenced by governance mechanisms at the rm
and country levels. Similarly to disclosures, corporate governance mechanisms are intended to reduce
information asymmetries between managers and investors. In recent years, several countries have
introduced new regulatory requirements to improve investor protections and increase the efciency
of capital markets. In addition, national or supra-national standard setters and working groups have
used a soft law approach to develop principles of good corporate governance (e.g., Cadbury Report,
Blue Ribbon Report, OECD Principles of Good Corporate Governance, German Corporate Governance
Code, Italian Corporate Governance Code, Dutch Corporate Governance Code, Spanish Unied Good
Governance Code). However, the ways in which country-level governance regulations interact with
rm-level corporate governance mechanisms to affect rms disclosure levels remain unknown. The
transparency-increasing effect of strong corporate governance might be reinforced by a strong legal
environment, suggesting that governance mechanisms at the rm and country levels exert complementary effects on corporate disclosures. However, corporate governance arrangements could also
serve as a bonding mechanism in weak legal environments. In these environments, rms may commit
to stronger corporate governance arrangements, possibly causing these arrangements to assume more
pronounced transparency-increasing roles in this context than in strong legal environments. This situation suggests a substitutive relationship between rm-level and country-level governance mechanisms. In this study, we examine whether the impact of corporate governance arrangements varies
with the legal environment and assess whether the variance that is observed reects a complementary
or a substitutive relationship between corporate governance arrangements and the legal environment.
In our empirical tests, we use the following proxies for disclosure and governance mechanisms.
Corporate disclosure is measured by applying the Articial Intelligence Measurement of Disclosure
(AIMD) (Grning, 2011) to rms annual reports. This metric provides an automated approach for
determining the quantity and quality of corporate disclosure in an objective way. This measure serves
as a better proxy for a rms commitment to a certain level of disclosure because it is stickier than
other disclosure metrics, such as earnings properties or earnings forecasts. In this study, rm-level
corporate governance is measured by a broad index of 52 variables, and proxies for investor protection
and general law system quality are used to assess country-level governance mechanisms.
We focus on a sample of listed rms from 16 European countries. Restricting our study to a European setting ensures that the required minimum level of disclosure is the same for all of the examined
companies across the 16 countries in question because these countries have shared regulations with
respect to disclosure; in particular, the EUs IAS Regulation required rms to adhere to IFRS in their
reporting practices, whereas the EU Transparency Directive placed other disclosure requirements on
EU member states. The legal enforcement of compliance with these disclosure requirements is largely
harmonized by the EU Transparency Directive.

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J. Ernstberger, M. Grning / J. Account. Public Policy 32 (2013) 5067

Following the approaches of the prior literature, we regress our disclosure variable on several rm
and country characteristics that have been demonstrated to inuence disclosure policy, including
proxies for corporate governance and for the strength of the legal environment. In addition, and most
important for our research question, we include an interaction term between the proxies for corporate
governance and the strength of the legal environment. We nd that a transparency-increasing effect of
corporate governance arrangements is more pronounced for rms in a weak institutional environment
and less pronounced for rms in a strong institutional environment. Thus, we provide evidence in favor of a substitutive relationship between rm and country governance mechanisms with respect to
affecting corporate disclosure. Our ndings are corroborated by several robustness tests.
This paper seeks to contribute to the existing literature in the following ways. First, prior studies
have separately examined the impact of either corporate governance arrangements on disclosure
(e.g., Chen and Jaggi, 2000; Cheng and Courtenay, 2006; Eng and Mak, 2003; Gul and Leung, 2004;
Chau and Gray, 2002) or of the regulatory or institutional environment on disclosure (e.g., Jaggi and
Low, 2000; Hope, 2003). We contribute to these streams of literature by examining how both corporate governance and a rms legal environment affect disclosure practices and, particularly, how both
rm-level and country-level governance mechanisms interact with respect to their impact on disclosure. Using a multi-country study context, we document a substitutive relationship between corporate governance arrangements at the rm and country levels that affects corporate disclosure.
Second, we respond to Leuz and Wysockis (2008, p. 27) call for more research to improve existing
proxies as well as to capture qualitative and narrative disclosures more broadly (and a similar statement by Core, 2001). Accounting research has only recently begun to measure disclosure for a large
sample of rms by applying techniques based on natural language processing technologies (e.g., Kothari et al., 2009; Li, 2010). We use the AIMD approach, which has been demonstrated to be a highly
comprehensive and objective measure of disclosure, to contribute to this stream of research. The stickiness of this metric renders it superior to previously deployed proxies for disclosure with respect to
capturing a commitment to a specic disclosure policy.
Third, we seek to contribute to the literature on the complementarities and contingencies that affect rms behaviors (e.g., Ennen and Richter, 2010). In particular, we use the theoretical framework of
Aguilera et al. (2008) regarding complementarities and contingencies in corporate governance research to examine the interactions between corporate governance arrangements and governance regulations at the country level and assess the ways in which the links between corporate governance and
disclosure are contingent on the legal environment of a rm. Through this analysis, our paper seeks to
contribute to the emerging stream of literature that addresses how the interactions of governance
mechanisms at the rm and country levels (e.g., Chen et al., 2009; Bruno and Claessens, 2010) affect
outcome variables.
Finally, our paper may be of interest to public policy makers and regulators that are considering the
implementation of additional mandatory requirements to improve investor protections or corporate
governance. A high level of national regulatory requirements could curb the transparency-increasing
role of corporate governance on disclosure at the rm level. Therefore, regulators should be aware of
the perils of overregulation, which can damage the positive impact of rm-specic good governance
practices.
The remainder of this paper is organized as follows. In Section 2, we provide a summary of relevant
strands of the extant literature. Section 3 develops the hypothesis. Section 4 presents the research design and sample selection. Section 5 reports the results of our baseline regressions and of several
robustness tests. Section 6 concludes.

2. Prior literature
Our study is related to several streams of literature. Prior studies examine the link between corporate governance mechanisms and rms disclosure activities. Many of these studies investigate
whether and how self-constructed disclosure indices based on manually collected data respond to selected corporate governance mechanisms at the rm level, including board independence (Chen and
Jaggi, 2000; Cheng and Courtenay, 2006; Eng and Mak, 2003; Gul and Leung, 2004; Ho and Wong,

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53

2001; Leung and Horwitz, 2004), CEO duality (Cheng and Courtenay, 2006; Gul and Leung, 2004; Haniffa and Cooke, 2002; Ho and Wong, 2001), ownership structure (Chau and Gray, 2002; Hossain et al.,
1994), family control (Chau and Gray, 2002; Haniffa and Cooke, 2002) and state/foreign ownership
(Wang et al., 2008). Other studies focus on the relationship between corporate governance mechanisms and specic types of disclosure, such as management compensation disclosure (Bassett et al.,
2007; Laksmana, 2008), internet-based disclosure (Kelton and Yang, 2008; Xiao et al., 2004) and management earnings forecasts (Ajinkya et al., 2005; Chen et al., 2008; Karamanou and Vafeas, 2005).
Although most of these prior studies nd that corporate governance exerts a positive impact on disclosure, several investigations demonstrate mixed results or indicate a negative impact of governance
on disclosure. Different studies of the same governance mechanism, such as board independence, also
yield varying ndings. One reason for these mixed results might be that these studies focus on specic
but different institutional settings within a single country. Studies that investigate the association between institutional corporate governance arrangements and disclosure in an international setting are
sparse. Chau and Gray (2002) consider only two countries (Hong Kong and Singapore) in their investigation, and Cerbioni and Parbonetti (2007) examine a specic sample of 54 biotechnology rms in 10
European countries. Nowland (2008) provides evidence that the introduction of national corporate
governance codes in eight Asian countries increases rms disclosure, which is proxied by nancial
analysts forecast accuracy and dispersion, and levels differences in rms disclosure practices. In addition, governance codes have an indirect effect on disclosure by increasing board independence. We
contribute to these prior studies by examining a large cross-country sample of rms to investigate
whether the impact of corporate governance arrangements on a rms disclosure policy varies with
the legal environment.
Another stream of literature investigates the determinants of rms disclosure practices (see, e.g.,
Healy and Palepu (2001) for a review). Although most of the papers in this stream of literature focus
on rm characteristics that inuence the quantity and quality of disclosure, certain studies focus on
country-level factors. Jaggi and Low (2000) analyze the impact of legal systems on nancial disclosures and nd that higher levels of nancial disclosure are evinced by rms from common law countries than by rms from code law countries. These authors also provide evidence that cultural values
have an insignicant impact on nancial disclosures by rms from common law countries, whereas
the impact of cultural values on the disclosures of rms from code law countries is mixed. Hope
(2003) uses a larger and more representative sample of countries and nds that both legal origin
and culture contribute to explaining corporate disclosure. Archambault and Archambault (2003) document that culture, national political and economic systems and corporate nancial and operating
systems inuence rms disclosure practices. However, a study investigating the interaction of rms
legal environments with their corporate governance arrangements remains lacking.
A more recent stream of literature examines the interaction of corporate governance mechanisms
and a rms legal environment. Doidge et al. (2007) nd that rms governance ratings are explained
to a much greater extent by country characteristics, such as legal protections for minority shareholders and economic or nancial developments, than by observable rm characteristics. Choi and Wong
(2007) investigate whether the likelihood of choosing a Big 4 auditor varies with a rms legal environment for rms with capital-raising needs and high risks. They provide evidence that external auditors generally have a more important governance function in countries with weak legal institutions
than in countries with strong legal institutions, suggesting a substitutive relationship between Big 4
audits and investor protection regulations. Chen et al. (2009) investigate how corporate governance
and investor protection interact to affect rms costs of capital. These researchers examine a sample
of rms from emerging markets and nd that rm-level corporate governance and country-level
shareholder protection appear to substitute for each other for the purposes of reducing the costs of
equity. Bruno and Claessens (2010) focus on the interactions of rm-level and country-level governance mechanisms with respect to rm performance. They nd that rms with higher corporate governance levels demonstrate a valuation discount in stringent legal environments relative to similar
rms in exible legal environments. Moreover, a stronger regulatory environment does not reduce
the valuation discount of companies with weak governance practices. Again, this nding suggests a
substitutive relationship between governance measures at the rm and country levels. Renders
et al. (2010) nd that the strength of the relationship between compliance with corporate governance

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ratings and rm performance is dependent on the quality of the institutional environment. Price et al.
(2011) examine how governance reforms in Mexico affect the impact of corporate governance mechanisms on the performance and transparency of rms and argue that poor investor protection in Mexico is the reason that an increase in rms corporate governance indices is not accompanied by any
apparent impact on the economic behaviors of these rms. However, no previous study has examined
how corporate governance and the legal environment interact to affect corporate disclosure. We attempt to ll this void by investigating potential interaction effects on the rm-level and country-level
with respect to disclosure as an outcome variable.

3. Hypothesis development
In our study, we rst adopt a traditional agency theory-based view of corporate governance and
then focus on an organizational or open system approach to corporate governance. The latter perspective is proposed by Aguilera et al. (2008) and builds on the more general research by Milgrom
and Roberts (1995) and Aoki (2004). This perspective extends the agency-based view of corporate governance by considering the contingencies and interactions of corporate governance arrangements.
Although the traditional agency theory-based view of corporate governance seeks to establish a universal link between corporate governance practices and outcome variables regardless of the organizational context, the organizational view suggests that corporate governance arrangements produce
different impacts in distinct environmental contexts (Thompson, 1967; Scott, 2003).
Traditional agency theory suggests a universal link between corporate governance and disclosure.
Strong corporate governance arrangements may encourage managers to disclose more information
because the adoption of internal control mechanisms enhances the monitoring of managers disclosure strategies and reduces the benets of withholding information. Corporate disclosure is a capital
market transformed ex-post corrective of management actions. Internal governance measures are
associated with stronger external corrective responses and encourage managers to increase corporate
disclosure because improved rm-specic governance inhibits opportunistic management behavior,
which may result if a conict of interest occurs between managers and public interests. For instance,
a conict of interest would occur if information disclosures revealed inadequate management performance or the misuse of corporate resources for private purposes (Verrecchia, 2001). Opportunistic
behavior and information withholding can be mitigated by comprehensive corporate governance
measures (Kelton and Yang, 2008). Furthermore, Nagar et al. (2003) argue that particular types of
additional information (good news) increase a rms value, and these authors further claim that
the institutional governance arrangements of share-based compensation increase a rms information
transparency. Effective control mechanisms, such as independent boards, help managers to credibly
commit to a high-disclosure policy. If strong governance measures are absent, managers can easily
and quickly return to a low-disclosure policy to fulll short-term objectives to the disadvantage of
long-term value creation. Overall, these arguments suggest that stricter corporate governance practices increase corporate disclosures.
In contrast to these arguments, an overly strong corporate governance arrangement may induce
information withholding. If the performance-based proportion of the overall compensation is overly
high or if compensation is determined by the achievement of short-term objectives, particular information (bad news) is withheld or delayed. Furthermore, managers and the board may attempt to
avoid the costs of disclosure, which primarily consist of indirect strategic and legal costs (Dahya
et al., 2008; Darrough and Stoughton, 1990). Managers may replace costly disclosure with institutional corporate governance arrangements that are expected to reduce information asymmetries in
a more cost-effective fashion (Forker, 1992). However, based on the aforementioned arguments and
most prior literature, we predict that, overall, corporate governance should exert a positive impact
on disclosure.
In addition to corporate governance, country characteristics, such as regulatory or institutional
environments, inuence rms disclosure levels. Countries with stronger legal environments generally
demand greater transparency because a stronger legal environment restricts insiders ability to acquire private control benets, thereby mitigating the incentives of those insiders to withhold

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55

information from the rms stakeholders (Leuz et al., 2003). However, it remains unclear whether
the regulatory or institutional environment inuences the impact of rms governance arrangements on corporate disclosure. To address this research question, we extend the traditional agency
theory-based view to an organizational view by examining whether the impact of corporate governance on disclosure differs for weak and strong legal regimes or remains stable across different
regimes.
The regulatory or institutional environment may affect the disclosure-inducing role of corporate
governance in two ways. First, a stronger legal environment may reinforce the impact of certain corporate governance mechanisms. If underlying institutions, such as a strong legal system, are not available to support the implemented corporate governance arrangements, managers are likely to withhold
information. These arguments support a complementary relationship between corporate governance
and the strength of the legal environment with respect to the effects of these factors on corporate
disclosure.
Second, certain corporate governance mechanisms are not implemented through legal protections
(Chen et al., 2009). For example, in weak legal environments, the dissipation of control among minority shareholders may play an important governance role (Bennedsen and Wolfenzon, 2000) by inducing managers to provide more and better disclosures. Because investors cannot rely on regulatory
requirements to reduce agency conicts in weak legal environments, the effectiveness of corporate
governance arrangements in increasing corporate disclosure may be higher in these types of legal
environments. In addition, consistent with the bonding hypothesis (Coffee, 2002), corporate governance arrangements may play a stronger bonding role in weak legal environments than in strong legal
environments. Because agency costs are likely to be high in weaker legal environments, there will be a
demand in these environments for stronger corporate governance to avoid information withholding
and protect against expropriation. This agency cost-related demand for stronger corporate governance
is expected to be lower in countries with stronger legal environments because there are already country-level investor protection mechanisms in place (Choi and Wong, 2007). These arguments suggest a
substitutive relationship of corporate governance and the regulatory environment with respect to the
effects of these factors on corporate disclosure.
We present our formal hypothesis in the null form to test whether the link between corporate governance and disclosure is constant across various legal environments or whether this link is dependent
on the legal environment; the latter conclusion would be in accordance with the organizational view
of rms. Thus, we formulate the following hypothesis:
Hypothesis. The relationship between a rms corporate governance arrangements and its disclosures
does not vary with the strength of the legal environment.
The rejection of this hypothesis and the identication of a less pronounced disclosure effect of corporate governance in strong legal regimes would support the organizational view of corporate governance, suggesting the existence of a substitutive relationship between rm and country governance
with respect to affecting disclosure. The traditional agency theory-based view of corporate governance
would be supported if the above hypothesis was not rejected; this result would suggest a universal
link between corporate governance and disclosure across countries.
4. Research design
4.1. Measurement of disclosure
Previous studies use a wide variety of measurements of corporate disclosure, such as ratings from
the Association for Investment and Management (AIMR) (e.g., Botosan and Plumlee, 2002; Lang and
Lundholm, 1993), from the Center for International Financial Analysis and Research (CIFAR) (e.g.,
Bushman et al., 2004; Francis et al., 2005), from Standard & Poors (e.g., Doidge et al., 2007; Durnev
and Kim, 2005) and scores that are derived from manual proprietary text analyses. Marston and
Shrives (1991) comprehensively review the earlier manual proprietary scoring literature. Although
these studies focus on hand-collected disclosure scores or indirect measures of disclosure, an

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emerging body of literature uses more direct and objective measures. Li (2008) investigates the
determinants and consequences of annual report readability and other lexical features of the annual
report and Li (2010) examines the determinants and consequences of the tone and content of the forward-looking statements in 10-K and 10-Q lings. Kothari et al. (2009) use content analysis to assess
disclosure reports from managers, analysts and members of the business press and provide evidence
regarding the impact of disclosure content on rms risk.
Because there are limited third-party disclosure data available for the most current years and because manual scoring methods have low validity and entail considerable effort, we follow a recent
stream of literature and apply a computerized measurement approach that uses articial intelligence.
This approach was introduced by Grning (2011) and, in contrast to other computerized disclosure
measurement methodologies, it does not rely on simple word-count systems (e.g., Hussainey et al.,
2003) and does not restrict the software application to merely assisting the manual coding process
(e.g., Beattie et al., 2004). Instead, the computerized content analysis applies an information retrieval
vector space model that was introduced by Salton et al. (1975), and the disclosure measure is based on
the occurrences of certain N-grams (i.e., ordered sequences of N words). Order backlog is an example
of a bigram, and order backlog development is an example of a trigram.
We measure disclosure in 10 distinctive information dimensions (nancial, customers, value chain,
employees, R&D, strategy, governance, stock market, environment and society). Because voluntary and
mandatory disclosure cannot be reasonably discriminated for most of these information dimensions
(Cooke and Zeff, 2007), we do not distinguish between these two types of disclosures. A xed, mandatory disclosure component should only affect a constant in the estimation results but should not
affect the other estimated coefcients; therefore, the existence of these types of components should
not impact the explanatory power of our empirical results. We aggregate the disclosure measures
for the 10 information dimensions using factor analysis (KMO = 0.91, one Eigenvalue above
one = 8.11). In our robustness tests, we also use the unweighted sum and logarithmic transformations
to combine the 10 information dimensions.
The AIMD approach consists of a training phase and an application phase. During the training phase, a
list of all semantical units that are connotative categorical equivalents for a particular disclosure dimension is manually extracted from textual documents. The empirical evidence suggests that the lists of
semantical units quickly converge; therefore, a training sample of 24 exemplary annual reports is comprehensive and complete (i.e., spans all of the relevant aspects of corporate disclosure) (Grning, 2011).
To reduce the complexity and improve the applicability of the analysis, different orthographical (e.g.,
labor vs. labour), and grammatical forms (plural, conjugation and word order within an N-gram)
in the raw N-gram lists are standardized to a particular canonical morphological form.
In accordance with the aforementioned specications, the coding scheme is independent of (1)
stopwords without meaning (e.g., and or or), (2) the morphology of the elements of N-grams
and (3) permutations of the elements of N-grams. For example, the standardized bigram of employee
number also represents the tetragram of number of the employees. We use the stopword list of the
Information Retrieval Group of the University of Glasgow for the rst step of the AIMD approach. For
the grammatical and orthographical normalization that occurs in the second step of this approach, we
conduct a dictionary-based stemming process that uses the Automatically Generated Inection Database (AGID), which contains 112,503 roots of 281,904 inected word forms, and the Variant Conversion Info (VarCon), which lists spelling variants for 16,019 words.
Following the morphological normalization, the permutations of the elements of an N-gram are standardized. Different grammatical structures in the English language result in varying word orders within
a sentence (Murphy, 2007). In measurements of the level of corporate disclosure, only semantical differences are of importance. For instance, there is no relevant semantical difference between the N-grams
exible arrangement of work time and an arrangement of exible working time. The standardized
N-gram lists for all of the information dimensions contain 13,314 standardized N-grams.
In the application phase, similar standardization processes are applied to the annual reports that
are examined. In accordance with Weber (1990), we use category counts to establish a disclosure measure for each information dimension. The entire application phase is implemented in C#.
The reliability, criterion validity and construct validity of the computerized disclosure measurement have been empirically demonstrated for large U.S. and German samples (Grning, 2011). The

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57

measure has construct validity with respect to the AIMR rating, Standard & Poors Transparency and
Disclosure Score and other rating methods; the measure also demonstrates criterion validity with respect to information asymmetry reductions, which are proxied by spreads and by the probability of
information-based trading.
4.2. Measurement of corporate governance
As stated in the literature review, many of the previous studies on the relationship between corporate governance and disclosure use narrow proxies for rm-level corporate governance. However, corporate governance arrangements appear to interact with each other and may display complementarity
or substitutability (Aguilera et al., 2008). The studies of single corporate governance mechanisms neglect these interactions and therefore may fail to provide a comprehensive picture of the effectiveness
of corporate governance arrangements. Krishnan (2005), for example, emphasizes the complementarity of two internal control mechanisms, namely, audit committees and internal control procedures.
Although Aguilera and Desender (forthcoming) criticize the use of governance ratings from a validity
perspective, we follow Ward et al. (2009), who stipulate that research should focus on rms corporate
governance bundles or corporate governance arrangements rather than on single corporate governance mechanisms.
In response to these concerns about the use of single corporate governance mechanisms, we use
the comprehensive FTSE Institutional Shareholder Services (ISS) corporate governance rating that is
provided by the Risk Metrics Group (RMG). This rating aims to provide information to institutional
investors about rms corporate governance for their investment decisions.
The ISS corporate governance rating for non-U.S. companies considers 55 criteria in eight categories. Following the approaches of Brown and Caylor (2006) and Doidge et al. (2007), we construct a
corporate governance score by coding each of the 52 usable criteria of the ISS rating criteria as either
one or zero for each examined rm, depending on whether or not minimally acceptable corporate governance standards are met by the rm in question.2 A summary score ranging from 0 to 52 is then
determined by adding these criteria scores.
4.3. Measurement of country-level governance mechanisms
In line with Durnev and Kim (2005), we use the product of investor protection and law enforcement conditions in a country as a proxy for each countrys legal system with respect to actual investor
protections (enforced investor protection rights). For a current measurement of investor protection,
we rely on the updated data of Djankov et al. (2008) for the La Porta et al. (1997, 1998) anti-director
rights index. Similarly to Doidge et al. (2007), we measure law enforcement in terms of the rule of law
component of the World Governance Index (WGI) that is provided by Kaufmann et al. (2008). This rule
of law component is an annual, country-specic measure of the quality of contract enforcement, the
police and the court system within a nation. Finally, law and order is a measure of the general law system quality that is obtained from the International Country Risk Guide (ICRG).
4.4. Regression model
To evaluate the interaction of corporate governance and the legal environment in affecting corporate disclosure, we use the following regression model:

DISCij b0 b1 CORPGOVij b2 REGi b3 REGi  CORPGOVij b4 SIZEij b5 SIZEij  REGi

b6 ROAij b7 ROAij  REGi b8 OWNij b9 OWNij  REGi b10 LEVij b11 LEVij  REGi
b12 CROSSLISTij b13 CROSSLISTij  REGi industry fixed effects error term;

2
Brown and Caylor (2006) focus on U.S. rms; slightly different criteria are dened by the ISS for U.S. rms. In contrast to
Doidge et al. (2007), we include ofcer and director ownership in the criteria that we examine.

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where for every country i, DISCij = the disclosure index for rm j, calculated as the factor of the 10 disclosure categories extracted from rms annual reports, as described above; CORPGOVij = the corporate governance index for rm j, calculated as the sum of the 52 minimum requirements in the ISS
rating, as described above; REGi = one of the indexes for the legal environment in country i, as described above; SIZEij = the natural log of the total sales in millions of Euros of rm j; ROAij = the return
on assets, which is dened as the net income per the total book value of assets for rm j; OWNij = the
ownership structure, which is dened as the percentage of tradable shares of rm j that are not held
by large shareholders; LEVij = the leverage, which is dened as the year-end total debt per common
equity book value for rm j; CROSSLISTij = the number of countries in which rm j is listed.
The regression coefcient b3 measures the interaction of corporate governance and the legal environment with respect to affecting corporate disclosure. A non-signicant regression coefcient indicates that the impact of corporate governance on disclosure does not vary with the legal
environment, a signicant positive regression coefcient indicates a complementary effect between
these two factors, and a signicant negative coefcient indicates a substitutive effect between these
two factors. In addition to the variable of interest CORPGOV we interact REG also with all of the control
variables following Choi and Wong (2007) because the impact of the controls on disclosures may be
dependent on a countrys legal environment.
Table 1
Descriptive statistics on sample characteristics.
Country

Firms in
sample

Total
listed
shares

Market value
of sample rms
(million )

Panel A: Distribution of sample rms by registering countrya

Austria
19
104
105,246
Belgium
27
162
219,727
Denmark
22
188
97,322
Finland
30
139
99,780
France
78
872
1,220,752
Germany
87
1039
1,229,404
Greece
43
315
128,782
Ireland
16
88
78,087
Italy
52
322
556,479
Netherlands
46
223
406,867
Norway
22
239
168,809
Portugal
12
62
66,705
Spain
56
159
696,086
Sweden
45
450
244,382
Switzerland
57
276
716,201
UK
432
2568
2,253,000
Total
1044
7206
8,287,630

Total market
value
(million )

Number of
rms covered
by sample (%)

Market value
covered by
sample (%)

161,165
325,939
165,467
237,680
1,873,775
1,524,765
194,044
115,146
792,825
578,699
257,452
96,894
844,579
363,391
883,130
2,810,976
11,225,929

18.27
16.67
11.70
21.58
8.94
8.37
13.65
18.18
16.15
20.63
9.21
19.35
35.22
10.00
20.65
16.82
14.49

65.30
67.41
58.82
41.98
65.15
80.63
66.37
67.82
70.19
70.31
65.57
68.84
82.42
67.25
81.10
80.15
73.83

Industry group
Panel B: Distribution of rms by industry groupsb
1 Consumer Durables, NonDurables, Wholesale, Retail, and Some Services
2 Manufacturing, Energy, and Utilities
3 Business Equipment, Telephone and Television Transmission
4 Healthcare, Medical Equipment, and Drugs
5 Other
Total
a

Firms in
sample

Total listed
shares

Firms
covered (%)

229
224
135
51
375

1262
1140
1212
321
2986

18.15
19.65
11.14
15.89
12.56

1014

6921

14.65

Notes: The table reports the distribution of our baseline sample of 1044 rms from 16 European countries across countries
and provides evidence about the samples coverage of the number of rms and the market value of equity in these countries.
Total number of shares is the number of shares in the countrys Worldscope index with trading activity in 2007. As the index
may contain several shares issued by a rm the total number of listed shares overestimates the number of listed rms. The table
reports data for December 31 2007.
b
Notes: The table reports the industry distribution of our sample for which industry classications are available. It consists of
1014 rms from 16 European countries. It also reports the overall industry distribution of all listed rms in the 16 European
countries. Industry groups are formed based on the SIC of the primary segment using Kenneth R. Frenchs aggregation rules. See
footnote 3 for details.

59

J. Ernstberger, M. Grning / J. Account. Public Policy 32 (2013) 5067

Table 2
Descriptive statistics of the dependent and independent variables for the sample.
Variable

Mean

0.25 quantile

Median

0.75 quantile

Standard deviation

DISCij
CORPGOVij
REGi = ENFOR_ANTIDIRi
REGi = LAW_ORDERi
SIZEij
ROAij
OWNij
LEVij
CROSSLISTij

0.0000
24.6858
6.5588
5.3281
7,740
0.0495
66.62%
1.4442
1.5641

0.6353
22.0000
4.75
5.0000
374
0.0178
49.00%
0.1808
1.0000

0.2331
26.0000
6.65
5.5000
1,390
0.0519
72.00%
0.5569
1.0000

0.4093
28.0000
8.75
5.5000
5,610
0.0911
88.00%
1.1989
2.0000

0.9955
5.0407
2.4063
0.4977
19,300
0.1577
26.53%
5.3060
1.3382

Notes: The table reports the mean, the 0.25 quantile, the median, the 0.75 quantile and the standard deviation of the variables
used in our analysis for a sample of 1044 rms from 16 European countries. The variables are dened as follows: for every
country i, DISCij is the disclosure index for rm j calculated as described in Section 4, CORPGOVij is the corporate governance
index for rm j calculated as described in Section 4, REGi is one of the indexes for the regulatory or institutional environment of
country i (ENFOR_ANTIDIRi is the enforced antidirector index and LAW_ORDERi is the rule of law of country i which are both
described in Section 4), SIZEij is the total sales in millions of Euros of rm j, ROAij is the return on assets dened as net income
per total book value of assets for rm j, OWNij is the ownership structure dened as the percentage of tradable shares not hold
by large shareholders for rm j, LEVij is the leverage dened as year-end total debt per common equity book value for rm j,
CROSSLISTij is the number of countries in which rm j is listed.

The control variables in our regression are motivated by the ndings of prior studies, which suggest
that a rms disclosure is associated with its size (e.g., Chavent et al., 2006; Depoers, 2000), protability (e.g., Ahmed and Courtis, 1999; Akhtaruddin, 2005; Chavent et al., 2006; Marston, 2003; Marston
and Polei, 2004; Patten, 2002), shareholder structure (e.g., Chau and Gray, 2002; Leuz and Verrecchia,
2000) and funding (e.g., Chavent et al., 2006; Francis et al., 2005), as well as the internationality of its
nancial market activities (e.g., Olibe, 2006; Ramnath, 2002; Ryan and Tafer, 2005).

4.5. Sample selection and description

In our study, we focus on a sample of rms from the European Union (EU) because the EU member
states have a number of shared regulations with respect to disclosure; in particular, the EUs IAS Regulation requires rms to adhere to IFRS in their nancial reports, and the EU Transparency Directive
species other disclosure and enforcement requirements for EU member states. Thus, the mandatory
disclosure requirements and their enforcement are very similar across the EU member states, and
therefore, these factors are not likely to bias the study results. We focus on observations from the year
2007; at this time, the mandatory adoption of IFRS was completed (and adoption effects are therefore
less likely to be observed), but the nancial crisis had not yet taken effect. Our baseline sample includes all of the rms with European origins that are included in the RMGs ISS ratings. Of these
1204 rms, we remove eight that are registered in countries in which data for less than 10 rms
are available (e.g., Guernsey, Jersey, Luxembourg). In addition, 152 rms could not be clearly identied
on the basis of their rm names in the RMG database, and these rms were removed from the sample.
After these procedures, a total of 1044 rms from 16 European countries remained in our sample. Panel A of Table 1 reports the distribution of this sample by the registering country of the sample rms.
Although our sample only consists of approximately 14%3 of the listed rms in European countries, we
cover approximately three-quarters of the market with respect to market capitalization. Panel B of
Table 1 reports the distribution of rms by industry groups, based on Kenneth R. Frenchs methodology
of industry aggregation.4 The sample rms adequately represent the overall mix of European industries.
3
We benchmark the number of rms in the sample against the number of listed shares in the countries Worldscope indices.
Because these indices often include several different shares for each rm, 14% is a very conservative estimation; the actual
proportion of rms that are covered might be higher.
4
A list of the SICs that form the industry portfolios is available at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/
data_library.html.

60

J. Ernstberger, M. Grning / J. Account. Public Policy 32 (2013) 5067

Table 3
Correlation matrix.
(1)
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)

DISCij
CORPGOVij
REGi = ENFOR_ANTIDIRi
REGi = LAW_ORDERi
SIZEij
ROAij
OWNij
LEVij
CROSSLISTij

(2)
0.12

0.12
0.22
0.14
0.49
0.03
0.11
0.20
0.31

0.56
0.33
0.10
0.04
0.29
0.08
0.01

(3)

(4)

(5)

(6)

0.23
0.47

0.09
0.26
0.52

0.60
0.04
0.35
0.18

0.09
0.13
0.07
0.11
0.04

0.62
0.11
0.02
0.25
0.11
0.15

0.10
0.02
0.16
0.08
0.15

0.00
0.16
0.16
0.43

0.03
0.08
0.02

(7)
0.14
0.32
0.21
0.12
0.11
0.03
0.03
0.06

(8)

(9)

0.30
0.06
0.22
0.12
0.39
0.32
0.03

0.29
0.07
0.26
0.26
0.33
0.02
0.00
0.08

0.08

Notes: The table lists in the lower left triangle Pearson correlations and in the upper right triangle Spearman correlations. The
variables are dened as follows: for every country i, DISCij is the disclosure index for rm j calculated as described in Section 4,
CORPGOVij is the corporate governance index for rm j calculated as described in Section 4, REGi is one of the indexes for the
regulatory or institutional environment of country i (ENFOR_ANTIDIRi is the enforced antidirector index and LAW_ORDERi is the
rule of law of country i which are both described in Section 4), SIZEij is the total sales in millions of Euros of rm j, ROAij is
the return on assets dened as net income per total book value of assets for rm j, OWNij is the ownership structure dened as
the percentage of tradable shares not hold by large shareholders for rm j, LEVij is the leverage dened as year-end total debt
per common equity book value for rm j, CROSSLISTij is the number of countries in which rm j is listed.

Table 2 reports descriptive statistics for the variables that are used in our regression analysis.
The data are winsorized at 2% to remove possible outliers. The variables are statistically distributed
within reasonable ranges, suggesting that our empirical results should not be affected by extreme
values. Table 3 provides the correlation matrix for the variables in the models for which results are
reported. These correlations do not provide any indications of multicollinearity problems in the
data.

5. Empirical results
5.1. Baseline results
Table 4 reports the coefcients and t-statistics (in parentheses) from using an OLS regression with
heteroscedasticity-robust standard errors to estimate Eq. (1). The two columns indicate the results for
different proxies of the regulatory environment (REG). In the rst column, REG equals ENFOR_ANTIDIR, which is a countrys enforced antidirector index (as dened in Section 4). In the second column
of the results, REG is proxied by LAW_ORDER, which is a countrys general law system quality (as dened in Section 4). In the rst column, the coefcient of CORPGOV  REG is signicantly negative, indicating that the impact of corporate governance on disclosure is higher in countries with weaker legal
protection. The sign of this coefcient indicates a substitutive relationship between rm-level and
country-level governance with respect to affecting corporate disclosure. The overall impact of the regulatory environment, which is indicated by the sum of the coefcients of REG and CORPGOV  REG, is
negative and signicant, providing evidence that the level of disclosure is higher for rms in countries
with weaker investor protection. This result is in accordance with the notion that rms use disclosure
as a bonding mechanism in weak legal environments. The models explain approximately 43% of the
variation in corporate disclosure.
The law system quality regression provides very similar results. The coefcient of CORPGOV 
REG is again negative and signicant, although this signicance is weaker in this regression than
in the rst model. One reason might be that enforced antidirector rights better capture governance
mechanisms on the country-level than the more general measure of law and order. Nonetheless,
the coefcient of the interaction term again provides evidence for a substitutive interaction between law system quality and corporate governance with respect to the effects of these factors
on corporate disclosure. The overall effect of the regulatory environment is given by the sum of
REG and CORPGOV  REG and is signicantly negative. The adjusted R2 of the regression is approximately 43%.

61

J. Ernstberger, M. Grning / J. Account. Public Policy 32 (2013) 5067

Table 4
Regression results.
REG = ENFOR_ANTIDIR

REG = LAW_ORDER

CORPGOVij

(+)

0.23***
(5.78)

REGi

()

0.17***
(3.30)

0.08*
(1.78)

CORPGOVij  REGi

()

0.10***
(2.85)

0.12***
(3.10)

SIZEij

(+)

0.48***
(11.64)

0.51***
(12.03)

SIZEij  REGi

(?)

0.01
(0.27)

0.01
(0.28)

ROAij

(?)

0.08***
(2.84)

0.07**
(2.33)

ROAij  REGi

(?)

0.01
(0.42)

0.03
(0.95)

OWNij

(+)

OWNij  REGi

(?)

LEVij

(+)

0.15***
(4.02)

0.15***
(3.81)

LEVij  REGi

(?)

0.04
(1.13)

0.02
(0.48)

CROSSLISTij

(+)

0.05
(1.09)

0.00
(0.05)

CROSSLISTij  REGi

(?)

0.07**
(2.17)

Industry dummies
Adjusted R2
F-statistic
Sample size

0.08**
(2.18)
0.00
(0.01)

Yes
0.43
37.94
892

0.19***
(4.97)

0.10**
(2.39)
0.04
(1.13)

0.13***
(3.06)
Yes
0.43
37.32
892

Notes: The table reports standardized coefcients and t-statistics in brackets from a linear OLS-regression with heteroscedasticity corrected errors of the following regression:

DISCij b1 CORPGOVij b2 REGi b3 REGi  CORPGOVij b4 SIZEij b5 SIZEij  REGi b6 ROAij b7 ROAij  REGi
b8 OWNij b9 OWNij  REGi b10 LEVij b11 LEVij  REGi b12 CROSSLISTij b12 CROSSLISTij  REGi
industry fixed effects error term
where for every country i, DISCij is the disclosure index for rm j calculated as described in Section 4, CORPGOVij is the corporate governance index for rm j calculated as described in Section 4, REGi is one of the indexes for the regulatory or institutional
environment of country i (ENFOR_ANTIDIRi is the enforced antidirector index and LAW_ORDERi is the rule of law of country i
which are both described in Section 4), SIZEij is the total sales in millions of Euros of rm j, ROAij is the return on assets dened
as net income per total book value of assets for rm j, OWNij is the ownership structure dened as the percentage of tradable
shares not hold by large shareholders for rm j, LEVij is the leverage dened as year-end total debt per common equity book
value for rm j, CROSSLISTij is the number of countries in which rm j is listed. The regression is estimated with industry-xed
effects and with robust standard errors. All variables except of the country-level REG are windsorized at the two per cent level
at both extremes. We use above/below mean dichotomous variables in the interactions.
*
Signicant at the 0.1 level (two-sided t-tests).
**
Signicant at the 0.05 level (two-sided t-tests).
***
Signicant at the 0.01 level (two-sided t-tests).

Overall, we nd evidence in support of the organizational theory of corporate governance. The link
between corporate governance and disclosure is not universal; instead, this relationship varies with
the legal environment of the rm. Therefore, country- and rm-level governance mechanisms are substitutes with respect to their effects on corporate disclosure.

62

J. Ernstberger, M. Grning / J. Account. Public Policy 32 (2013) 5067

Table 5
Sample selection bias tests.
REG = ENFOR_ANTIDIR
CORPGOVij

(+)

REGi

()

CORPGOVij  REGi

()

SIZEij

(+)

SIZEij  REGi

(?)

ROAij

(?)

ROAij  REGi

(?)

OWNij

(+)

OWNij  REGi

(?)

LEVij

(+)

LEVij  REGi

(?)

CROSSLISTij

(+)

CROSSLISTij  REGi

(?)

Industry dummies
Selection:
OWNij
SIZEij
LEVij
INT_SALESij
Lambda
Standard Error of Lamda
Sample size

REG = LAW_ORDER

0.21***
(5.51)
0.19***
(3.59)
0.07
(1.63)
0.64***
(10.03)
0.03
(0.79)
0.13**
(2.33)
0.01
(0.27)
16.06***
(3.03)
0.02
(0.59)
0.16***
(4.92)
0.03
(0.69)
0.03
(0.80)
0.09***
(3.10)

0.17***
(4.43)
0.10**
(2.32)
0.08**
(2.11)
0.69***
(10.71)
0.02
(0.46)
0.11**
(1.97)
0.03
(0.68)
17.62***
(3.16)
0.05
(1.26)
0.17***
(5.10)
0.04
(0.79)
0.01
(0.32)
0.13***
(3.97)

Yes

Yes

226.09***
(3.32)
0.12
(0.18)
0.44
(0.78)
3103.70
(0.51)
0.26
0.61
3,120

226.09***
(3.32)
0.12
(0.18)
0.44
(0.78)
3103.70
(0.51)
0.35
0.61
3,120

Notes: The table reports standardized coefcients and t-statistics in brackets from a Heckman corrected regression with heteroscedasticity corrected errors of the following regression:

DISCij b1 CORPGOVij b2 REGi b3 REGi  CORPGOVij b4 SIZEij b5 SIZEij  REGi b6 ROAij b7 ROAij  REGi
b8 OWNij b9 OWNij  REGi b10 LEVij b11 LEVij  REGi b12 CROSSLISTij b12 CROSSLISTij  REGi
industry fixed effects error term
where the selection equation considers OWNj, SIZEj, LEVj, and INT_SALESj. For every country i, DISCij is the disclosure index for
rm j calculated as described in Section 4, CORPGOVij is the corporate governance index for rm j calculated as described in
Section 4, REGi is one of the indexes for the regulatory or institutional environment of country i (ENFOR_ANTIDIRi is the enforced antidirector index and LAW_ORDERi is the rule of law of country i which are both described in Section 4), SIZEij is the
total sales in millions of Euros of rm j, ROAij is the return on assets dened as net income per total book value of assets for
rm j, OWNij is the ownership structure dened as the percentage of tradable shares not hold by large shareholders for rm
j, LEVij is the leverage dened as year-end total debt per common equity book value for rm j, CROSSLISTij is the number of
countries in which rm j is listed. INT_SALESij is the percentage of international sales of all sales of a rm j. All variables except
of the country-level REG are windsorized at the two per cent level at both extremes. We use above/below mean dichotomous
variables in the interactions.

Signicant at the 0.1 level (two-sided t-tests).
**
Signicant at the 0.05 level (two-sided t-tests).
***
Signicant at the 0.01 level (two-sided t-tests).

63

J. Ernstberger, M. Grning / J. Account. Public Policy 32 (2013) 5067

Table 6
General endogeneity tests.

Sargan statistics
Basmann statistics
Durbin statistics
Wu-Hausman statictics

REG = ENFOR_ANTIDIR

REG = LAW_ORDER

1.42
1.39
1.57
1.53

4.00
3.91
0.07
0.06

Notes: The table reports the statistics of the overidentication and endogeneity tests for the models shown in Table 4. The
instrumental variables are the natural logarithm of INT_SALESij, INV_OPPij and the country mean of CORPGOVi where
INT_SALESij is the percentage of international sales of all sales of a rm j, INV_OPPij is the investment opportunities of rm j
measured as the rms 3 year annual growth rate of net sales and CORPGOVi is the mean of the corporate governance index
described in Section 4 of all rms in country i. All variables except of the country-level REGi and CORPGOVi are windsorized at
the 2% level at both extremes.

Signicant at the 0.1 level (two-sided t-tests).

Signicant at the 0.05 level (two-sided t-tests).

Signicant at the 0.01 level (two-sided t-tests).

5.2. Robustness tests

We perform several sensitivity analyses to test the robustness of our ndings. Table 1 indicates that
our sample is biased toward large rms because the corporate governance index is available only for
rms that received ISS ratings from the RMG. To address a potential sample selection bias, we re-run
our regressions using the two-step methodology of Heckman (1978, 1979). The population of listed
rms in this new regression consists of the 7206 rms that are included in the Worldscope country
indices of active rms. We use the natural logarithm of sales, leverage, international sales, which
are dened as its ratio of foreign sales to total sales, and ownership structure as determinants in
the selection equation, and we perform a Heckman correction for our regression models. The results
reported in Table 5 indicate that a sample selection error occurs because the ownership structure of
rms in our sample differs from the ownership structure of the population of all listed rms. Nevertheless, the Heckman-corrected regression that is reported in Table 5 demonstrates that the results
that we obtained in this corrected regression are structurally identical to the non-corrected ndings
that are listed in Table 4. Therefore, our ndings are considered to be robust against sample selection
bias.
Corporate governance arrangements are deliberately determined by a rms management, investors or board. If the decision to implement a specic corporate governance arrangement is inuenced
by factors that we do not control for in our regression, an endogeneity bias results from the omission
of these factors. Moreover, the corporate governance arrangements and the disclosure level may be
determined simultaneously; thus, each of these features could affect the other, a phenomenon that
might also produce an endogeneity bias. An inspection of the development of the corporate governance index over time for several rms reveals that this index appears to be fairly stable, which mitigates endogeneity concerns. In addition, we use an instrumental variable 2SLS approach to test for the
endogeneity that results from either omitted variables or simultaneous causality. In accordance with
Durnev and Kim (2005), we use investment opportunities (measured by the 3-year sales growth), the
countries governance regime (measured as the country mean of all covered rms corporate governance), the natural logarithm of a rms international sales and the ownership structure as the instrumental variables in this analysis. In this analysis, the Sargan and Basmann tests do not reveal any
indications of invalid instruments; moreover, the Durbin and Wu-Hausman tests do not provide evidence for endogeneity. All of the endogeneity statistics are provided in Table 6.
To examine whether the models are robust against varying specications, we consider alternative
dependent and independent proxies. We use the factor extracted from the natural logarithm of the
occurrences of content-relating N-grams, the sum of the occurrences of content-relating N-grams
and the sum of the natural logarithm of these occurrences as alternative disclosure measures. For
rm-level governance, we also use the factor that is extracted from the eight governance dimensions,
which are established in accordance with the approach of Brown and Caylor (2006). As alternative

64

J. Ernstberger, M. Grning / J. Account. Public Policy 32 (2013) 5067

enforced investor protection measures, we use the rst, second and third investor protection indices of
Bruno and Claessens (2010), which are recalculated from the revised anti-director rights index provided by Djankov et al. (2008), and the anti-self-dealing index, which is also provided by Djankov
et al. (2008). We also use various alternative specications for rm size, protability, shareholder dispersion, leverage and crosslisting. The results of these regression analyses (not reported) are structurally identical to the results that are reported in Section 5 of this paper.

6. Conclusions
The importance of corporate governance and disclosure for both academic research and public policy has increased in recent years. The previous studies of this topic examine the relationship between
corporate governance and disclosure in single-country settings and assume that a universal link exists
between these two concepts that is unaffected by the legal environment. In our study, we rely on the
organizational approach to corporate governance, which considers the interactions and contingencies
that impact the effectiveness of corporate governance arrangements. In particular, we investigate the
interaction of corporate governance arrangements with countries legal environments with respect to
effects on disclosure.
In our analysis, we use a sample of listed rms from 16 European countries for the year 2007. We
measure disclosure with a new, computerized approach that uses articial intelligence; this approach
facilitates a comprehensive and objective measurement of rms disclosure levels. Institutional governance is proxied by a comprehensive index of 52 rm-specic variables. We nd that the impact of
corporate governance on disclosure is particularly pronounced in weak legal environments. Thus,
our results provide evidence for a substitutive relationship between rm-level and country-level governance with respect to effects on corporate disclosure. This nding can be regarded as one reason for
the mixed evidence in prior studies investigating the link between corporate governance and disclosure. Moreover, the results of this investigation are consistent with the ndings of prior studies, which
document a substitutive relationship between corporate governance and the legal environment with
respect to either corporate performance or the cost of equity capital.
We interpret our ndings to support the bonding hypotheses that rms in weak legal environments opt into stronger corporate governance arrangements. A stronger corporate governance has a
more pronounced disclosure increasing effect in weak legal environments. We argue that rms respond to a weak legal environment by improving disclosure in order to gain legitimation and thus
to be competitive in capital markets. Our study implies that regulatory requirements to some extent
substitute for voluntary corporate governance arrangements.
This study may be of interest to regulators, policy makers and practitioners because it provides insight regarding the question of how a countrys legal environment may inuence the effectiveness of
rm-level corporate governance mechanisms. Our results suggest that greater investor protection may
curb the positive impact of corporate governance mechanisms on corporate disclosure. We argue that
policy makers might mitigate the impact of substitutions by using soft law to promulgate new (e.g.
comply or explain-) principles in lieu of enforcing these principles through statutory law. Public policy
initiatives with respect to countries governance arrangements could allow the managers, investors
and other stakeholders of rms to implement the most suitable corporate governance arrangements
for their rms and avoid the possible negative effects of substitutions.
We recognize that our study is subject to certain caveats. First, in this study, we only focus on a
broad measure of annual report disclosure. Although the annual report is the major disclosure instrument for most companies (e.g., Guthrie et al., 2004), rms also disclose information through other
channels (e.g., through interim nancial statements, ad hoc disclosures, conference calls, or internet-based reporting). Future research could explore whether rms follow a consistent disclosure policy or whether different disclosure instruments respond differently to various governance
mechanisms at the rm and country levels. Our country-level governance measure does not explicitly
distinguish between hard and soft enforcement of corporate governance measures. Purely voluntary
governance arrangements and arrangements due to comply-or-explain requirements allow rms to
decide on the level of corporate governance and thus also involve some discretion. It might be

J. Ernstberger, M. Grning / J. Account. Public Policy 32 (2013) 5067

65

interesting to investigate which of rms governance arrangements are required by law, which fall
within the realm of comply or explain and how much is purely voluntary. We leave it to future research to categorize countries governance regulation with respect to hard and soft law and investigate
how they interact with corporate governance, and rm disclosure.
Second, we use a sample of European rms in our study because the EUs IAS Regulation and the EU
Transparency Directive ensure that the mandatory disclosure requirements are comparable among the
sample rms. However, we know nothing about the potential variance in the relationship between
governance and disclosure in different regions of the world. Our AIMD measure of disclosure, considers all the disclosure of an annual report and does not explicitly distinguish between mandatory and
voluntary disclosure. Further research could examine the impact of mandatory disclosure requirements on the association of legal environment, corporate governance and disclosure.
Finally, a reliance on the ISS corporate governance rating may introduce considerable measurement
error because the reliability of commercial governance ratings is subject to heavy criticism (e.g.,
Daines et al., 2010). Furthermore, Aguilera and Desender (2012) criticize the use of governance ratings
from a validity perspective. Thus, future research should develop and test new measures for corporate
governance to address these issues.
Acknowledgements
We are grateful to Risk Metrics Group for providing us with Corporate Governance data. For helpful
comments and suggestions, we like to thank Alnoor Bhimani, Carolyn M. Callahan, Salvador Carmona,
Steve Dempsey, Igor Goncharov, Lawrence A. Gordon, Ole-Christian Hope, Susan B. Hughes, Martin P.
Loeb, Steven Monahan, two anonymous reviewers, and participants at the EAA Annual Congress 2012,
the AAA Annual Meeting 2012 and the 1st JAPP conference 2012. We thank Polina Koynova and Katharina Sikora for their help in data collection. All remaining errors are ours.
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