The current issue and full text archive of this journal is available at www.emeraldinsight.com/2042-1168.htm JAEE 3,1 Corporate governance, reporting quality, and firm value: evidence from Indonesia Ferdinand Siagian College of Business, Minnesota State University, Mankato, Minnesota, USA, and Sylvia V Siregar and Yan Rahadian Accounting Department, University of Indonesia, Jawa Barat, Indonesia Abstract Purpose – The purpose of this paper is to investigate whether corporate governance practices and the quality of reporting are associated with firm value for public firms in Indonesia Design/methodology/approach – The authors hypothesize that there are positive associations between firm value and corporate governance practices and reporting quality For the authors’ proxies for corporate governance and reporting quality they develop two new indices First, they develop a corporate governance index (the CGI) to measure corporate governance practices by Indonesian firms Second, they develop a reporting quality index (the RQI) to measure the firms’ quality of reporting and disclosures To examine the associations the authors run multivariate regressions of their proxies for firm value on the two indices Findings – Consistent with the first hypothesis, the paper finds positive associations between corporate governance and different proxies of firm value These findings suggest that firms that implement better corporate governance have higher values Contrary to the second hypothesis, the paper finds negative associations between reporting quality and the proxies for firm value These findings indicate that lower value firms tend to disclose more information that is consistent with the P3LKE than higher value firms Research limitations/implications – The results suggest that corporate governance practice by Indonesian public firms is value relevant and therefore, should provide incentives to the firms to improve their governance This shows that the Indonesian government’s efforts to promote corporate governance provide benefits to publicly traded firms The results also indicate that firms with low values are more likely to disclose information that is consistent with the P3LKE This warrants further research because this finding is inconsistent with the contention that more disclosures should result in higher value Practical implications – The authority needs to put more efforts in promoting good corporate governance implementations and making sure that public firms improve their disclosures and reporting quality in order to provide benefits to the users of financial information Originality/value – Corporate governance index for public firms is not readily available in Indonesia Therefore, the authors develop an index to measure corporate governance implementations by Indonesian public firms To the authors’ knowledge, this is the first paper that develops an index to measure adherence to the P3LKE, which is a comprehensive measure of the quality of reporting Keywords Corporate governance, Disclosure, Reporting, Firm value, Quality, Performance, Performance management, Indonesia Paper type Research paper Journal of Accounting in Emerging Economies Vol No 1, 2013 pp 4-20 r Emerald Group Publishing Limited 2042-1168 DOI 10.1108/20440831311287673 Introduction This paper investigates whether corporate governance and the quality of reporting are associated with firm value Specifically, we test the association between firms corporate governance index (CGI) scores and their values that we measure using price-to-book value (PBV), Tobin’s Q, and return on assets (ROA) We also investigate the association between firms reporting quality index (RQI) scores and their values After the financial crisis in 1997 and 1998, the Indonesian Government initiated several efforts to improve corporate governance and reporting quality For example, the government through the capital market authority (BAPEPAM) promotes corporate governance by requiring independent board members and an audit committee that is chaired by an independent director (Siagian and Tresnaningsih, 2011) In 2002, the BAPEPAM issued the P3LKE that provides guidance about what to report and disclose in the financial statements for firms that are publicly traded in the JSX (BAPEPAM, 2002) The objectives are to improve firm performance and the quality of financial statements reported to the public Separation of ownership and control creates agency problems within the firms ( Jensen and Meckling, 1976; Fama and Jensen, 1983) As a result, managers may take actions that are not for the best interest of the shareholders Because the shareholders are usually dispersed and not have the capabilities to directly monitor and control managers’ actions, performance of the firm may be harmed Moreover, the managers have better information about the firm than the shareholders This asymmetry of information costs the shareholders because they cannot make informed decisions A set of governance mechanisms can be implemented to mitigate the agency problems The purpose of the corporate governance is to make sure that managers will act for the best interests of the shareholders In addition, it can force the managers to disclose important information so that the information asymmetry between the managers and shareholders can be minimized We hypothesize that firms that implement good corporate governance and have more disclosures will have less agency problems and will have higher values To test our hypothesis we develop two indices in this study The first index is the CGI that we use to measure corporate governance implementations in a public firm This index is divided into five parts: rights of shareholders, equal treatment of shareholders, role of stakeholders, disclosure and transparency, and board responsibilities The second index is a reporting and disclosure index (the RQI) that we develop to measure firm’s adherence to the Financial Reporting and Disclosure Guidance (the P3LKE) issued by the Indonesian Capital Market Regulatory Body (the BAPEPAM) We consider firms that adhere to the P3LKE as firms with high-quality report Using a sample of 125 firms that were traded in the JSX we find that corporate governance is positively associated with firm value suggesting that firms with higher CGI score have higher value The results are consistent for all three proxies of firm value that we use in our tests In our sensitivity test, we use weighted CGI by putting different weights on corporate governance practices according to their importance We find that the results are consistent with our main test using the non-weighted scores We find that RQI score is negatively associated with all proxies for firm value These findings not support our hypothesis that predicts positive association between reporting quality and firm value One possible explanation is that firms with low values disclose more information that is consistent with the P3LKE because they try to improve their values by emitting more information to the market This inconsistent finding warrants further research to examine why high-value firms disclose less information that is consistent with the P3LKE We make two contributions to the literature First, we contribute to the literature by showing that corporate governance is positively associated with firm value for public Corporate governance JAEE 3,1 firms in Indonesia The use of CGI in Indonesia is still rare because such index for public firms is not readily available By developing a CGI for public firms we are able to measure corporate governance implementations by Indonesian firms Second, to our knowledge, compliance to the P3LKE has not been studied before and we are the first to develop a checklist to measure firm adherence to the guidance This index allows us to comprehensively evaluate the quality of reporting for our sample firms Other studies use other proxies for reporting quality such as earnings management or discretionary accruals (Xie et al., 2003), conservatism (Mayangsari, 2003), and restatement of financial reports (Agrawal and Chadha, 2004) Different from those studies, we use a comprehensive reporting index issued by the capital market authority We provide new evidence that the guidance is more likely to be followed by firms with low value that is shown by a negative association between the RQI score and firm value The remainder of the paper is organized as follows We draw the theories about the subjects and develop the hypotheses in Section Section describes the research method, sample selection procedure, and descriptive statistics We present the results of the tests in Section and conclude the study in Section Literature review and hypotheses development Separation of ownership and control in firms creates agency problems ( Jensen and Meckling, 1976; Fama and Jensen, 1983) Managers who are involved in firm’s daily operations have superior information than the shareholders who are usually dispersed Because of the dispersion the shareholders not have the ability to directly observe the managers This asymmetry of information creates problems if the managers’ objectives are not aligned with the objectives of the shareholders There is a potential moral hazard problem that the managers will pursue their own interests at the expense of the shareholders Because of information asymmetry the shareholders cannot accurately evaluate the actual performance of the managers Corporate governance represents a set of mechanisms that are intended to reduce agency risk that result from information asymmetry (Asbaugh et al., 2004) They state that corporate governance allows for better monitoring and control so that the managers are more likely to make decisions that are for the best interest of the shareholders such as investing in positive NPV projects It also improves protection to the shareholders by minimizing opportunistic behavior of the managers that decreases firm value Therefore, firms that implement corporate governance are more likely to have a higher firm value Studies find results that support the contention that corporate governance improves firm value Durnev and Kim (2005) find firms with higher governance and transparency rankings are valued higher in stock markets Asbaugh et al (2004) find that firms with better governance have lower cost of equity capital resulting in higher firm value Gompers et al (2003) analyze the empirical relationship of a governance index with corporate performance and find that corporate governance is strongly correlated with stock returns during the 1990s They find that firms with stronger shareholder rights have higher firm value, higher profits, and higher sales growth Mitton (2002) finds that corporate governance positively affects firm performance during Asian crisis in five East Asian countries Klapper and Love (2002) use corporate governance rank data of firms in 14 developing countries and find evidence that corporate governance is positively related to operating performance and market value Consistent with the above studies Alves and Mendes (2004) also find positive impact of corporate governance on stock returns Beiner et al (2006) find that corporate governance positively affect firm value but they also find reverse causality; higher value firms adopt better corporate governance practices They construct a broad CGI based on the Swiss Code of Best Practice and find result that supports the hypothesis of a positive relationship between firm-specific corporate governance and Tobin’s Q They find a one standard deviation increase in the CGI causes an increase of the market capitalization by at least 12 percent of a company’s book asset value Black et al (2006) also develop a CGI for all public firms in Korea for year 2001 and find evidence that higher CGI is associated with higher Tobin’s Q The above studies show that corporate governance provides benefits to the shareholders It improves the quality and independence of the board of directors and the committees and puts more monitoring and controls on the managers As a result, the managers are more likely to take actions that increase firm value We hypothesize the following (in alternative format): H1 Firms with better corporate governance will have a higher value Asymmetry of information creates agency problems and increases the risks faced by the shareholders To minimize the asymmetry of information, firms provide information and disclosure through financial reports that includes financial statements, notes to financial statements, and management discussion and analysis In addition, firms release information through voluntary disclosures and the shareholders can obtain information about firms through news and information intermediaries such as financial analysts Nagar et al (2003) argue that managers avoid disclosing private information because such disclosure reduces their private control benefits This is consistent with the opportunistic behavior of the managers due to various motives They further argue that disclosure problem is an important concern for investors and has a key role in capital market allocation and corporate governance decisions Healy and Palepu (2000) state that corporate disclosure is very important for the functioning of the capital market Managers have better information than the shareholders and information differences give rise to “lemons” problem that can harm the functioning of capital market One possible solution to this problem is information intermediaries that provide information to minimize the asymmetry of information Another solution is regulation such as accounting standards Regulators are concerned about the investors and issue regulations that allow firms to provide sufficient information to the shareholders In 2002, the BAPEPAM issued the P3LKE that provides a list of items that need to be reported and disclosed by firms that are publicly traded in the JSX The purpose is to improve reporting quality that will result in better information for the users of the financial statements Agency theory states that managers not always act in the best interest of the shareholders More transparency may mitigate some of the agency problems faced by the firms Shareholders will be more informed and information gap between the shareholders and the managers can be reduced Investors will perceive lower investment risk that would lead to a higher firm value Better disclosures will also help the board of directors to perform its oversight function and various board committees can work more effectively All these benefits will result in a higher firm value Several studies have examined the benefits of disclosures Botosan (1997) finds that greater disclosure is associated with a lower cost of equity capital for firms that attract low analyst following This suggests that disclosure quality positively affects firm value Corporate governance JAEE 3,1 Lambert et al (2007) show theoretically that information quality directly influences firms’ cost of capital and that improvements in information quality unambiguously reduce nondiversifiable risk Sengupta (1998) finds lower cost of debt in firms with better disclosures Healy et al (1999) investigate whether firms receive benefit from higher voluntary disclosure by examining changes in capital market factors associated with increases in analyst disclosure ratings They find that the expanded voluntary disclosure is accompanied by improved stock performance, increased institutional ownership, analyst following, and stock liquidity even after controlling for contemporaneous changes in firm characteristics including earnings performance, size, and risk Gelb and Zarowin (2000) find evidence that disclosure quality provides information benefit to the stock market and affects stock price positively They find that enhanced disclosure results in stock prices that are more informative about future earnings Mitton (2002) find that during the Asian Crisis in 1997-1998 firms with high quality of disclosures show better performance than firms with lower quality He finds that firms with higher disclosure quality have significantly better stock price performance Baek et al (2004) also find that during Korean crisis in 1997 firms with high disclosure quality experienced the lowest stock price decline These studies support the contention that disclosure is positively associated with firm value Because disclosures help in mitigating various agency problems, reducing investment risk, and reducing cost of capital, we predict that firms with better disclosures will have higher value We hypothesize the following (in alternative format): H2 Firms with more disclosures will have a higher value Research design 3.1 Sample selection Our sample consists of 125 firms that are traded in the JSX in 2003 and 2004 that submitted a P3LKE report to the BAPEPAM and had available CGI data We obtain the financial data from financial reports in the JSX database We present the sample selection process in Table I From the JSX database we were able to collect 411 firm-year of RQI data and 267 firm-year of CGI data For the RQI, we collect the data from firms’ financial reports and evaluate individually the quality of disclosure according to the P3LKE We also collect corporate governance data that are only available for some of the listed firms The intersection of the two groups of firms results in 248 firm-year Our data are not balance panel because not all firms have data for both years We exclude observations with negative book value of equity (25 observations), extreme outliers Total Firm-year Table I Sample selection Total firms or observations with RQI data Total firms or observations with CGI data Total firms or observation with both data Total observations with negative book value Total observations with incomplete financial data Total observation that are considered outliers Total firm-year in the final sample 411 267 248 (25) (20) (15) 188 (15 observations), and observations with incomplete financial data (20 observations) Our final sample includes 188 firm-year of data 3.2 Empirical test Our first hypothesis predicts that corporate governance is positively associated with firm value Our second hypothesis predicts positive association between reporting quality and firm value In our main test, we measure firm value using market to book value ratio (PBV)[1] We regress PBV on CGI score and RQI score while controlling for variables that may affect firm value Miller (2005) argues that PBV ratio is an appropriate measure of company value Higher PBV ratio is perceived by the market as an indicator of an ability to give higher economic profit We calculate PBV by dividing price per share by book value per share The CGI score is calculated based on a CGI that we develop using the corporate governance checklists from IICD, Num and Lam (2006), Standard & Poor’s and National University of Singapore (2004) checklist, and the OECD principles[2] This checklist is completed using secondary data from the financial statements The questions are divided into five groups according to the OECD principles: rights of shareholders, equal treatment of shareholders, role of stakeholders, disclosure and transparency, and board responsibilities (OECD, 2004) For the main test we not put any weight on the group[3] For the RQI, we follow the guidance issued by the BAPEPAM The BAPEPAM issued 13 different guidance based on industry, so we develop 13 different checklists with approximately 650 items in each checklist depending on the industry, which makes it a comprehensive proxy to measure quality of reporting[4] For each item, we read the notes to financial statements to determine whether an item on the checklist is reported and disclosed There are three possible answers to the questions in the checklist: disclosed, not disclosed, or not applicable (N/A) The score is calculated as the ratio of the total number of applicable items that are disclosed and the total number of items that are applicable to that firm (total number of items – N/A) as follows: Score ¼ disclosed ð items À N =AÞ For example, if a firm has 500 items and discloses all items and does not have ten items out of a total of 650 items on the list, it will score 500/(650À10) ¼ 0.78 It means the firms does not disclose a total of 140 items and loses 0.22 disclosure points In calculating the RQI score we realize the possibility of bias because of the difficulty in identifying whether an item that is not disclosed or is not applicable For example, P3LKE requires disclosure for prepaid expense We will not observe any disclosure about prepaid expense in the financial report of firms that not have a prepaid expense account and of firms that not want to disclose their prepaid expenses In the first case, the score would not be negatively affected by not disclosing prepaid expense because the firm does not have the account In the second case, the firm should get a lower score because of the lower numerator We include several control variables that may affect firm value in our regressions We specifically control for firm size, growth, and leverage We control for size because it is expected to be associated with firm value (Yermack, 1996) We include growth as an explanatory variable because firm value depends on future investment Corporate governance JAEE 3,1 10 opportunities (Myers, 1977; Smith and Watts, 1992; Yermack, 1996) Finally, we also control for the amount of leverage because it may have significant impact on firm value (Ross, 1977) Ross suggests that the value of a firm will increase with leverage because increasing leverage increases the market’s perception about value Stulz (1990) argues that debt can have both positive and negative impact on firm value We use debt-toequity ratio as the proxy for firm leverage We estimate the following regression to test our hypothesis: FIRMVALit ¼ a0 ỵ a1 CGIit ỵ a2 RQIit ỵ a3 SIZEit þ a4 GROWTHit þ a5 LEVit þ eit where FIRMVAL is the firm value that we measure using PBV, CGI, RQI, SIZE, GROWTH, LEV Our hypotheses predict that after controlling for variables that may affect firm value there is a positive association between CGI score and firm value (a140) and between RQI score and firm value (a240) Table II presents the descriptive statistics for the variables that we use in our tests Panel A shows that the average of PBV is 1.307 with a high standard deviation (1.157) This indicates that the PBV of the firms in our sample varies considerably The average CGI score is 0.670 with relatively low variation (standard deviations ¼ 0.072) RQI score is also relatively small with an average of only 0.629 with standard deviation of 0.132 Panel B of Table II shows an improvement in the average of the CGI score from 0.666 in 2003 to 0.676 in 2004 However, the difference is not statistically significant We also find an improvement in the score average of RQI from 0.623 in 2003 to 0.636 in 2004 However, our mean-difference test shows that the improvement is not statistically significant We believe that there is still a room for improvement for both the CGI and RQI scores Based on industry, we find improvements in RQI scores from 2003 to 2004 in investment, toll road, hotels, restaurants, transportation, and farm industries and deteriorations in manufacturing, construction, trade, real estate, and forestry (not reported) The average growth in the past three years is 11.3 percent with the average size of about 71.8 million The average debt-to-equity ratio is 1.752 that varies significantly with standard deviation of 2.66 Empirical results In this section we report the results of our empirical tests We first report the main results then we discuss the sensitivity tests using alternative proxies Table III presents the Pearson correlation for variables in our main model First of all, all our proxies for firm value show significant positive correlations to each other This suggests that the three proxies are appropriate to represent firm value The correlation table shows that PBV is positively correlated with the CGI score, firm size, and leverage This suggests that firms that implement corporate governance, larger firms, and firms with high debt tend to have higher market value We find that RQI and PBV are negatively correlated This indicates that firms with high RQI scores tend to be firms with low PBV and vice versa We find significant positive correlation between corporate governance and reporting quality at 10 percent level This suggests that firms that implement corporate governance tend to have higher RQI scores RQI is positively correlated with firm size suggesting that large firms tend to adhere to the P3LKE more Corporate SD 0.875 0.957 0.030 0.665 0.600 27.258 0.088 1.065 Median 0.657 0.597 0.675 0.627 0.140 0.225 À0.162 0.538 0.369 23.874 (0.696) 0.020 Minimum 0.538 0.389 0.541 0.369 0.859 0.907 0.858 0.916 6.790 3.695 0.255 0.859 0.916 31.661 0.913 18.490 Maximum FIRMVALit ẳ a0 ỵ a1 CGIit ỵ a2 RQIit ỵ a3 SIZEit ỵ a4 GROWTHit ỵ a5 LEVit ỵ eit Notes: FIRMVAL, firm value that we measure using PBV, Tobin’s Q, and ROA; PBV, price to book value ratio; TQ ¼ Tobin’s Q; ROA, return on assets; CGI, non-weighted corporate governance index score; RQI, reporting quality index score; SIZE, log total assets; GROWTH, average growth of sales in the last three years; LEV, debt-to-equity ratio Panel A: descriptive statistics for all variables for both years PBV 1.307 1.157 TQ 1.110 0.558 ROA 0.043 0.072 CGI 0.670 0.072 RQI 0.629 0.132 SIZE 27.329 1.605 GROWTH 0.113 0.215 LEV 1.768 2.661 Panel B: descriptive statistics for CGI and RQI by year Year ¼ 2003 CGI 0.666 0.068 RQI 0.623 0.133 Year ¼ 2004 CGI 0.676 0.077 RQI 0.636 0.131 Mean Corporate governance 11 Table II Descriptive statistics of variables in the regression JAEE 3,1 governance is also positively correlated with firm size This finding indicates that large firms tend to implement corporate governance To test our hypotheses we regress PBV on RQI and CGI while controlling for variables that are known to affect firm value We present the regression result in Table IV TQ ROA CGI RQI SIZE GROWTH LEV 0.84 (0.00)*** 0.41 (0.00)*** 0.46 (0.00)*** 0.28 (0.00)*** 0.29 (0.00)*** 0.31 (0.00)*** À0.13 (0.08)* À0.14 (0.05)* À0.08 (0.28) 0.12 (0.09)* 0.28 (0.00)*** 0.29 (0.00)*** 0.18 (0.02)** 0.51 (0.00)*** 0.17 (0.02)** 0.08 (0.25) 0.09 (0.24) 0.28 (0.00)*** À0.01 (0.88) 0.07 (0.36) À0.00 (0.94) 0.26 (0.00)*** À0.01 (0.89) À0.23 (0.00)*** À0.02 (0.76) 0.02 (0.75) 0.08 (0.28) À0.06 (0.44) 12 PBV TQ ROA CGI RQI SIZE GROWTH Table III Correlation of variables in the model Notes: n ¼ 192 FIRMVAL, firm value that we measure using PBV; PBV, price to book value ratio; RQI, reporting quality index score; CGI, unweighted corporate governance index score; SIZE, log total assets; GROWTH, average growth of sales in the last three years; LEV, debt-to-equity ratio ***,**,*Correlations significant at 0.01, 0.05, and 0.1 levels, respectively FIRMVALit ẳ a0 ỵ a1 CGIit ỵ a2 RQIit ỵ a3 SIZEit ỵ a4 GROWTHit þ a5 LEVit þ eit Variable Predicted sign n Intercept CGI ỵ RQI ỵ SIZE GROWTH LEV R2 Adjusted R2 Prob (F-statistic) Table IV Regression results using PBV as the dependent variable and un-weighted CGI as the independent variable PBV 188 À3.375 (0.011)** 3.700 (0.003)*** À1.735 (0.004)*** 0.110 (0.050)** 0.619 (0.083)* 0.115 (0.000)*** 0.208 0.186 0.000*** Notes: FIRMVAL, firm value that we measure using PBV, PBV, price to book value ratio; CGI, unweighted corporate governance index score; RQI, reporting quality index score; SIZE, log total assets; GROWTH, average growth of sales in the last three years; LEV, debt-to-equity ratio *Test variables significant at 10, 5, and percent levels, respectively FIRMVALit ẳ a0 ỵ a1 CGIit ỵ a2 RQIit ỵ a3 SIZEit ỵ a4 GROWTHit ỵ a5 LEVit ỵ eit Consistent with our first hypothesis we find positive association between PBV and CGI score The CGI coefficient (a1) is positive and significant at percent level suggesting that firms that implement better corporate governance are likely to have a higher value The magnitude of the slope (3.7) is large, suggesting that an increase in CGI score is associated with a large increase in firm value We find negative association between RQI and firm value This finding does not support our second hypothesis that predicts a positive association It suggests that firms with lower values tend to disclose more information that is consistent with the P3LKE One possible explanation is that low-value firms try to improve their values by disclosing more information that is consistent with the P3LKE It is possible that when the BAPEPAM issue the P3LKE, the managers of low-value firms would follow the guidance in order to influence market perception about the company On the other hand, high-value firms may not see this guidance as something important and therefore, may not follow the guidance in determining what information to disclose Consistent with prior studies, we find size, growth, and leverage affect firm value The coefficient for SIZE is positive and significant suggesting that larger firms tend to have higher values We also find positive and significant coefficient on GROWTH suggesting that firms with higher growth have higher values Leverage (LEV) is also positively associated with firm value suggesting that these firms seem to be able to benefit from their leverage 4.1 Sensitivity analysis 4.1.1 Tobin’s Q and ROA for firm value To test whether our results are sensitive to how we measure firm value, we also run multivariate regressions using Tobin’s Q and return on assets as our proxy for firm value Earlier work on firm performance has used Tobin’s Q as the measure of firm value (Demsetz and Lehn, 1985; Morck et al., 1988; Yermack, 1996; Gompers et al., 2003) We calculate Tobin’s Q by comparing the market value of a companys stock (MVEQ ỵ BVDEBT) and the value of a companys equity book value (BVEQ ỵ BVDEBT) MVEQ is market value of equity and BVEQ is book value of equity We use book value of debt (BVDEBT) for both the numerator and denominator because market value of debt is not available in Indonesia Table V shows the regression results of regressing Tobin’s Q and ROA on CGI, RQI, and the control variables The coefficients on CGI are positive and significant for both regressions using Tobin’s Q and ROA These results are consistent with the results of using PBV and support our first hypothesis that there is association between firm value and corporate governance even when we use different proxies for firm value Consistent with our main test the results show significant negative coefficients for RQI suggesting that firms with lower values tend to disclose more information that are consistent with the P3LKE In general, the results of our sensitivity tests support the results of the main test that finds a negative association between firm value and RQI and positive association between firm value and CGI Our results also show that the independent variables in our models explain the variation in ROA better than variation in PBV or Tobin’s Q The R2 for ROA regression is 0.244, which is higher than that for PBV (R2 ¼ 0.208) and for Tobin’s Q (R2 ¼ 0.159) 4.1.2 Weighted CGI In our main test we use the non-weighted CGI It means that we not put any weight on the five groups of items in the index In this sensitivity analysis, we follow the IICD recommendation and calculate the weighted CGI based on 20 percent weight on rights of shareholders, 15 percent weight on equal treatment of shareholders, 15 percent weight on role of stakeholders, 25 percent weight on disclosure and transparency, Corporate governance 13 JAEE 3,1 Variable Predicted sign n Intercept CGI 14 ỵ RQI ỵ SIZE GROWTH LEV R2 Adjusted R2 Prob (F-statistic) Table V Regression results using Tobin’s Q and ROA as dependent variables TQ ROA 188 À1.494 (0.023)** 1.572 (0.012)** À0.884 (0.003)*** 0.076 (0.007)*** 0.265 (0.136) À0.003 (0.862) 0.159 0.136 0.000*** 188 À0.189 (0.019)** 0.297 (0.000)*** À0.077 (0.033)** 0.003 (0.386) 0.095 (0.000)*** À0.006 (0.002)*** 0.243 0.223 0.000*** Notes: FIRMVAL, firm value that we measure using TQ and ROA; TQ, Tobin’s Q, ROA, return on assets; CGI, unweighted corporate governance index score; RQI, reporting quality index score; SIZE, log total assets; GROWTH, average growth of sales in the last three years; LEV, debt-to-equity ratio *Test variables significant at 10, 5, and percent levels, respectively FIRMVALit ¼ a0 ỵ a1 CGIit ỵ a2 RQIit ỵ a3 SIZEit þ a4 GROWTHit þ a5 LEVit þ eit and 25 percent weight on board responsibilities Table VI shows the result of regressing various proxies for firm value on the weighted CGI, RQI, and the control variables The tests using weighted CGI scores provide consistent results with the main tests that the CGI is positively associated with firm value and the RQI is negatively associated with firm value Consistent with our main tests, our tests using the weighted CGI also show that the independent variables in our models best explain the variation in ROA (R2 ¼ 0.238) Conclusions After the severe crisis in 1997 and 1998, the Indonesian Government initiated some efforts to improve corporate governance and reporting quality by Indonesian public firms One of the efforts by the government is the issuance of reporting and disclosure guidance by the BAPEPAM in 2002 In this study, we investigate whether corporate governance and reporting quality are associated with firm value We predict that the associations are positive To test our hypotheses we use PBV ratio, Tobin’s Q, and ROA as our measures for firm value Consistent with our hypothesis we find that corporate governance is positively associated with firm value and the results are consistent for the different proxies of firm value Firms that implement better corporate governance tend to have higher value We also find that size, growth, and leverage are positively associated with firm value suggesting that larger firms, firms with more investment opportunities or high growth, and firms that have higher leverage are likely to have higher values We find negative associations between reporting quality and our various proxies of firm value These findings suggest that firms that firms with lower values tend to disclose more information that adhere to the P3LKE One possible explanation is that Variable Predicted sign n Intercept CGI ỵ RQI ỵ SIZE GROWTH LEV R2 Adjusted R2 Probablity (F-statistic) PBV TQ ROA 188 À3.239 (0.015)** 3.474 (0.005)*** À1.710 (0.004)*** 0.112 (0.048)** 0.625 (0.081)* 0.116 (0.000)*** 0.205 0.183 0.000*** 188 À1.437 (0.029)** 1.370 (0.025)** À0.871 (0.003)*** 0.079 (0.005)*** 0.267 (0.135) À0.002 (0.866) 0.153 0.129 0.000*** 188 À0.178 (0.027)** 0.278 (0.000)*** À0.075 (0.038)** 0.003 (0.363) 0.096 (0.000)*** À0.006 (0.002)*** 0.238 0.217 0.000*** Notes: FIRMVAL, firm value that we measure using PBV, TQ, and ROA, PBV, price to book value ratio; TQ, Tobin’s Q; ROA, return on assets; CGI, weighted corporate governance index score; RQI, reporting quality index score; SIZE, log total assets; GROWTH, average growth of sales in the last three years; LEV, debt-to-equity ratio *Test variables significant at 10, 5, and percent levels, respectively FIRMVALit ẳ a0 ỵ a1 CGIit ỵ a2 RQIit þ a3 SIZEit þ a4 GROWTHit þ a5 LEVit þ eit firms that have high values may think that adherence to the P3LKE is not important and they not follow it when deciding about their disclosures On the other hand, lowvalue firms may see this as an opportunity to gain market value They have higher incentives to adhere to in order to improve their value We find slight and insignificant improvement in the CGI score from 2003 to 2004 Similarly, there is insignificant change in RQI score from 2003 to 2004 We believe that both the CGI and RQI scores can be improved in order to provide benefits to the shareholders We recommend that the Indonesian Government continue its efforts in promoting corporate governance and in improving reporting quality because of the benefits that they provide This study should become a trigger for the government to promote further the importance of high-quality reporting and corporate governance to Indonesian public firms We realize that there is a possibility of bias in calculating the RQI score because of the difficulties in deciding whether an item is not applicable or is applicable but is not disclosed Because in both situations the information is not observable we use judgment in deciding whether an item is not applicable or not disclosed For future research, it is important to investigate why firms with high value not disclose information that is required by the P3LKE It is also important to examine whether there are improvements in the CGI and RQI scores in the long run It is possible that public firms reacted to the issuance of the guidance in 2002 but fail to improve in the following years Finally, it is also important to see whether in the following years, the negative association between reporting quality and firm value change into positive that would suggest that adherence to the P3LKE is value relevant Corporate governance 15 Table VI Regression results using weighted CGI score as independent variable with different dependent variables JAEE 3,1 Notes For sensitivity test, we also use Tobin’s Q and ROA as our proxies for firm value We explain the detail in the sensitivity test section We report the CGI in Appendix 16 For sensitivity test we calculate the weighted CGI using different weights for different groups based on the IICD recommendation We show the detail calculation and the regression results using the weighted CGI in the sensitivity analysis section We not report the index in Appendix because of the length of the document even when we summarize the list A P3LKE for one industry consists of more than 100 pages References Agrawal, A and Chadha, S (2004), “Corporate governance and accounting scandals”, AFA 2004 San Diego Meetings, San Diego, CA, January Alves, C and Mendes, V (2004), “Corporate governance policy and company performance: the Portuguese case”, Corporate Governance: An International Review, Vol 12 No 3, pp 290-301 Asbaugh, H., Collins, D and LaFond, R (2004), “Corporate governance and the cost of equity capital”, working paper, University of Iowa and University of Wisconsin – Madison, Lowa city, Lowa, December Baek, J.-S., Kang, J.-K and Park, K.S (2004), “Corporate governance and firm value: evidence from the Korean financial crisis”, Journal of Financial Economics, Vol 71 No 2, pp 265-313 BAPEPAM (2002), Surat Edaran Bapepam Nomor No SE-02/PM/2002, BAPEPAM, Jakarta Beiner, S., Drobetz, W., Schmid, M and Zimmermann, H (2006), “An integrated framework of corporate governance 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Evidence from Korea”, Journal of Law, Economics & Organization, Vol 22 No 2, pp 366-413 Botosan, C.A (1997), “Disclosure level and the cost of equity capital”, The Accounting Review, Vol 72 No 3, pp 323-50 Demsetz, H and Lehn, K (1985), “The structure of corporate ownership: causes and consequences”, Journal of Political Economy, Vol 93 No 6, pp 1155-77 Durnev, A and Kim, E (2005), “To steal or not to steal: firm attributes, legal environment, and valuation”, Journal of Finance, Vol 60 No 3, pp 1461-93 Fama, E and Jensen, M (1983), “Separation of ownership and control”, Journal of Law and Economics, Vol 26 No 2, pp 301-25 Gelb, D and Zarowin, P (2000), “Corporate disclosure policy and informativeness stock prices”, working paper, New York University, New York, NY Gompers, P., Ishii, L and Metrick, A (2003), “Corporate governance and equity prices”, Quarterly Journal of Economics, Vol 118 No 1, pp 107-55 Healy, P and Palepu, K (2000), “A review of the empirical disclosure literature”, working paper, Harvard University, Cambridge, MA, December Healy, P., Hutton, A and Palepu, K (1999), “Stock performance and intermediation changes surrounding sustained increases in disclosure”, Contemporary Accounting Research, Vol 16 No 3, pp 485-520 Jensen, M and Meckling, W (1976), “Theory of the firm: managerial behavior, agency costs and ownership structure”, Journal of Financial Economics, Vol No 4, pp 305-60 Klapper, L and Love, I (2002), “Corporate governance, investor protection, and performance in emerging markets”, World Bank Policy Research Working Paper No 2818, World Bank, Washington, DC, April Lambert, R., Leuz, C and Verrecchia, R (2007), “Accounting information, disclosure, and the cost of capital”, Review of Finance, Vol 45 No 2, pp 385-420 Mayangsari, S (2003), “Analisis Pengaruh Independensi, Kualitas Audit, serta Mekanisme Corporate Governance terhadap Integritas Laporan Keuangan”, Makalah SNA VI, pp 1255-73 Miller, M.H (2005), “Is American corporate governance 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S (1977), “The determination of capital structure: the incentive-signalling approach”, The Bell Journal of Economics, Vol No 1, pp 23-40 Sengupta, P (1998), “Corporate disclosure quality and the cost of debt”, The Accounting Review, Vol 73 No 4, pp 459-74 Siagian, F and Tresnaningsih, E (2011), “The impact of independent directors and independent audit committees on earnings quality reported by Indonesian firms”, Asian Review of Accounting, Vol 19 No 3, pp 192-207 Smith, C and Watts, R (1992), “The investment opportunity set and corporate financing, dividend, and compensation policies”, Journal of Financial Economics, Vol 32 No 3, pp 263-92 Standard & Poor’s and National University of Singapore (2004), “Corporate governance disclosures in Indonesia: a study of LQ45 companies”, working paper, National University of Singapore, Singapore Stulz, R (1990), “Managerial discretion and optimal financing policies”, Journal of Financial Economics, Vol 26 No 1, pp 3-27 Xie, B., Davidson, W.N and DaDalt, P.J (2003), “Earnings management and corporate governance: the roles of the board and the audit committee”, Journal of Corporate Finance, Vol No 3, pp 295-316 Yermack, D (1996), “Higher market valuation for firms with a small board of directors”, Journal of Financial Economics, Vol 40 No 2, pp 185-211 Further reading Anderson, R and Reeb, D (2003), “Founding-family ownership and firm performance: evidence from the S&P 500”, Journal of Finance, Vol 58 No 3, pp 1301-28 Anderson, R., Mansi, S and Reeb, D (2003), “Founding family ownership and the agency cost of debt”, Journal of Financial Economics, Vol 68 No 2, pp 263-85 Holderness, C and Sheehan, D (1988), “The role of majority shareholders in publicly held corporations: an exploratory analysis”, Journal of Financial Economics, Vol 20, pp 317-46 Corporate governance 17 JAEE 3,1 18 Kole, S and Mulherin, J (1997), “The government as a shareholder: a case from the United States”, Journal of Law and Economics, Vol 60, pp 1-22 Leuz, C., Lins, K and Warnock, F (2006), “Do foreigners invest less in poorly governed firms?”, Review of Financial Studies, Vol 22 No 8, pp 3245-85 McConaughny, D., Matthews, C and Fialko, A (2001), “Founding family controlled firms: performance, risk, and value”, Journal of Small Business Management, Vol 39 No 1, pp 31-49 McConnel, J and Servaes, H (1990), “Additional evidence on equity ownership and corporate value”, Journal of Financial Economics, Vol 27 No 2, pp 595-612 Suehiro, A (2001), “Family business gone wrong? Ownership patterns and corporate performance in Thailand”, Working Paper No 19, Asian Development Bank Institute (ADBI), Tokyo, May Yammeesri, J and Lodh, S (2001), “The effects of ownership structure on firm performance: evidence from Thailand”, Hawaii International Conference on Business, Honolulu, Hawaii, May Appendix Table AI Corporate governance index Rights of shareholders Assess the quality of the notice to call the annual general shareholders’ meeting (RUPS) in the past one year Does the notice include: a) Appointment of directors and commissioners b) Appointment of auditors c) Dividend payment Is the decision on the remuneration of the board members (commissioners and directors) approved by the shareholders annually? Is the remuneration of the board (commissioner and director) presented individually? Do board members hold more than 25% of outstanding shares? Equitable treatment of shareholders Have there been any cases of insider trading involving the company directors and commissioners in the past two years? Does the company provide rationale/explanation for related-party transactions affecting the corporation? Has there been any non-compliance case regarding related-party transaction in the past two years? How many days in advance does the company send out the notice of general shareholders’ meeting? Role of stakeholders Does the company explicitly mention the safety and welfare of its employees? Does the company explicitly mention the role of key stakeholders such as customers or the community at large (or creditors or suppliers) Does the company explicitly mention environmental issues in its public communication? Does the company provide an ESOP (Employee Stock Option Plan) or other long-term employee incentive plan linked to shareholder value creation to employees? Disclosure and transparency Does the company have dispersed ownership structure? Assess the quality of financial report in each of the following areas: a) Financial performance b) Business operations and competitive position d) Basis of board remuneration e) Operating risk Is there any statement requesting the directors to report their transactions of company shares? Does the company have an internal audit operation established as a separate unit in the company? (continued) Are there any accounting qualifications in the audited financial statements apart from the qualification on uncertainty of situation? Does the company offer multiple channels of access to information, include: a) Company website b) Analyst briefing c) Press conference/press briefing Is the financial report disclosed in a timely manner? Does the company have a website disclosing up-to-date information, include: a) Business operation b) Financial statement c) Press release d) Shareholding structure e) Organization structure f) Corporate group structure g) Downloadable annual report h) Downloadable interim report i) Available of both Indonesian and English Does the company disclose fees paid to external auditors? 10 Does the company’s Annual Report include a section devoted to the company’s performance in implementing corporate governance principles? 11 If the complete list of BOC members is disclosed, is detailed information on each commissioner disclosed? 12 If the complete list of BOC members is disclosed, does it include details of previous employment? 13 If the complete list of BOC members is disclosed, are educational qualifications of commissioners disclosed? 14 If the complete list of BOC members is disclosed, are other commissionerships of commissioners disclosed? Responsibility of the board Does the company have its own written corporate governance rules that clearly describe its value system and board responsibility? Does the board of commissioner provide code of ethics or statement of business conduct to all directors and employees to ensure that they aware of and understand the code? Is there disclosure of company’s guidelines of matters that require approval by the board of commissioner? Does the annual report include report from board of commissioners? Does the company have a corporate vision/mission? Does the JSX/Bapepam have any evidence of non-compliance of the company with JSX/Bapepam rules and regulation over the last two years? Have board members participated in corporate governance training? Does the company report board meeting attendance of individual board of commissioner members? How many times board of commissioner meet in the calendar year? 10 Does the company report board meeting attendance of individual board of director members? 11 How many times board of director meet in the calendar year? 12 Among board of commissioners, how many are independent commissioners? 13 Is the board of commissioner chairman an independent commissioner? 14 Does the company state in its annual report the definition of independence? 15 What is the size of board of commissioner? 16 Is individual performance of BOC members evaluated? 17 Is criteria for evaluating board of director performance disclosed? 18 Does the board appoint independent committees with independent members to carry out various critical responsibilities such as: a) Audit committee b) Compensation committee c) Director or nomination committee (continued) Corporate governance 19 Table AI JAEE 3,1 20 Table AI 19 Assess the audit committee based on following criteria: a) Audit committee size b) Independent members c) Financial/accounting background d) Chairman 20 Is disclosure made of the basis of selection of audit committee members? 21 Does the company disclose audit committee report in the annual report 22 Assess the quality of the audit committee report in the annual report, include the following items: a) Frequency of meetings b) Internal control c) Management control d) Proposed auditors e) Financial report review f) Legal compliance g) Scope, results, and effectiveness of audits h) Adequacy of internal audit function i) Conclusion or opinion 23 Is the complete list of audit committee members disclosed? 24 Does the corporate secretary attend all board of directors meetings? 25 Does the company provide contact details for a specific investor relation person? 26 Does/did the company have an option scheme for top management? Corresponding author Ferdinand Siagian can be contacted at: fsiagian@maine.edu To purchase reprints of this article please e-mail: reprints@emeraldinsight.com Or visit our web site for further details: www.emeraldinsight.com/reprints Reproduced with permission of the copyright owner Further reproduction prohibited without permission  ...price-to-book value (PBV), Tobin’s Q, and return on assets (ROA) We also investigate the association between firms reporting quality index (RQI) scores and their values After the financial crisis... associated with firm value Our second hypothesis predicts positive association between reporting quality and firm value In our main test, we measure firm value using market to book value ratio (PBV)[1]... rankings are valued higher in stock markets Asbaugh et al (2004) find that firms with better governance have lower cost of equity capital resulting in higher firm value Gompers et al (2003) analyze